Business strategies for navigating Australia’s economic downturn | talkBIG podcast | Season 3 Episode 5

Is Australia in a recession?

Andrew Sykes (00:00)

Does it feel like we're in a recession? I think we might be and technically we may be. Economists can't quite agree on what the definition of a recession is. But if we look at the economic figures, the Australian economy grew by just 0.2 % in the June quarter.

If we look at it on a per capita basis, so that's when we divide it by the number of people in the country, we've actually been in a recession for the last six quarters. This is the longest per capita recession we've had since the early 1990s, in fact. I've been a business adviser since then.

And we've had our ups and downs and we've had recessions before. Recessions can be good things for business. They can hurt a lot of people though.

Welcome to the RSM talkBIG podcast. My name's Andrew Sykes and I'm a partner in the Business Advisory Division of RSM.

I'm joined today by Jonathan Colbran. He's a partner in the Restructuring and Recovery Division. G'day Jon.

Jonathon Colbran (01:00)

G'day Andrew, how are you?

Andrew Sykes (01:01)

Good, mate, good. And Gavin Stacey, who's in our Business Advisory Division as well. How are you, Gavin?

Gavin Stacey (01:08)

Yeah, good thanks, Andrew.

The impact of economic distress on businesses

Andrew Sykes (01:10)

Good, mate, good. So we're gonna have a bit of a chat today about what recessions look like, what they mean for business, and how we can come up with some strategies to help you cope. As I said before, for many business owners, I think it does feel like a recession. Back in May, RSM undertook a survey of business owners.

And business owners said ahead of the federal budget that 82% of them were struggling to pay their costs. I see today we've had some figures out from finder.com saying that almost 50% of Australians are struggling to meet their mortgage payments. Certainly feels like a recession and what a cost there is to the federal government or the Reserve Bank meeting the 2-3% recession inflation target

So a six consecutive quarter fall in per capita GDP. Jon, how do you think that's impacting on businesses that you deal with?

Jonathon Colbran (02:10)

I think there's certainly been an increase in distress, whether it's interest rates, whether it's external pressures, whether it's just a reset post COVID. What we've certainly seen is not a tsunami, but a trending increase in personal insolvency and business distress. And I think it will continue for the foreseeable future.

Andrew Sykes (02:29)

So this is really being driven by, do you see more impact of interest rates or cost of production, just general costs?

Jonathon Colbran (02:38)

So I'm seeing a few different levers and a few different pressures. And I think there's not necessarily any one driver, but what I'm certainly seeing is cost of production is high, wages are high, productivity is a challenge. So, typically I'm seeing businesses needing to recruit less experienced staff that just can't produce the same outputs that staff in the past may have been able to produce. I'm seeing interest rate pressures,

particularly on finance goods, so equipment. 

And now I've also seen the Australian Taxation Office wanting its money back. And that's probably the big one.

Andrew Sykes03:12)

So they're pushing a hell of a lot harder.

Jonathon Colbran (03:15)

They are. So certainly during COVID, if we go back to 2019, 2020, the ATO clearly had a policy mandate to support every small business. They simply didn't collect debt. And whilst I certainly respect the narrative, what they've done is they also prolonged the life of businesses that just weren't viable and fundamentally had issues back in 2020. And we refer to them as zombie companies or zombie businesses.

And one of the challenges the economy has now is it has these zombies taking inputs, so taking labour and taking resources out of the economy, and they're using them inefficiently and incurring losses. So the ATO is driving a bit of a catch-up game and starting to collect debt, and that's causing or driving a lot of the increase in insolvencies.

Andrew Sykes04:02)

Yeah, it's one of those really interesting problems, isn't it? Where we had public policy which supported businesses and then overnight their public policy changes. Gav, are you seeing a lot of that come through in your client base?

Navigating taxation challenges, and the ATO as creditor

Gavin Stacey (04:14)

Absolutely. I think, yeah, the public versus private policy is an interesting point, Andrew, because it seemed to flip pretty quickly. I think historically, clients had always used the ATO, rightly or wrongly, as a source of funding, which has always been an indication  of financial distress. But I guess the implications of it have

never been so high. So that's the negative implication. Sorry. So gone are the days where you could get interest free loans and tap on the ATO and get all your interests remitted and get very lenient payment terms. That's become a real, real struggle across the board. And we've had to train clients accordingly, because they, especially mature businesses might have gone in and out of going through some cycles, gone in and out of cashflow problems.

Now [they] don't have that release valve that they've had in the past.

Andrew Sykes05:07)

Yeah, and that poses another interesting question there. Be interested in getting both your thoughts on this. Historically, if we went back sort of 20 years ago, the ATO was a priority creditor in an insolvency matter. Now they have the same ranking as any other unsecured creditor, but they act, they don't act like it, do they? They can certainly put a lot more pressure on...

a business than any other creditor can.

Jonathon Colbran (05:34)

They certainly, they're typically a major creditor. And if I look at, say, for example, the spike in what we're seeing at the moment, which is small business restructures, the vast majority of the small business restructuring appointments that I'm seeing, the ATO is by far and away the major creditor in almost every instance, if not the only major outstanding creditor. And the way the voting works is the proposal is accepted to compromise the debts, whatever the proposal may be,

based on the value of the debts in favor. So you could have 30 creditors in the room voting, for example, if 29 of those creditors vote against, but they add up to say, for example, $300,000 and then one creditor is the ATO and they add up to, let's call it $500,000, then the one ATO vote captures everybody. So in that context, they are a very, very major player in the market.

Andrew Sykes06:25)

So that really puts them in control of A lot of restructuring situations as the largest creditor.

Jonathon Colbran (06:31)

A lot of them, yes. And the only reason they've become popular practically in the last 10 to 12 months has really been the policy shift where now I'm receiving advice from accountants and from taxpayers who are ringing the ATO to seek to negotiate their tax debt. The ATO are actually suggesting that they explore a small business restructure. And there's clearly a policy shift to support that type of an arrangement to compromise tax debts.

Andrew Sykes06:58)

Okay, so you're suggesting the ATO no longer does, they won't compromise unless it's a formal appointment.

