New insolvency laws bring small business funding needs into focus

Craig Michie

By Craig Michie*

With new insolvency laws in play in 2021 small businesses have broader options around restructuring – but they need the right funding in place as the new options may exacerbate pressure on their cashflow.

When asked what was required for small business to rebound from the COVID-19 recession, one of the key factors named by Australia’s SME owners was insolvency law reform.

In ScotPac’s late 2020 SME Growth Index research, small business leaders identified that permanent insolvency changes were required outside of the rushed and temporary safe harbour rulings put in place to handle the unique circumstances of the pandemic in 2020.

The Federal Government delivered, with new insolvency laws coming into effect on January 1 2021.

Aware that these changes would have an impact on many small businesses, ScotPac partnered with Blair Pleash, insolvency and restructuring partner at Hall Chadwick, to run information sessions for business owners and their advisors outlining the implications of the new laws.

What SME directors and their advisors need to know

In 2020 temporary protections around insolvency safeguarded directors from personal liability during insolvent trading, with the law being hastily changed so that creditors had to be owed $20,000 (not $2,000) before they could make a statutory demand. Under these temporary rules debtors had a full six months, not 21 days, to comply with a statutory demand.

Effectively what the government has done in the legislation in effect from January 1 2021 is to remove these temporary measures and replace them with a more permanent framework designed to assist the small business sector with COVID recovery.

Under these new laws companies can formally restructure, with the option of small business restructuring for those companies that may not be able to afford the voluntary administration process.

The small business restructuring option is available for eligible businesses who have less than $1 million in liabilities, and who have their tax lodgements (although not necessarily payments) up to date and their employee entitlements paid up.

These eligible businesses can access restructuring under a debtor in possession model – they, rather than an external party, are the ones who stay in control of the business.

Under this model directors are entitled to incur debts in the ordinary course of business while a registered small business restructuring practitioner helps put together a proposal for creditors and assists and guides the directors behind the scenes.

The aim is to reduce the cost of restructuring compared to external administration and to help those small businesses for whom cost considerations puts voluntary administration out of reach.

Hall Chadwick’s Blair Pleash says for those small businesses who have less than $1 million in liabilities, the main attraction of this new model is that directors will be more likely to choose this option because the implication is that they can remain in control of the business.

The other, perhaps less obvious, implication of the new system is that there is no equivalent protection of trade suppliers during the restructuring period.

This increases the likelihood that suppliers may withdraw supply or put it as “cash on delivery” as opposed to offering credit to a business while it is restructuring.

This could create very serious cashflow consequences for a small business looking to restructure.

The Australian small business sector has been dealing with the staged withdrawal of government pandemic assistance since late 2020, culminating in late March 2021 with the end of the JobKeeper scheme so many SMEs have relied on to survive the past year.

Lawmakers believe ending government assistance allows the market to adjust itself and that the new insolvency laws will see any business experiencing cashflow problems realising that they can access more permanent assistance measures rather than just close their doors and liquidate.

In theory this is correct – as long as small business owners are prepared to take fast and early steps to secure their cashflow to handle the unintended consequences of the new restructuring measures.

How to secure cashflow while restructuring

Directors should be looking to ensure financial accounts are up to date. This is the starting point to see where they are at after having relied on assistance such as JobKeeper.

It’s also crucial to get ATO lodgements up to date, so that they are eligible to access this new restructuring mechanism if restructuring is required.

SMEs need to look at budgets and formulate a month, 3-month and 6-month forecast to get an accurate picture.

Actions from this point really depend on how the business is tracking – if things are going well there is probably less need for external assistance, but the reality is that the recovery will be unpredictable and uncertainty around trade and border closures may remain for some time.

Early consultation with a trusted strategic advisor, such as an accountant, bookkeeper, business consultant, finance broker or solicitor, could help a business plan for the worstcase scenario and for contingencies.

By acting early and making sure they get expert advice, business owners can open up access to the broadest range of financing options and guidance around how to protect both the company and their own personal financial position as directors.

Simply placing a business into administration and hoping for the best is not a great idea and is very likely to fail.

Sufficient financial resources are needed to get through a period of administration, and access to the right finance offers the ability to restore profitability as well as to pay whatever proposal is put to creditors.

It’s important for small business directors to be well versed in what funding options are useful in restructuring scenarios, because cashflow pressures are likely to increase due to the absence of creditor support under the new system.

Look at the balance sheet to see what assets can be financed. If a business is selling B2B, they may be able to access finance via their receivables.

Directors and advisors have to be conscious that it’s ➤

not just what’s on the books: some styles of funding offer mechanisms to free up liquidity in these assets, assisting with cashflow requirements to help a business get through restructure successfully. Try to work with a lender who makes a real effort to maximise the business’ leverage against these types of assets.

In the November 2020 ScotPac SME Growth Index, small businesses flagged their intentions to keep trying new ways to fund their businesses. Nearly two thirds planned to reassess the way they fund their business, with almost a quarter planning to reassess their actual funding provider, and COVID made business owners more open to using multiple funders, increasingly non-bank lenders.

One in 12 small businesses say they have already added non-bank funding facilities to deal with the impact of supply chain and revenue issues created by the shutdown. A further one in 8 plan to add non-bank funding to their future funding mix.

Funding that suits restructuring

The reality is that a business has finite resources, so they might only get one chance to successfully restructure. Acting early gives more options with restructuring and refinancing.

Look at the balance sheet, see what’s available from a security point of view and ensure that your chosen funder has a clear understanding of the business’ requirements.

Any business owner who might need to restructure in 2021 but isn’t already working to secure the right funding might just have their head in the sand.

JobKeeper relieved cashflow pressure for many businesses but when support measures are withdrawn it is prudent to act early to replace missing sources of cashflow.

Small business leaders were spot on when they indicated in the November 2020 SME Growth Index that one of the top challenges they must overcome in 2021 was avoiding insolvency.

Conditions were so challenging that at the time of the research (September and October 2020) one in three small businesses indicated the need to sell or close if conditions didn’t significantly improve.

Credit managers would be aware of the need for small businesses not to get caught short as the protection of government stimulus tapers off. It’s important for business owners to take the time now to make sure they have the right finance in place.

*Craig Michie Group Executive, ScotPac E: michiec@scotpac.com.au T: 1300 209 417

ScotPac is Australia and New Zealand’s largest non-bank SME lender, and for more than 30 years has helped thousands of business owners with the working capital they need to succeed.