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The insolvency tsunami

Held up by JobKeeper, deferrals and a range of other temporary financial assistance measures, the time will come where all of that winds down and a tsunami of small business insolvencies will likely follow. Can it be stopped?

The insolvency tsunami
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  • AFlores
  • October 08, 2020
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NOTE: This feature was written before the federal government extended temporary insolvency and bankruptcy protections until 31 December 2020. Due to the extension, the number of “zombie” companies can be expected to rise.

Small-business owners all over the country breathed a collective sigh of relief when Prime Minister Scott Morrison announced a wage subsidy program (originally estimated at $130 billion before future miscalculations emerged) to keep their business afloat during widespread shutdowns to save as much of the population as possible from the spread of COVID-19. Creating what would eventually be known as JobKeeper, the program was designed with the assumption that six months would be more than enough time for businesses to work out how to adjust and survive through the uncertain times of a pandemic.

But almost six months later, many small businesses are still struggling for survival even with JobKeeper, rent deferrals, government grants and a range of other measures. From the end of September onwards, with JobKeeper being phased down, rent relief agreements to an end and government grants being exhausted, the threat of insolvency looms for many business owners.

After everything they have already gone through this year, what can they do to survive the impending tsunami of insolvencies that is likely to follow?

Delaying the inevitable?

According to credit reporting agency CreditorWatch, the potential insolvency wave was something it could see even from the moment JobKeeper was announced. Its data revealed a 20 per cent decrease in the number of SMEs entering into administration from May to June, which is also 50 per cent fewer than in June 2019. It also showed a 17 per cent decrease in court actions and a 25 per cent decrease in payment defaults.

While these insights would traditionally indicate a healthy economy, CreditorWatch said policymakers should be concerned that a large number of businesses are simply delaying entering into administration.

Another telling sign SMEs are struggling to make ends meet is data that is showing significant payment delays. According to CreditorWatch, payments in June were overdue by an average of 49 days across all industries, 342 per cent higher than the June 2019 figure.

While at first glance a decrease in business administrations, court actions and defaults seems to indicate a rebounding economy, according to CreditorWatch chief executive Patrick Coghlan, when we take a deeper look, it’s clear that trouble is brewing and that businesses are struggling with significant cash flow issues.

“As a result, we’re likely to see a significant jump in the number of businesses coming out of hibernation and entering into administration in the coming months,” Mr Coghlan said.

He said the priority for the initial months of the pandemic has been to keep as many businesses as possible above water. But come September, support packages will be lifted and we’ll find that a substantial number of “zombie businesses” have been kept artificially afloat.

“Banks will not be prepared to prop unviable companies and nor should taxpayers,” Mr Coghlan added. “However, the government can ease the impending insolvency curve by lifting safe harbour measures gradually and forming an administration service to support the industry.”

Financial advice to the rescue

Ahead of the predicted uptick of insolvencies, the Australian Small Business and Family Enterprise Ombudsman, Kate Carnell, recommended a voucher program of up to $5,000 to enable small businesses to access financial advice.

Remarking on the final report from the Insolvency Practices Inquiry, she said the system needs to change dramatically so that small-business owners are given the chance to make important decisions about the future of their business.

One recommendation was to establish a Small Business Viability Review program where small-business owners experiencing significant financial stress can receive a voucher valued up to $5,000 to access financial advice.

“We know the sooner a small business seeks help, the more likely it is they can achieve a restructure or turnaround. But cash flow issues, compounded by falling revenue, may mean those small businesses can’t afford the professional financial advice they need,” Ms Carnell explained.

“The ramifications of this could be devastating, both for the business and its owner and family, down the line.”

Ms Carnell also said the cost of insolvency should be capped for small businesses, adding that the majority of small businesses entering liquidation have assets of less than $10,000.

“We have spoken with a range of registered liquidators who have indicated the minimum cost of a straightforward voluntary administration is about $12,000, while the average is closer to $50,000. For businesses that need to wind up, it is critical that the process be cost-effective, quick and dignified,” she said.

The report also recommended a small business debt hibernation instrument when a state, territory or federal government declares a systemic shock such as a pandemic or significant economic downturn, such as the second lockdown in Victoria. According to Ms Carnell, COVID-19 has shown that businesses need a mechanism where they can take stock of their situation and prepare for the reopening of trade. Under such a mechanism, the minimum hibernation period would be 90 days, during which payments on loans, rent, tax and other outgoings could be deferred.

Further, the report also explores the idea of a potential directors’ insolvency agreement where a small-business owner can provide a registered liquidator with a proposal on the best way to manage the business.

Ms Carnell said external administrations are focused on maximising the benefit to creditors, while the small-business owner’s expertise and knowledge is often brushed aside.

“Small businesses have spoken of stock being sold at a low point in the market, assets being put up for sale in publications that aren’t relevant to their industry and thousands being spent by registered liquidators to chase down payments worth far less than the amount spent,” she said.

“If the small-business owner, with the approval of a registered liquidator, could restructure their affairs, it would likely lead to more positive outcomes, including a greater return to creditors.”

Planning ahead

Given the Australian economy contracted 7 per cent in the June quarter, a new national record since the Australian Bureau of Statistics began documenting national accounts figures in 1959, it would be foolish for the federal government to discontinue providing support for small businesses any time soon, given how many are still struggling to stay afloat.

For the time being, with or without government support, small businesses can best prepare for the insolvency wave by adding up the total value of expenses they have deferred in the last six months and factor in what cash businesses will need between now and Christmas.

SME lender Scottish Pacific’s general manager for Victoria, Jane Starkins, said advisers can help business owners address the problem in small chunks so it’s not one overwhelming debt.

“They don’t need complicated analysis models, it’s about sitting down and helping them work out what they’ve deferred that they’ll need to catch up on,” she said.

Ms Starkins noted that while many businesses may be reluctant to take on traditional bank debt in uncertain times, there are other options available to help them get back on track. With business owners reluctant to extend their borrowings, she said accountants and brokers have a crucial role to play in making them aware of other funding that harnesses the value of assets already in their business, such as their sales invoices or plant and equipment.

Perhaps most importantly for many small businesses out there with family ties, Ms Starkins said it’s also the time to protect the family home by unlinking it from a business’s debt.

“More than ever before, business owners have to think on their feet and act quickly.”

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