Jonathon Colbran (07:06)

That's what I'm seeing. I'm certainly seeing repayment arrangements being put in place, but they're far more challenging, particularly if there's historical compliance challenges. I have in the past, about 10 years ago, actually successfully entered into an informal compromise. They have a process. It's available on their website to compromise the tax debt, but I'm really clear that that's not a common process and that they don't typically compromise on debts. It's repayment arrangements,

in a formal process like a small business restructure that allows you to access better terms or a compromise or payments over time.

Andrew Sykes07:40)

So Gavin, when you approach the tax office to get a payment arrangement, what kind of response do you get generally?

Gavin Stacey (07:48)

Well, they're a lot more thorough in the last 12 to 18 months. Payment arrangements used to be quite a flippant process on their end, I would suggest, as long as we were within 12 or 24 months. They weren't really too fast on the amount of upfront payments and the financial information provided. Now, pretty much across the board, they want to see financial viability.

They're asking for, they're almost stress testing their ability for taxpayers to meet these payment arrangements and just not accepting of arrangements that aren't going to pay this debt down in a reasonable time. Combine that with the fact that their interest rates are increasing, their credit card interest rates essentially, and their policy shifts to

only remitting interest as an exception, whereas historically we would have interest remissions across the board once we get compliance measures up to date. So those combining factors means these debts are growing and unless they can get under control in a reasonable basis, the ATO will act accordingly.

Andrew Sykes08:55)

Yeah, and look, I don't think we would suggest for a minute that it's not the best thing to do to pay your tax debts as and when they fall true. I mean, common sense says that as a small business person when you make a sale, you should set aside your GST, you should pay your pay as you go regularly and of course meet your super

requirements - which according to the tax office over 90% of it think it's 94% of Australian businesses are able to do that so only talking a small group that can't but I think that group may be getting larger.

Acting early: Strategies for business survival

Gavin someone comes into your office and presents and says "Hey, I can't pay my tax how can you help me?" what kind of conversation you're having with them and not just tax let's talk

in terms of all other creditors. So I've turned up, I'm struggling, I can't pay all my debts. As a business accountant, what's your advice to me?

Gavin Stacey (09:50)

Well, essentially acting early is key. What we would find is often behavioral issues with people maybe putting their head in the sand and not lodging activity statements to not crystallize debts and these kind of things and just continuing to use other creditors' pushing out creditor days and really making a problem

Andrew Sykes10:01)

Hmm.

Gavin Stacey (10:11)

infinitely worse by continuing to trade. And I'm sure Jonathan can talk about that, the issues that trading while insolvent can put out there. But essentially, the key is to act early. Options just continue to fall off the table as the longer this drags out. Act early, we can, Jonathan mentioned the restructures that we can look at.

I've got number of clients where we're not necessarily insolvent per se, but there's definitely immediate cashflow issues. So then we can look at a formal appointment, whether it be a member's voluntary liquidation or something like this, where we can actually work with insolvency specialists and the like to limit the personal exposure. We set up companies to, for,

as it's separate legal entity. We really don't want to let that personal exposure leak out just by behavioral issues and whatnot.

Andrew Sykes11:05)

Yeah, and that's a really good point. We'll dig through a little bit of that more technical insolvency a bit later on. But from what I'm hearing from you, Gavin, it really aligns with what I think. When business gets tough, start working on your business a bit more. Get your accounts up to date. You can get an MYOB, which is what I use for my business subscription for about $30 a month, or you can get a Xero subscription.

Not really many excuses these days for not having your accounts up to date, is there? Do you see that a lot? That the better businesses keep their business, their accounts up to date?

Gavin Stacey (11:43)

100%. And they don't just use it for a record keeping tool. I think businesses that find themselves in trouble look at their management accounts, their accounting data file as an obligation. I've got to do that to get my tax return sorted. I think once you start shifting your mindset and looking at it as an opportunity to look at your business, look at real time data, I think real time data is...

fundamental to business success at the moment. If you're still looking at tax returns or financial statements from 11 months ago as your reference point, a lot can change in 11 months. Really using your financial data to your advantage to find out, well, hey, if you do have critical issues in your business, you can find them

straight away, you can stop, can act and you can restructure or can limit the bleeding a little bit.

Andrew Sykes12:37)

Yeah, I agree with that because modern business is often about managing things quickly and getting into some of the details. Really easy to blow $30 a day in business and $30 a day is $10,000 a year. You blow $100 a day and there's $40,000 out the door, which could be critical to your business survival. 

The philosophy of companies: Limited liability and personal risk

You mentioned companies and I think that's a...

That's one of my talking points generally is that we seem to have forgotten that companies were designed to fail. So why did we, why were companies established? It was to allow a group of people to get together and pull some capital on to take a risky endeavor. And then if the company failed, they didn't lose everything. Jon, how does that philosophy stand the test of time? There seems to be increasing moves to

push personal liability.

Jonathon Colbran (13:33)

Yeah, very much so. But it's funny when I start a conversation with someone, invariably I tell them that their accountant almost foresaw this potential day, and because I set them up in the structure they are in, whether it's a company or a corporate trust, they have a trust typically for two main reasons. One is tax minimisation, obviously completely legally, but the other one is the separate legal entity principle. And to a point, in the first instance, company directors and shareholders are personally liable for business debts.

Andrew Sykes13:55)

Hmm.

Jonathon Colbran (14:02)

If the business is conducted through a company with the exception of a few exclusions. And that's what you're touching on there where the market and to an extent now the Commonwealth government have recognised that there is a barrier. So the market has responded with some steps to make directors personally liable.

Andrew Sykes14:20)

Yeah, and that's a, I certainly know when I talk to my clients and I've had experience as well when I've had companies that owe me money go broke. I don't think if a company goes, if you're dealing company to company, you're in business yourself and you're dealing with another company and that company becomes insolvent, you shouldn't be surprised when you don't get paid. So if I'm sitting there, I've got my well-run company, my accounts are up to date and

I need to do business with another company. Jon, how would you recommend I protect myself as the good business?

Jonathon Colbran (14:57)

I think what you first and foremost consider doing is explore your letter of engagement or your terms and conditions and adopt the market standard, which is a personal guarantee. So if you provide, and even as chartered accountants, I have this conversation with other accountants pretty regularly who are owed fees by clients that fail. The first thing I say is, do you have a personal guarantee for the work that you've done for the company in your engagement letter? Then the second thing I say, which is also not uncommon, is do you have a charging clause?

