One of the harsh realities of starting your own company is that it may not survive. For various reasons, some companies experience financial trouble to the point where they can no longer pay their debts as they fall due.
In other words, they become insolvent.
Dealing with insolvency
One of the most common ways of dealing with an insolvent company is to appoint a Liquidator or Voluntary Administrator. However, this option has a number of disadvantages including:
- The costs involved can be significant.
- If a Liquidator is appointed, the company usually stops trading immediately (this is also common when a Voluntary Administrator is appointed).
- Even if the company can continue trading under voluntary administration, appointing a Voluntary Administrator will damage its relationship with suppliers and customers.
- A Liquidator can pursue claims against a director, including claims for insolvent trading.
- If the company is part of the building industry in Queensland, its building licence will most likely be immediately cancelled by the QBCC.
- The appointment may terminate, or be an event of default, under contracts.
- The appointment may lead to a secured creditor appointing a Receiver to the company.
- The company’s directors can still be held liable for personal guarantees.
Fortunately, there are other options to deal with financial trouble besides voluntary administration and liquidation.
Here are four alternatives to appointing a Liquidator or Voluntary Administrator that, depending on the circumstances, may give the company and its directors a more favourable result.
1. Negotiate settlements and/or payment plans
One option is to negotiate with creditors directly and come up with a settlement amount or payment plan you can both agree to. As you can imagine, this option works better when you have to negotiate with only a few key creditors (for example your bank, your landlord and the Australian Taxation Office).
At Pearce & Heers we can help you formulate a settlement offer or payment plan. We’ll then make the offer to your creditors. We deal with all matters differently depending on their relevant circumstances, however commonly we provide the offer or proposal for a payment plan along with details of a company’s financial position and the likely outcome if a Liquidator or Voluntary Administrator is appointed.
2. Contribute capital and/or obtain finance
If you do not know why your company is in trouble, or you have figured out the problem but not the solution, then this isn’t really an option at all. It would be like trying to fill a bucket with a hole in the bottom. You’d just be throwing away good money after bad.
But if you’ve plugged the hole, and just need the money to get your company back into the black, this may be worth considering.
However, if directors or their families are lending money to the company they should take security over the company at the time funds are advanced and register the security on the Personal Property Securities Register within required timeframes.
3. Develop turnaround and profit improvement strategies
A big factor in a company’s success is focussing on its key profitability drivers. Unfortunately, a lot of company directors fail to do this. In fact, some don’t even know the company’s break even point.
If this sounds familiar, then it’s time to start working on your business rather than in it. And your accountant of financial advisor can help. They can look at your revenue and expense profiles, suggest opportunities for profit improvement, help develop new customers or revenue streams, and look at marketing, technology and other initiatives. If there is a cost to pay to your accountant or financial advisor to obtain these services, often this will be the best money that can be spent as if things aren’t changed, then a company’s financial position is unlikely to change and it may in fact get worse.
4. Restructure or sell the company’s business
When a company can’t pay its creditors, entering into a formal insolvency appointment may seem inevitable. However, another option is to sell the company’s business and/or assets to another entity that can (hopefully) trade profitably in the future. Such a sale may occur prior to such an appointment being made. The sale could be to an unrelated entity of the company, or in certain appropriate circumstances to a related party.
Prior to any such sale it is important to get proper legal and accounting advice. The sale must be for fair value on commercial arm’s length terms and the proceeds of the sale must be dealt with in accordance with directors’ duties. If the sale doesn’t “stack up” as a proper commercial transaction (that is it is illegal phoenix activity) or the sale proceeds are dealt with inappropriately, it could lead to potential recovery claims by a Liquidator and even prosecution by the Australian Securities and Investments Commission.
There a number of advantages to selling a company’s business prior to an insolvency appointment including:
- Business continuity is maintained.
- Some or all employees and unpaid employee entitlements will be transferred to the purchaser.
- The directors, or the purchaser, can communicate with and manage dealings with clients, employees and suppliers.
- A sale prior to an insolvency appointment may be for an amount which is significantly greater than that which can be achieved by an Administrator or Liquidator. This is because the value of a business will generally decrease once an insolvency practitioner is appointed.
However, there are also some disadvantages or problems with such a sale including:
- The purchaser will need to fund not only the purchase price but also the initial trading until the cashflow of the business stabilises.
- If the vendor company goes into liquidation, and creditors’ debts aren’t paid, it could damage the business and cause other issues.
- There may be residual debts for directors, such as personal guarantees and Director Penalty liabilities to the ATO.
How we help clients who are referred to us
While every client who comes to us is facing financial difficulty of some sort, their situation is almost always unique. We never use a cookie-cutter approach and we treat each case differently depending on its circumstances.
However, to give our clients the best possible help and advice we follow four steps:
1. Review the client’s circumstances with both the client and their accountant or advisor.
2. Consider whether the business can trade profitably in the future, taking into account any steps already taken (or soon to be taken) to improve profitability.
3. Look at the risks associated with any future insolvency appointment.
4. Provide details of each option available including informal strategies or turnaround solutions, liquidation or voluntary administration.
As we said at the beginning, one of the harsh realities of starting a company is that it may not survive. But if you act quickly when your company is in financial trouble, then it stands a much better chance. The best approach is to take action at the first warning signs to give a company options and hopefully avoid dealing with insolvency.
So if you even suspect your company is in trouble, and want to consider every available option, don’t hesitate to get in touch with us.