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NOBODY PLANS ON FAILURE AND NOBODY PLANS NOT TO FAIL...

Entrepreneurs start businesses every day with high hopes and grand visions and accountants are often criticised for being the wet rag for looking on the negative or conservative side.

Drawing from our conservative side we set out below our list of reasons why businesses fail:

• Inadequate start-up capital
• No business plan
• The business started for the wrong reason e.g. to buy the owner a wage
• The target market was too small
• Poor product placement
• No market differentiation
• Poor or lazy management
• Slow to respond to changing markets
• Poor execution (of a great idea)
• Failing to reinvest profits
• Thinking too big, too soon
• Unhappy customers / poor customer service
• Not engaging experts to help
• Inadequate marketing execution
• Litigation.

Our office has seen multiple insolvencies that fit all of the above categories and, in most cases, business failure resulted in personal financial failure as well.

With this in mind, apart from great entrepreneurial skill, hours of planning and no small dose of luck, what do we advise business owners to do to help protect themselves from failure?

Structure your business - The easiest way to protect your personal finances from business creditors or from company-related litigation is to create a separate legal entity to operate your business venture.

Separating assets - Personal assets should be separated from business assets so that if the business gets into financial difficulty the personal assets are not at risk.

Where the risk of litigation is higher, the business entity should own little or no assets. In the case of a married couple where one of the individuals is a professional or has a high risk of being sued, a good compromise is for the family home to be owned by the low-risk spouse. This would provide asset protection whilst maintaining the capital gains tax main residence exemption.

Avoid the use of personal credit cards – We continue to witness the use of personal credit cards by company directors to finance non-viable businesses. Whilst this strategy may be extending the life of a business, it is usually short-lived and inevitably leads to the demise of the corporate entity and the personal insolvency of its directors.

Insurance - Adequate insurance cover is vital so that even if a person is found at fault, the insurance cover will satisfy any claim, rather than risking personal assets.

Avoid personal guarantees - A personal guarantee is when you undertake to be personally responsible for a debt, usually to support the debts of your business. Strategies to avoid personal guarantees include seeking an alternative supplier or capping the impact of the guarantee.

Lodge tax returns and SGC statements on time – With recent amendments to the Taxation Administration Act it is imperative that corporate entities lodge their tax returns and superannuation guarantee charge statements on time regardless of their ability to satisfy the associated PAYG and superannuation liabilities. The legislation appears to require that PAYG and superannuation be both unreported and unpaid prior to the issue of a director penalty notice for a director to be held personally liable for the statutory debts of a corporate entity.

Avoid insolvent trading – Company directors can be held personally liable for the debts of a corporate entity that is wound up if debts are incurred at a time when the Company was insolvent. To mitigate liability we recommend that:

• directors must keep themselves informed about the company’s financial affairs and regularly assess the company’s solvency
• directors should investigate financial difficulties immediately as soon as they identify concerns about the company’s financial viability
• directors should seek appropriate professional advice to help address the company’s financial difficulties and,
• directors should consider and act appropriately on the advice received, in a timely manner.

Reasons for liquidating a company and the benefits of doing so

Liquidating a company is a difficult decision for a director to make, but in many instances, it is the most responsible and reasonable decision a director can take.

The obvious reasons insolvent companies are liquidated are as follows:

• The company is insolvent and unable to pay its debts
• To avoid an insolvent trading claim (both civil and criminal) by ceasing to trade at an early stage
• To act in the interest of all stakeholders, particularly if there is a dispute between shareholders or directors
• To address the risk of a Directors’ Penalty Notice (“DPN”) for unpaid tax and super
• To end the stress of continued unprofitable trading and pressure from creditors seeking payment

The reasons solvent companies are liquidated are as follows:

• To fully wind up the affairs of a business at the end of its useful life
• To distribute retained profits tax effectively in a corporate reorganisation
• To bring about the dissolution of the company.

Benefits to directors

The liquidation of insolvent companies has some benefits which include:

• The ATO tends not to (but can) issue a DPN once a company is in liquidation
• Creditors’ focus is diverted from the director to the liquidator bringing immediate stress relief to the director
The director is relieved from the responsibility for the management of the company and is free to move on with life and earn an income to regain what has been lost in the failure of the company.

It is our impression that directors generally hang on too long to their insolvent companies, focussing on the negatives of the process, but a balanced assessment of a liquidation including the benefits we have highlighted above may make those difficult decisions easier.

Ways to improve the cash flow in your business

We say in our office that “revenue is for vanity and cash flow is for sanity” and we reflect on this when preparing business reviews for clients or advising directors whose companies are approaching insolvency.