Andrew Sykes15:05)

Mmm.

Jonathon Colbran (15:25)

Because it's very common for businesses and professional advisers now to actually insert not just a personal guarantee, but a charging clause that gives them then a charge against a real property interest held by the individual that might be the director of that business.

Andrew Sykes15:38)

Hmm. Yeah, so just get some security that's outside of the operating environment, even if it's a personal guarantee.

Jonathon Colbran (15:47)

Yep, 100%.

Exploring options when business becomes unprofitable

Andrew Sykes15:48)

Okay, so just say that things are getting a little bit tough. So I've been to see Gavin and Gavin's told me things are a bit tough. And I will say, Gavin, one thing that you said that resonated with me is sometimes you should just stand back and say, I should either sell or close this business down if it's no longer profitable. Jon, what are my options if I've reached that point?

Jonathon Colbran (16:14)

It's a really, really good question. And we actually use the terminology options, but I think Gavin made two really good points. The first thing is act early. I would agree with that 100%. Act as early as possible because this conversation when Gavin invariably or someone like Gavin as a trusted adviser introduces us to their client is completely confidential. The world doesn't know that we're there. The world has no idea that we're exploring the current position.

And for us, it's all about, what are your plan B options? So we talk about plan A, Andrew and Gavin, we talk about plan B and invariably when somebody is going through a challenging period as a business owner, they have a plan A. Plan A can be refined and it can be improved. But plan A is what they're currently doing to try and improve their business circumstances and turn around. And Gavin also made the point, as you did as well, Andrew, the starting point is often let's get the books and records up to date.

Let's make sure that we're making informed decisions. mean, Andrew, there's a client that you and I are consulting to, they operate childcare centres in New South Wales and they've burnt through cash reserve. And the primary reason why they've burnt through the cash reserve is the forecasting and the numbers weren't accurate enough. And what they've done is increased wages and not increased fees. So as a consequence, their cost base increased and those...

Had the numbers and the forecasting and the budgeting tools been more accurate, I don't think they'd be talking to us. But coming back to it, for us, it's all about what are your Plan B options? And Plan B starts with, okay, the best case scenario of saving the business, navigating through this, perhaps it looks like informal arrangements with your creditors, all the way through to the last option, which we never start with, which is perhaps selling the business or exit.

Dealing with insolvency: Emotional and practical steps

Andrew Sykes17:56)

Yeah, because we have seen and Jon, you and I have worked on a number of engagements and unfortunately, we have had a tough time in the construction sector over the last couple of years. And there's been some really good family businesses that have had exposure to larger construction companies and through no fault of their own. They wind up in a pressure situation. So that may be a builder goes becomes insolvent and then all of a sudden

this business is not being paid. I would say that that business puts themselves in a better plan A position to be able to go and talk to their bank and their creditors if their books and records are up to date and they've got all of their BAS's lodged and all of their supers paid and it does give them options. If that's happened to my business, what's my next step? All of a sudden, yeah, I'm a small business.

Builder has gone broke and I've lost say half a million dollars. I don't have the cash. How are the two of you dealing with that situation?

Gavin Stacey (18:52)

Well, first off, would bring them in. Obviously, it's a, we're not just dealing with business, we're dealing with people. It's often a pretty emotional time if something catastrophic like that happens to the business. But really bring them in. And I think being a full service firm at RSM, I've got the benefit of walking down the corridor and talking to Jonathan's colleagues in restructuring recovery and bringing them in on a

Jonathon Colbran (19:13)

No, no, no, no, no, no, no, no, no,

Gavin Stacey (19:17)

on a confidential basis, as Jonathan said, trying to pull that stigma down of talking to an insolvency practitioner, essentially, and talk about options. So we can have, I've had a few instances this year where we just, get in early, we talk about our options, right, you've maybe, you've not only worn your own financial risk in this environment, but someone else, another business has fallen over. Well, do we have any,

Jonathon Colbran (19:19)

same thing, I can perform it. So, you can see this is the...

Yeah.

Gavin Stacey (19:44)

recourse there, to have an ability to recover on that side. But you also need to work on the basis that if you don't, we can't make this worse. You can't continue to incur debts if it is clear at a point in time that you can't pay your debts as and when they fall due. Anything beyond that, you're creating further personal exposure for yourself. So it's really about doing an immediate assessment at the time. Well, are you?

insolvent by definition and leaning on Jonathan and his team to help with that and then going, well, what's up? What do we do from there?

Communicating with banks: It’s all about numbers

Andrew Sykes20:19)

Yeah, so that's a couple of really good points there, Gavin. So Jon, we've gone through and Gavin's done his assessment. He's had a look and said, okay, well, let's go and have a talk to Jon and his team. As a business person, I turn up and say, well, can you go and talk to my bank? What happens when you open that conversation with the bank and what does the bank ask? If I'm going to ask for support from them.

How does that work?

Jonathon Colbran (20:45)

All right, invariably they need the numbers. So the numbers need to be up to date. And it's funny how important the numbers already always are. So I think if Gav gave me a call or you gave me a buzz, the first thing I try to do is understand the current position. And I invariably, we work as a team. Sometimes we also bring in a solicitor if there are legal issues. But if an RSM client was subject to a major insolvency event, the first thing I would do would be get as much information

as possible around the insolvency event so that I understand what's happening on that side of the fence. I know what to look for and I know where to find it. And to try and get a sense of is there any money coming back? Then I'd be working with the client to see how we best protect ourselves and lodge our claims. Often RSM clients and business advisory clients have debtor insurance. So I'd see if there was a prospect for us to go to the insolvency practitioner, get an immediate adjudication on the proof of debt to get the insurance policy or the insurance claim pushed through.

And then I'd help the RSM client lodge their formal proof of debt. So at least they've done the things they need to do in the first instance. If we were providing services and depending on the client, we might also have other legal rights. We might hold retentions that we could perhaps claim against. We might hold bank guarantees as security for incomplete works. So what I do is try and understand contractually all the different levers the RSM client could pull to try and best protect themselves and get some money back.

