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Solutions every SME needs to know when facing financial distress

Many are unaware that voluntary administration is just one option for financially distressed companies. Business turnaround specialist Stephen Barnes explains the other vital options that you might not know.

Financial Distress

Small and medium-size enterprises are considered the backbone of the American and European economies. In Australia, approximately 95 per cent of all businesses are SMEs. Therefore, it is a reasonable assumption that the vast majority of formal insolvencies are also SMEs.

When companies get to the point where they are insolvent, there are typically two types of actions that occur: a court or creditor liquidation whereby the business is shut down and all assets are sold, with the proceeds used to repay creditors, or a voluntary administration where an administrator is appointed.

The existing solutions

The voluntary administration alternative came from a recommendation of the 1988 ‘Harmer Report’ to mitigate the loss of business value resulting from liquidations. The view taken by the report was that the existing processes led to the liquidation of the wrong businesses, which could have been saved through a more flexible insolvency process.

The object of voluntary administration is to first maximise the prospects of corporate rescue and, if salvage is not possible, to get a better return for creditors and members than would result from an immediate liquidation.

Voluntary administrations are designed to be quick and easy. To do this, the administrator has a short period of time to either put the company in liquidation or agree to a Deed of Company Arrangement (DOCA) with the creditors.

There is a third option, though seldom used, to return the company to the directors for it to resume trading.

The Australian Securities and Investments Commission (ASIC) statistics indicate that around 85–90 per cent of voluntary administrations fail to get a DOCA approved by creditors and are placed in liquidation. Also, of the companies that enter a DOCA, the return to creditors averages around 10 per cent of the monies they are owed.

With these startling and dire statistics, the question is what else is there? What else can a business in financial distress do?

The early bird saves their business

Every insolvency practitioner – both formal and informal – will tell you two things: many company collapses can be prevented, and acting early gives you options.

I proudly wear a T-shirt with #GYST (which stands for Get Your S*** Together) emblazoned on the front. Second, be aware that there are turnaround specialists in Australia. The earlier you identify and admit your business is in trouble, put your hand up and get the help you need, the greater the chance you have of getting through the financial distress.

I had an undischarged bankrupt contact me at 9.30pm on Maundy Thursday. The company (with his wife as sole director and shareholder) had been issued with a statutory demand. They had failed to respond and were therefore facing a creditors’ petition to place the company in liquidation. They were behind on tax lodgements, superannuation and employee entitlements.

They were not following up debtors and were unable to raise finance, and costs had blown out on a couple of jobs due to the impact of bushfires, floods and a global pandemic. If this person had contacted me at Byronvale Advisors three, six or nine months earlier, the range of options and the strategies we could have used would have increased. Without trying to sound arrogant, this business was saveable, had the owners put their hands up and sought help earlier.

Time buys options and provides room for clarity of thought. I often think there is a particularly good reason pride is one of the seven deadly sins. What should be considered is whether it is worse seeking help and admitting to yourself and your family that the business is in trouble, or having people chase you down in the street for monies and then sue you in court, resulting in you losing your house and business, having to withdraw the kids from the school they go to and giving up your golf club membership?

Enter the deed administrator

Even companies that are placed in voluntary administration, where the administrator manages to negotiate a DOCA with the creditors, are not out of the woods. A deed administrator is appointed for the DOCA and is appointed by the creditors. This person typically, although not always, has previously been the company’s voluntary administrator.

The DOCA process can be difficult to manage, with multiple parties involved and complex financial issues needing to be addressed. The deed administrator needs to ensure that the company and all other entities comply with all financial commitments and obligations under the new arrangement. At the end of the day, they are the person that creditors will approach if concerns are raised or obligations are not met. In addition, the deed administrator needs to report directly to ASIC on behalf of the company and DOCA agreement.

In summary, the deed administrator is working for the creditors to ensure they receive a dividend as prescribed in the DOCA.

  • They are not there to help you treat the underlying issues that caused the company to get into distress.
  • They are not there to assist the director’s turnaround of the company and to help it grow.
  • They are not there to mend relationships and forge new ones. This is where an informal insolvency or turnaround adviser can assist – this is their forte.

In a situation like the above one, a turnaround adviser could work with the directors and the voluntary administrator and/or the deed administrator to first formulate a turnaround strategy that would provide creditors some weight as to how they would receive a dividend.

They would work to maximise profitability and ongoing sustainability, so the dividend proposed in the DOCA was maximised and supported.

There are also alternatives that are, in my opinion, not utilised enough in Australia at least.

These include:

  • Informal restructuring: This is the most flexible solution to return a company in financial distress to financial health. A turnaround adviser will work with the company, creditors and debtors, and behind the scenes in most cases. Engagements can be quick to resolve core issues, or long-term to complete an entire change. Personally, I have worked on engagements from a matter of weeks to two-and-a-half years.
  • Small business restructuring: At the start of 2021, a new set of laws were introduced that I’ve nicknamed ‘VA lite’. It operates like a voluntary administration, but with less regulatory reporting requirements, therefore it costs less and the directors do not pass control of the company to the administrator.
  • Safe harbour: With the supervision of an ‘appropriately qualified adviser’, the directors formulate a plan to turn the company around and will be reasonably likely to lead to a better outcome for the company than immediate administration or liquidation. Directors remain in control of the company and again, this process is conducted behind the scenes.

Many financially distressed businesses are not bad businesses – rather they have been mismanaged. In my book Run Your Business Better, I propose there are only three reasons a business fails:

  • A lack of business skills in the business.
  • A lack of attention to applying business skills within the business.
  • Spending the majority of the time working in the business rather than on the business.

Now there are three more:

  • Not seeking help early enough.
  • Being unaware that there are specialist turnaround advisers in Australia – there is even the Turnaround Management Association and a number of similar associations and groups of turnaround specialists.
  • Pride is a deadly sin – and in business, particularly a business in financial distress – a very deadly sin.

Stephen Barnes is a business turnaround and recovery specialist, board adviser and the Principal of management consultancy Byronvale Advisors. He has more than 25 years’ experience advising clients from new business startups to publicly listed companies and across a wide array of industries.

Read next: Smartest ways to revive a small business during a global crisis

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