With that in mind, the question that follows is how can businesses improve their cash flow. There is often a mix of factors contributing to poor cash flow and not all of them can be predicted or controlled; however, the following cash flow improvement strategies will help:

• Have a cash flow budget and reconcile monthly performance to it – don’t produce the budget just because the bank asked for it!
• If cash becomes tight, break the monthly budget down into weekly budgets and plan the release of payments and the commitment to expenditure based on it
• Negotiate delayed payment terms with suppliers to re-schedule when debts are paid facilitating better cash flow management
• Communicate payment problems to suppliers and clients, if necessary, so your company does not look reactionary to key stakeholders and damage the business brand and management reputation
• Apply to your banker for increased facilities that are affordable based on the new cash dynamic in your company (again, be in control, not reactionary)
• Sell more and bank more – change pricing models to stimulate demand, quit inventory that is tying up cash flow and increase efforts with debt collection
• Reduce overheads by examining any overhead line that is above 10% of sales and find a way to reduce it by 5% – wages and rent are the obvious low hanging fruit
• Seek help if you cannot manage – addressing the problem early avoids a temporary lack of liquidity turning into an insolvency crisis
• Review credit terms and credit worthiness – don’t sell to people who will not pay
• Reduce customer disputes by increased customer care – nothing causes a customer to slow pay more than receiving slow or inadequate goods and or services.

There are many ways to look at improving cash flow in a business, but the overriding message is that the management of cash flow is about being informed, staying in control and communicating effectively.

Options to deal with unmanageable personal debt

In our role we often see directors of failed companies struggle with massive personal debt following the failure of their businesses and the delay in transition into personal insolvency administration. People often view bankruptcy as a personal failure; however, bankruptcy is often the only means by which a director can regain control of their personal affairs and move on.

That said, bankruptcy should be avoided if workable compromises and arrangements with creditors can be made as bankruptcy is permanently recorded on the National Personal Insolvency Index – a database which may be accessed by anyone, including potential employers.

In our experience bankruptcy relieves a great deal of the stress and anxiety experienced by directors when faced with debt collection procedures and constant creditor pressure.

Prior to committing to bankruptcy we always recommend a director explore whether a Personal Insolvency Agreement (“PIA”) is workable. A PIA is a formal means to settle debts with unsecured creditors in a binding way to avoid bankruptcy. Often this involves a lump sum payment or by instalments through resources that are not otherwise available in bankruptcy.

For smaller estates, informal agreements with creditors or a Part IX Debt Agreements can achieve the same outcome as a PIA.

Should the Voluntary Administration convening period be extended?

One of the underlying objectives of a voluntary administration is that the affairs of the company are swiftly administered and that there is a quick transition through to Liquidation or Deed Administration.

This objective is sometimes interrupted by commercial imperatives to delay the transition of the company from Voluntary Administration into Liquidation or Deed Administration, often as a result of a Receiver being appointed to the company.

In many cases, a Court is called upon to extend the convening period and in the matter of Harrisons Pharmacy Pty Limited (Administrators Appointed) (Receivers and Managers Appointed) [2013] FCA 458 the factors the Court considered relevant were discussed.

The key conclusions were:

• Tasks of the Administrators – were the Administrators able to finalise their report to creditors required under s 439A(4) of the Corporations Act 2001 (“Act”) or to provide meaningful recommendations about the future of the company in the time available?
• Assets in the control of Receivers – where the Receivers have control of substantially all of the company assets and access to the books and records is restricted, investigations will take longer to complete.
• Complexity – where the administration involves large groups of entities, multiple locations of trading and differing administrative and ownership links, the investigations are more difficult to complete swiftly.
• Sale process – if a Receiver has commenced the marketing process for the sale of the businesses and the process is ongoing, to compromise that process may be to the detriment of the sale.
• Employees – where continuity of employment occurs and the continuation of the businesses as a going concern maximises the likelihood that the employees’ employment will be retained upon sale of the business.
• Trade creditors – the Receivers are continuing to pay trade creditors, leases and employee creditors during the receivership.
• Pre-appointment claims are not prejudiced and the continuation of the administration will not adversely affect any amount that unsecured creditors might receive by way of a distribution in the Liquidation.
• Difficulty of assessing the value of the businesses where a sale campaign is ongoing and may impact upon the recommendations to be made in the Administrator’s report pursuant to s439A(4) of the Act.
• Inability of the directors to provide a proposal for a Deed of Company Arrangement (“DOCA”) until the sale of assets has been finalised or the difficulties in the formulation of a DOCA due to an uncertainty of cash flows that will not become clear until the sale of assets has been completed.
• The attitude of creditors or the Creditors’ Committee after being notified of the application to the Court to extend the convening period.
• The attitude of ASIC. 
  

Each of the above factors helped the Court in this matter exercise its discretion to grant the extension of the convening period. In this matter, it was demonstrated that it was in the best interests of the creditors that the business is sold as a going concern, that a sale of the business was likely and that if the company were wound up immediately even the secured creditor would not be fully satisfied for their debt. 

The above factors must be considered by an administrator and/or creditor when called upon to consider an extension of the convening period and are equally relevant to a consideration of an adjournment to a proposal meeting in a voluntary administration as well.