And then I'd be very focused on the future. Okay, this is going to create a hole in your cashflow forecasts and your current operating position. You may get some money back, invariably you won't get all your money back. So what does that look like and how does that impact both your cashflows and your P &L? And then start mapping out options so that they can navigate through things. And we always start with the informal side. You need to build a pot of gold and get some working capital in the door.

So to your point about going to the bank, that's one conversation, but they're gonna want those forecasts and the numbers. So that is one option. The bank of mom and dad and all the directors bank is often a very popular one. You might have drawdowns, but if an RSM client is gonna put money in and there's not already a bank there, we talk to the RSM client about taking security, preparing loan documents and actually lending the money in the best possible way to protect the RSM client. And then we look at how do we deploy the capital.

Do we enter into repayment arrangements with creditors? Do we try and assist to negotiate deferral of payments, rental abatements, get on the phone with the bank and see if existing loans can go interest only for a period of time if they're currently P &I. Get on the phone with the ATO, try and negotiate a repayment arrangement. They're just some of the things that we would do as a team with your team and with Gav's team and maybe with a lawyer for any RSM client that went through that type

to sit down.

Andrew Sykes23:29)

Hmm. Yeah, because if we went back, say, 20 years ago, or even a decade ago, Jon, the banks were a little more aggressive in this area, weren't they? They were more happy to appoint an insolvency practitioner. Now, my understanding of what I see across businesses, banks are actually really reluctant to call in loans. They'd rather work with the business, is that right?

Jonathon Colbran (23:50)

100. They are. The phrase a banker will use is a client-led solution. So the preference for any major lender in Australia, and even really the big six, is they would all prefer a client-led solution. So first and foremost, it's about clear communication. So we open the line of communication with the bank, we explain the current position, and then it's about where to from here. So we map out a strategy to either

make sure we can continue to comply with the loans or worst case exit the bank. I've worked with RSM clients where the exit typically looks like a sale to exit the bank and pay them out in full and or refinance. And certainly since probably the GFC, there's been a proliferation of new banks. And if we look at the position of say the big six or the big seven, if you include maybe Judo Bank in that as well now...

The last three weren't as prolific as they are now with Macquarie, Bendigo and Adelaide Bank and Judo Bank. And they have different risk profiles, all the banks. So outside of the non-bank lenders, where obviously there's a proliferation of those now as well, the Moolers, the Prospers, the Biz Caps, which can be solutions in different scenarios.

Andrew Sykes25:02)

Yeah, and if you understand what your business looks like and what your cashflow is like, paying a slightly higher interest rate to a second or third tier bank isn't going to kill you, but not acting and not understanding potentially will. Interesting you mentioned forecast, because I don't think enough businesses keep accurate and up-to-date forecasts. And once again, with modern accounting software, really easy, really cheap to do that kind of thing.

Superannuation: A critical liability for business owners

I will say one thing that seems to be a really big issue in any sort of insolvency or debt situation is superannuation. Gavin, do you see many of your clients like, sometimes they won't pay the tax or they won't pay certain creditors. Do you see them not paying superannuation as well?

Gavin Stacey (25:46)

Potentially new clients that come on board. Hopefully, a lot of my mature clients know better. We talk about that, the limited liability environment of a company, superannuation is just one thing that breaks that down. So if a company doesn't pay its super on time, the directors can be personally liable.

All right. And it's really important. The ATO looks after the little man. They look after the employee. So, Super is right at the top of their list. And then you've got like other PAYG withholding requirements and these kind of things. Often it can fall away when times are tough, but that's the worst possible time. You really just need to stay on top of those as a priority.

Andrew Sykes26:07)

Hmm.

Gavin Stacey (26:28)

Because there's also additional factors that the ATO is recognising this in legislation as well by denying tax deductions for super that's paid late. These kind of things.

Andrew Sykes26:38)

And horrendous penalties. The penalties are tough, aren't they?

Gavin Stacey (26:42)

Well, yeah, so if we pay late, technically we need to look at superannuation guaranteed charge statements, which essentially you can have someone paying superannuation two days late, five years ago, be subject to an ATO audit and calculating interest up to this point in time. And then 200% penalties if we don't engage with the ATO on a voluntary basis. So.

We've got a global employment services team that I'm working with a lot of recent times, and they specialise in engaging with employers around their wage compliance and dealing with the ATO if we do find any compliance issues and putting our hand up and saying, yeah, we've, found this issue historically. We want to make it right. Because really we, we want to be out, yeah, we want to

limit the director's exposure there.

Andrew Sykes27:32)

Yeah, and I will say that when I work with businesses that are experiencing cashflow shortfalls, I say to them, just make sure you pay your super because it's the worst thing you can do is not pay your super. It's a strict liability with large penalties. If you pay it a day late, you've got that liability and there's no way that the commissioner, legislatively, the commissioner can't actually remit those penalties. So you're on the hook. But I think even worse so,

Gavin Stacey (27:56)

it.

Andrew Sykes27:59)

is that nobody will touch you if you haven't paid your super. Is that a fair statement, Jon? Like the difficulty in refinancing if you have unpaid super increases exponentially.

Jonathon Colbran (28:11)

Yeah, generally taxed it, find, particularly for the majors, probably the big six at least, they'll expect when you're providing them with your financial accounts, they'll ask for all the relevant documentation to confirm that you comply. So there's no denying the fact that unpaid superannuation raises your risk profile. And I know the ATO's view of superannuation, although it's obviously if it's outstanding, it converts to superannuation guarantee charge and is collected by the ATO.

They take the view it's not their money and it's not their money. In reality, it's employees money and they 100% prioritise the collection of superannuation. So in terms of risk profiling as a client, we find that if you have a tax debt over $100,000, if you have outstanding superannuation guarantee charge and you don't have an active repayment arrangement, you are absolutely in the high risk category and more than likely you will receive legal notices

Andrew Sykes28:40)

Mm.

Jonathon Colbran (29:04)

that will continue to escalate. So you will receive director's penalties [notices], you will receive garnishee notices and eventually you'll receive a winding-up application.

Andrew Sykes29:12)

Yeah, and Gavin did touch on the point that it doesn't matter if you paid your superannuation late five years ago or 10 years ago, that liability never goes away. So even if you make it through, all right?

Jonathon Colbran (29:22)

It also doesn't matter if it's your super. Well, the other point is it doesn't matter if it's your super. So we find that pretty commonly. The directors who invariably have challenged businesses will pay themselves last. They also don't pay their super. The problem is, that again, and the ATO sees it as SGC debt and it raises your profile for risk, even though you try to help. And they will find out.

Andrew Sykes29:30)

Hmm.

So just to clarify, hang on, just clarify there, Jon. So if I'm running my own business, my own company, just myself and a family member, the only employees, we don't pay our super, we're gonna end up with penalties.

Jonathon Colbran (29:56)

Yes.

Gavin Stacey (29:57)

Yeah, that's a common one that we see, Jon. Common misconception is it's, yeah, it's my money. I'll do the right thing. I'll fall on my sword by not paying my own super. But again, they're making the problem infinitely worse.

Formal insolvency appointments: What to expect

Andrew Sykes30:10)

Yeah. So Jon, we'll go back to you on some of these insolvency appointments. I've been to see Gavin once again and we recognise that we need to do something formal. What are my listeners say? We've tried doing something informal. We need to seek a formal appointment. What does that actually mean and what's involved? What is a formal insolvency appointment?

Jonathon Colbran (30:10)

and for

Yep.

Understanding insolvency: Australia vs. America

It's a really good question. So in Australia, we use language which is not consistent with the language you probably hear in America because their legislation is slightly different. for example, yeah, that's right. The most common word that everybody associates, I guess, insolvency with, I think, is bankruptcy. But see, for me, when I hear the word bankruptcy, I know that that's strictly in Australia dealing with personal insolvency. And it can also can be a sole trader. It's not dealing with--

Andrew Sykes30:41)

The TV language.

Anyways.

Jonathon Colbran (31:00)

--with anything to do with a company insolvency. So if you're the owner of a company and we wanna try and save the business, then our two major options are a voluntary administration or a small business restructure. And that's always our immediate focus. Okay, let's see if we can save the business. It needs to be viable. We need to be able to obviously improve cash flows and improve profitability. But if we can turn the business around for argument's sake, there could have been a catastrophic event, could have been COVID.

Could have been the death of a patriarch or a matriarch that then triggered challenges in the business. Those sorts of things do happen regularly. Directors disputes in fundamentally great businesses happen very often, but then triggers insolvency when the directors freeze bank accounts. There are ways to navigate through it. And the two primary levers, like I said, are the SBR, that's the acronym, or VA. And the SBR is the preferred approach in the first instance, but there are criteria.

The VA is then the more expensive, more robust process that allows somebody independent to come in in the event that the SBR criteria can't be met.

Navigating Small Business Restructures

Andrew Sykes32:00)

Okay, so we've come to see you and we're saying that we want to do something informal or sorry, something formal because we've had one of these catastrophic events. So if we go back to the example, small business had one of my builders, for example, has gone broken and now I don't have enough cash, but I have a fundamentally good business. What's the criteria for a small business reconstruction?

Jonathon Colbran (32:28)

That's a really good question. So the first thing is that the company has debts of less than a million dollars. Its lodgements are up to date. So tax lodgements, you don't have to have paid all your tax debt, but your tax lodgements need to be up to date and your employee entitlements need to also be up to date. So it's funny, critically to enter into this process again, the starting point is it's all about the numbers.

Andrew Sykes32:49)

Hmm.

Jonathon Colbran (32:49)

So it's very common that when an RSM client comes to us or a client referred by another business adviser, that all those boxes aren't ticked. But fundamentally the key one, and we can work on the numbers and we can work on the entitlements being up to date and current before we commence, is that the debts need to be less than a million dollars. So what we would do is if the debts were less than a million and the accounts were outstanding and the entitlements just needed to be paid up,

we'd work with the director on a solution to make sure those criteria could be met. And typically we'd work with say, Gavin and his team, they bring the accounts up to date, make sure that they're all up to date and the lodgements are done. And if they're outstanding entitlements, we need a solution to pay those to meet the criteria. And there are two common solutions, well there's three. One is the business can pay the entitlements. And these are not entitlements that are accrued. These are entitlements that are accrued and due. So for example, outstanding wages that are unpaid,

or outstanding super that is unpaid. You don't have to pay, for example, annual leave or long service leave if it's not currently due. It's just accrued. So the first option to tick the box is pay the debt through the company. The second option is a third party pays it. So the directors commonly the third option is and I haven't utilised this service, but I'm aware of it is there are lenders. There are lenders that will lend the money to the business and or to a director.

and then the director can on lend the money to the company to ensure the company meets the criteria. So the company.

Andrew Sykes34:16)

So going back to that conversation we had around super that once again, if you haven't paid your superannuation, it cuts an option off for you. And then you're gonna be out there struggling with higher risk finance. So say, I owe my creditors, I'm an RSM client and I've been dealing with Gavin for years. So of course all my BAS's are lodged and my books are up to date. Thanks for your help Gavin, you kept me on track.

Jonathon Colbran (34:24)

Thank

Gavin Stacey (34:40)

That works.

Andrew Sykes34:41)

But all of a sudden I find I have $300,000, I owe some creditors $100,000 and I owe the tax office $200,000 for GST and PAYG. What does that look like for me? So I'm coming to, so I'm sitting in front of you, Jon, and what are you gonna tell me? How much is it gonna cost me? And what are you gonna tell me I need to do?

Jonathon Colbran (34:59)

Yeah.

Yep. So I'm going to tell you that the small business restructure based on those numbers and based on Gav's excellent work and business improvement work with the business advisory time is the best option because what we need to do is deburden or unburden the company from the problems of the past and essentially clean up the balance sheet. So what I would recommend is that we put forward a proposal that would be ideally a lump sum compromise, sorry, from a third party.

So a director, for example, or a relative or a lender lend the money as a lump sum and offer a compromise to your creditors, ideally within three months. Alternatively, I'd recommend that we offer either a hybrid with a lump sum contribution or surplus from profits over time or just contributions over time to the creditors. Typically the cents on the dollar that we're seeing accepted fairly regularly is in the 25 cent.

40 cent the dollar after costs. Certainly the higher the offer, the higher the propensity it will be accepted and the quicker the creditors receive their return, the higher the propensity will be accepted. But if the offer is within those parameters and although you can offer a proposal over three years, we're seeing proposals of up to 12 months be accepted. We're not seeing proposals longer than 12 months be accepted.

Then I would recommend we put that proposal to the creditors. They will vote on it. And the cost to you of putting that proposal would be about $15,000 plus GST.

Andrew Sykes36:34)

Okay, so I'd need to make costs of about $15,000 and I'd have to come up with probably somewhere between 100 to 150,000 to contribute into the company and then that would be dispersed to the creditors and they would write their debt down and I would continue on with my business. That seems like a reasonably fair outcome. I know everyone loses but everyone gets something.

Jonathon Colbran (36:49)

Yeah.

That's exactly right.

Andrew Sykes37:01)

back, it seems reasonably fair, particularly when it's no fault of the business.

Jonathon Colbran (37:06)

It's a compromise. And whenever there's a compromise, mediation or otherwise, no one should win. Everyone should give a little and take a little. So it is very much the definition of a compromise. The only challenge with it, which is why fundamentally we always talk about three phases with any of our assignments. The first is planning. The second is implementation. And the third is post implementation is you always have additional things pop out because we come all the way back to the conversation we were having in the beginning

about personal liability and the separate legal entity principle. If there are personal guarantees or if there are directors' penalty notices, in that third phase, there needs to be a strategy for how you will deal with those as well. And we talk to you about that.

Andrew Sykes37:48)

Okay, so it reminds me that old maxim about a successful mediation or compromise is success is everybody feels like they've won or everybody feels like they've lost.

Jonathon Colbran (37:59)

Success is a thing to compromise.

Voluntary Administration

Andrew Sykes37:59)

So now if I'm a slightly bigger business, I'm one of, I'm Gavin's number one client. I've got a hundred employees and I might have say $5 million in debts that I can't meet. Once again, successful business. I've got my projections. I think I'm looking good for the long-term. What are my options then?

Jonathon Colbran (38:21)

Yeah, look, the best option then and really the only practical option outside of the plan A, which is always informal resolution is a voluntary administration. Now the key distinctions with a voluntary administration as opposed to a small business restructure is that the small business restructure is kind of the DIY insolvency restructure. You have an insolvency practitioner who is a registered liquidator that is in the background, but it's a debtor in possession model. And what that means is the director remains in control of the business while they undertake the small business restructure and the creditors don't get the benefit of either one and independent party taking control like an administrator in an administration that comes with personal liability and guarantees from the administrator that they'll get paid. It also doesn't come with the detailed meetings of creditors or reports so that you don't get a detailed investigation. The voluntary administration gives you all those things and for something that is more complex and bigger.

Jonathon Colbran (39:14)

Where, for example, you might be ordering hundreds of thousands of dollars of goods, or you might have 2-300 staff as you mentioned. In my experience, everybody wants guarantee they're going to get paid and they get that guarantee from the RSM balance sheet as an example. So the voluntary administration is still a highly effective tool. It's just bigger and typically for more complex situations. Probably one of the best voluntary administrations, which is on public record that our team successfully implemented,

was the voluntary administration of Star Aviation. So Star Aviation continues to operate today. It's a market leader in providing above wing and below wing services to major domestic and international airlines in Australia, or ports all across the country. It's grown exponentially since its voluntary administration and was a classic quintessential example of a great business that had been started up that just was carrying some problems of the past. It had some...

investors, had an excellent management team, good key stakeholders, new accounting firm providing advice. They just needed to restructure their debt and restructure their business. And we were able to come to the table, work as part of a team to effect that. And that was about six years ago now, and still trading successfully today.

Andrew Sykes40:24)

Yeah. So that's those good people that clean the planes when they land.

Jonathon Colbran (40:29)

Yeah, they do baggage handling. The above wing is the cabin cleaning and the below wing is the baggage handling bits and pieces. That's the lingo.

Andrew Sykes40:38)

I will say, and Gav, you'd have to agree, mate, isn't it? You learn so much when you're an accountant, don't you, about different businesses. I've never heard those terms before.

Gavin Stacey (40:38)

Absolutely. I'm learning so much from this call, Yeah, good to know the lingo going forward. But yeah, you learn as much as you get involved with businesses. At the end of the day, the greater understanding you have of their business, the greater understanding you have of the challenges and whatnot, provides you, positions you to advise bespokely to them.

Signs you should speak to an insolvency adviser

Andrew Sykes41:06)

Yeah, and Gavin, like myself, you probably don't, you know, it's not the best thing having to deal with businesses in distress. What are the kinds of signs you look for to advise a client to say, hey, you should seek help or we can work through this? What are the key financial indicators you're looking at there?

Gavin Stacey (41:25)

Well, often, I suppose we can look at the financial data. You can look at growing creditor days if we're taking longer to pay our creditors. Obviously, ATO debt is massive. It's just a really big beacon that there's some issues there. But also the behavioral stuff, and it's a common theme. People often don't want to face up to the problems. And I call it the putting their head in the sand.

Not lodging, just continuing to work in the business and the old Aussie attitude, she'll be right mentality, which doesn't allow us to actually stop and track our accredited days and work out, hang on, there's something not right here. We're not collecting, we're not paying as quickly as we should, or we're not collecting. And we're not only wearing our financial risk, we're wearing the financial risk of our customers as well.

Andrew Sykes41:52)

Come on.

Hmm.

Gavin Stacey (42:17)

So really that, I would say it's more so the more extreme examples are where people just aren't responsive to tax lodgements. They keep pushing those to the side because you can't actually answer the question whether, will everything be all right? Well, we can't tell you. We can't get in and have look at the numbers.

Andrew Sykes42:37)

No, and despite what people think, a lot of accountants say, I don't think it's exciting doing a business activity statement and doing taxes. Some of the outcomes are interesting, but the actual grind of doing it every month can be just that. So I would say to a lot of businesses out there, if you don't like doing it, go and get a bookkeeper to do it for you.

It costs you every month but it can be cheap in the end.

Gavin Stacey (43:03)

Absolutely. It's investing in that finance function so the business owners can utilise their skill set.

Andrew Sykes43:09)

Yeah, and quite often, as you said, business owners, know, 20% of what they do is going to make them 80% of their profits. So if you don't want to spend your Sunday mornings doing bookkeeping, get someone to do it. But worst thing you can do is ignore it. And to a certain extent, I also think, you know, if we paraphrase that great Australian movie, The Castle, yeah, it's the vibe of the thing. If you're sitting there and talking, so we're talking to this business operator,

Gavin Stacey (43:24)

Absolutely.

When to wind up a business

Andrew Sykes43:38)

And they just, this might have been their second time that they've started. And I've got a matter I'm dealing with at the moment where it's the second time this person has started a business. The first one went insolvent through non-lodgement and accumulation of tax debt in the same position again. So you're just thinking, well, maybe you're not suited to run the business. So then I send this person over to you, Jon, and we're really not looking good for the future.

Jonathon Colbran (43:51)

Thank you.

Andrew Sykes44:03)

What does that now look like? So this is our third case scenario where this business is not good and needs to be wound up.

Jonathon Colbran (44:10)

Invariably I have a conversation. Whenever somebody comes to see me, always first and foremost try to understand the current state. And then I'll always say to the business owner, what would you like to achieve? And usually in that moment, the business owner will give me what they're really after. And more often than not, it's just a way out or to better understand their options to navigate through things. But typically the business owner, if they're talking to me, probably deep down,

knows if their business is viable before I even tell them. And it's really, really common to that point around them winding down a business that if I ask a business owner off the back of that question, if they're paying themselves, they'll invariably say no, or they'll invariably say not much. And I'll say, how much are you paying yourself? And typically they'll tell me maybe $500-$1000 a week. And I'll say, are you working about 80 to 100 hours a week in the business? And they'll say yes.

And then I'll say, why are you still doing this? And they'll say, because I just don't know what my other options are. And I'll say, if you weren't doing this, what would you do? And then invariably, they've actually already thought through that. And they'd say, you know what, if I could get away from the business, I would go and do this, make me happier, focus on my health, and or go and earn an income and earn $150,000 a year. At which point we say, well, you've got two options. One is you could

Andrew Sykes45:14)

Hmm.

Jonathon Colbran (45:33)

personally contribute funds and pay out all the debts if you don't have a personal guarantee or coming all the way back to the structure that your accountant put you in because they were prudent, you can step back from the business, invoke the separate legal entity principle. You're not personally liable for the company's debts and the law says you should be proactive and appoint a liquidator. Now, unfortunately in Australia, there's not a government solution to that. There's no free service. So really, unfortunately, you'd need to fund that.

But we'd be looking for a contribution from the director if there are insufficient assets to then wind up the company. Now, in that case, the director can only be liable in one of three ways. One is, or personally liable, one is if they've signed a personal guarantee, but invariably they won't have signed personal guarantees with every creditor. Two is if they've received a director's penalty notice. That is always a risk, the best possible way to minimise that risk is to be proactive. And the third way is if they've done the wrong thing.

So for argument's sake, I always use the Louis Vuitton handbag example. If you've used the company's bank account to go and purchase Louis Vuitton handbags, and that's a really good example of deliberately doing the wrong thing. But if you've tried and failed and tried to do the best you can, and maybe you've made some mistakes on the way, you've still got directors duties. But all you can do now is try and be proactive, take control of the situation and continue to minimise that risk to you by appointing a liquidator.

And in that scenario, typically, a liquidator would be appointed.

Andrew Sykes46:55)

Yeah, generally, think a more modern example of that, one we see a lot of is all of a sudden, a young trades person decides to go into business and within six months is the big flash American ute that you suspect may have been paid for out of the GST account, often a warning sign.

Remember you have options

Jonathon Colbran (47:18)

Can I give you an example of somebody that I've spoken to in exactly this situation? So somebody that I've worked with professionally had been funding the business with personal assets for about two or three years. And unfortunately, they ran out of money. They couldn't continue to sell personal assets to put into a business that wasn't making any money. And this person professionally knew what I did. So they knew that I was an insolvency practitioner.

Andrew Sykes47:32)

Mmm.

Jonathon Colbran (47:44)

And they had seen some of our marketing collateral and they were aware of our options campaign. But still this person didn't reach out to me and their strategy, their plan A was to go and borrow further money from family and friends, about $150,000 and personally pay the company's debts. And this person rang me. I was in the back of a cab on my way to the Melbourne office, rang me to tell me they were closing down the business and they were gonna pay out all the debts. And I said, hang on.

Have you explore all your options? And in that moment, they said, No, I was scared. And I said, Really, this is what we do. You know, this is what we do. And it's completely confidential. So I talked to this person for half an hour. And at the end of the conversation, they sent me this text message. I'm so glad I called you. I've asked my accountant to give you access to zero. She'll do that today. Tomorrow, she'll send you a short summary email of where we're up to to give you a head start. Thank you for being there, Jon.

Every word of the options campaign that I've seen before is ringing in my ears. And I know I need your help. Enjoy your day I'll be in touch.

Now I assisted that director to appoint a liquidator. They invoked the separate legal entity principle and they didn't contribute $150,000 because they didn't have the money. And in the end, they didn't have to borrow the $150,000 from family and friends. And if they do borrow money now, it'll go for the benefit of starting afresh.

Andrew Sykes49:04)

Yeah, and you raise a really good point there because not only if you don't act in a timely manner, it can lead to personal insolvency and you are, I mean, it's a tough conversation telling mum and dad that you can't pay them back that $150,000 because you're personally insolvent. Have you seen that kind of scenario? That's where you try and stop, isn't it?

Jonathon Colbran (49:23)

Yeah.

More often than not, what I actually see is they'll go to essentially a payday lender. They can't grip 150 anywhere, but what they can do is there are lenders that are essentially cashflow lenders. You can apply online. You don't need to have a viable business or collateral assets. You put some information into an online platform. They'll immediately approve your loan or approve a loan in a very short turnaround.

Andrew Sykes49:32)

Mmm.

Hmm.

Jonathon Colbran (49:54)

You can commonly get between $100,000 and $150,000. The issue is the interest and the charges and the penalties. More often than not, in that type of a scenario where this person was going to be unemployed, that's when you lose the family home, and that's when you, worst case, go bankrupt.

Andrew Sykes50:12)

Yeah, which is a very tough scenario to go through. You talk about that and a lot of businesses on a very practical point. So the business is not sustainable.

The importance of acting early in business decisions

I will say, and my experience has shown the sooner you act the better. If your business is looking bad, don't spend the two or three years, try and sell the business. Try and sell it while you still have an asset to sell. Because we have seen

Jonathon Colbran (50:33)

Yes.

Andrew Sykes50:37)

there's this situation, Jon, where all the assets of the business are a fit out. What's the difference in value between a solvent and an insolvent basis on the fit out of, our retail store?

Jonathon Colbran (50:49)

It's monumental. So invariably, one of the suggestions we always make to somebody wanting to exit plan A and sticking to sell their business is that they go and get a valuation from someone ... options. The advantage of the valuation is it's itemised. So it gives you something tangible to give to a buyer because invariably you'll say, I think my fit out's worth X dollars. And invariably the response will be on what basis.

So you get the itemised valuation. I'll give you a valuation in two scenarios if you ask for it. One is liquidation and one is market value. The market value assumes that the fit out is a going concern. In other words, someone wants to use that fit out to continue to operate the same business or a similar business. The liquidation is what can you take out and sell away from the premises? And invariably, it's five to 10 cents on the dollar in liquidation.

Andrew Sykes51:36)

Hmm.

Jonathon Colbran (51:40)

As compared to the market valuation because you simply can't sell all the assets. So classic example, you can't take the light fittings out, no one will buy them. You're really only looking to take out assets that are movable. So tables and chairs, which aren't worth very much, perhaps some equipment, but it obviously wouldn't be a cool room. There's very little to sell typically in a liquidated room.

Andrew Sykes51:45)

Hmm.

No.

So if I've spent half a million dollars on my fit out or a million,  half a million dollars spent on my fit out, I then become insolvent, it's worth 25 to 50,000 if I'm lucky. So that goes, yeah. I think we're coming up with a bit of a golden rule there, which is act early, sell while there's still some value. Gavin, have you taken many businesses to market in that situation or do you have many of those discussions with clients?

Jonathon Colbran (52:10)

10 to 15. 10 to 15.

Gavin Stacey (52:28)

Sometimes we've had the opportunity, yes.  I think something resonated from Jon previously is what are you trying to achieve? Some recent example has been there is a succession plan strategy that hadn't been documented and executed properly. But we had a client and one of Jon's colleagues, Jerome, over here in Perth, with meeting with the client and outlining the plan. Really, there was some,

the short term cash flow issues. But his whole plan was to transition the business to his son. And there was this golden succession plan intent that hadn't been mapped out correctly. And really, we looked at options through this process to sell that business to his son in a very documented and formal way where we took it out of an environment where there was

the cash flow issues, it was almost a, it was a plan A restructure, if you like, Jon, where we could sell that business to a third party at complete market value to achieve the succession plan story along the way. And that was something that it was, it wasn't a formal SBR approach, but it was that plan A strategy of what, was the most important thing they were trying to achieve.

Other instances where we've gone to market, think the hospitality food and beverage industry has done it tough in the last kind of few years. That fit out example resonates pretty strongly. With a client around investing a lot of funds to fit out a venue, the precinct didn't quite get off the ground. But we've got enough time, we've got enough

Jonathon Colbran (53:47)

stroke.

Andrew Sykes53:48)

Hmm.

Jonathon Colbran (53:50)

Because I'm a woman, so I'm a

Thank you.

Gavin Stacey (54:00)

got real data to look at this and go, hang on, if we're not hitting these key metrics, we're in trouble in six months time. That six months gives you time to get to market it, to go to market, get a business broker involved and get someone that might have the fresh idea, but can come in on a going concern basis and take that fit out. And yeah, when you spent 250 grand on fitting out a cafe,

Jonathon Colbran (54:12)

Thank

Gavin Stacey (54:26)

The five to 10 cents on the dollar doesn't really stack up. But this strategy was all about leases, right? Leases have personal guarantees a lot of the time. So our clients were not trying to generate value and generational wealth from stepping away from this. It was more trying to limit that personal exposure by not being on the hook for another three and a half years of personal liability in line with the lease.

Jonathon Colbran (54:30)

See you later.

and that's we're I'm trying to get people out of the way, and I'm to out way, and get people out and I'm trying out I'm trying way,

Andrew Sykes54:36)

Hmm.

Gavin Stacey (54:52)

So was a really just win-win benefit where someone came in, paid a reasonable value, but not a lot of goodwill to get an established business, established fit out and be up and running in weeks. And our client could step away from that personal liability. So again, was what, yeah, sorry.

Jonathon Colbran (54:53)

So.

So.

Andrew Sykes55:10)

Yeah, you raise a... Sorry Gavin, you raise an excellent point there is that the crystallization of those personal guarantees, particularly most businesses rent their business premises. That's a tough one when you have to meet those personal guarantees, isn't it?

Jonathon Colbran (55:21)

and we'll

Yeah.

Gavin Stacey (55:29)

Absolutely. And you see it so often. It's a starting position. Everyone's trying to look after their interests. Landlords are trying to. They want security of tenancy. Personal guarantees are a way to kind of secure that cash flow. Jon, I'm sure you'd suggest limit your personal guarantees at all costs, but...

Sometimes there's a commercial reality there that you're somewhat boxed in and you're going into business thinking you're going to succeed, right? No one's going into business thinking that they won't be able to pay rent in 18 months time. But yeah, it's putting little steps in place to try and protect yourself is important.

Andrew Sykes56:03)

Yeah, terrific. Well, Jon and Gavin, thank you very much for your time today. I learned a few good things from that. I will say in particular, what really resonated from what you both said was make sure you bring your records up to date, make sure you've got good information and start to act early. Unlike red wine, debts don't get better with age, do they? So if we open ourselves up,

to data-driven strategies where we can come up with a good outcome. We can often achieve a better outcome and we can also hopefully help businesses remain successful. I'd like to, Jon, Gavin, thank you for your time today.

Gavin Stacey (56:41)

Thanks, Andrew.

Jonathon Colbran (56:41)

Thank you.

Andrew Sykes56:42)

Very informative. My name's Andrew Sykes. I've been your host for our talkBIG podcast. I encourage you to subscribe wherever you get your podcasts from and we'll talk to you next time on that talkBIG. Thank you.