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Update Friday 15 May

The 3 Steps to Business Survival

We have discovered a three-part survival pack to help business owners consider all their options and make difficult decisions in a very tough environment.

How this Business Survival Pack Works

This business survival pack has been developed in a simple three stepped approach:

  • Step One – Calculate your “exposure” and cash flow forecast

  • Step Two – Your options

  • Step Three – Take action

Calculate your "Exposure" and Cash Flow Forecast

Circumstances are changing day by day and crippling revenue. The first immediate step is whether your business can sustain a period of diminished revenue and whether you can repay the liabilities once the downturn ends.

The following is a simplistic approach for illustrative purposes.

Exposure calculation

Your exposure would be calculated as follows:

Total Current Liabilities + Break Costs + Critical Holding Costs = Exposure

Here's an explanation of the components of this formula:

  • Total current liabilities: These are your creditors that are due and payable now. In accordance with the new legislation, these creditors are restricted in recovery proceedings for a period of 6 months (unless they had initiated recovery proceedings before the legislation was passed) and must be owed greater than $20,000 to initiate these proceedings. It is important to note, that if proceedings had already been initiated before the new legislation was passed, then you are only afforded 21 days to set aside the statutory demand, not six months.

  • Break costs: Business disruption often leads to break costs that may entitle a creditor to legally claim. These claims mainly fall within the following classes:

  • Employee claims – you may have had to stand employees down. As such you may have incurred redundancy and employee entitlement claims. Although employees would also be restricted to not being able to commence recovery proceedings for six months under the new legislation, these liabilities would ultimately need to be paid.

  • Supply agreements – you may be subject to a supply agreement where you are required to purchase a minimum amount of goods or services. Breaching these agreements may incur break costs.

  • Contractual agreements – you may be subject to a contractual agreement to deliver a number of goods or services. Breaching these agreements may incur break costs.

  • Contractual leases – you may be subject to financial lease arrangements or hire purchase agreements for assets such as real property, plant and equipment and vehicles. By not continuing the repayment of your financial obligations under these agreements may result in an event of default and cause termination and break costs under the agreement.

  • Banking facilities – you may be subject to banking facilities such as bank loans, overdrafts and debtor finance. By non-repayment or not achieving certain borrowing levels, you may be in breach of your facilities causing an event of default.

Critical Holding Costs

One of the hardest factors in the current climate is that no one knows when the downturn will end. It would be prudent for business owners to assume this period being at least 6 to 12 months. As such, it is critical that a solid cash flow forecast is developed with attention to your critical holding costs, just to keep your business “alive” during this difficult period.

These costs would fall within the following classes:

1. employees

2. insurance including workers compensation

3. leases for equipment and property storage of critical assets such as stock

4. utilities such as electricity and phone accounts

5. banking facility minimum repayments and reporting covenants

6. maintaining intellectual property such as licencing and trademarks and systems.

You are not alone in this crisis, and therefore you may be able to negotiate payment terms for the above. We suggest getting on the front foot and calling your suppliers of these critical costs and work out a repayment plan.

Once you have established the “holding costs”, prepare a simple but flexible weekly or monthly cash flow forecast for the next 12 months.

Recent Changes in Insolvency Laws

The Australian Government has taken the unprecedented step of amending insolvency laws to address the current situation with significant relief for business now in force.

For the next 6 months:

a) statutory demands can only be issued for debts over $20,000 (up from $2,000) and the timeframe to pay or apply to set aside a statutory demand is extended to 6 months.

b) the level of debt for a bankruptcy notice to be issued will increase to $20,000 (from $5,000). The time to respond to a bankruptcy notice is likewise increased from 21 days to 6 months.

c) Australia's personal liability for directors for insolvent trading is suspended.

These are very helpful and much-needed changes however they may not be enough. We have shared this survival pack so that a business can weather the current storm and return to success once this downturn is over.

Your Options

Once you have calculated your exposure in Step One, the critical question is whether your assets and capital on your balance sheet can cover the exposure. Some businesses may simply cover it from their assets, however not every business is afforded with this luxury and therefore needs to look other options.

12 options a business can consider

1. Seek government funding relief

The Australian Government has announced various relief measures to support businesses. The following is a summary to date and is subject to change as further stimulus packages are released.

  • Temporary cash flow support of grants up to $100,000.

  • The instant write-off scheme has been extended to 30 June 2020, to be included in tax returns for the 2019-20 financial year. In addition, the threshold has increased from $30,000 to $150,000 and extended to businesses with an aggregated annual turnover of less than $500 million.

  • Businesses with an annual turnover of less than $500 million will be able to deduct 50% of the cost of an eligible asset on installation.

  • Banks have been granted $90 billion – and for every $1 a bank lends to a business, the bank will be eligible for an additional $5 in funding themselves. In addition, a $15 billion facility has been granted to non-bank lenders.

  • The government will guarantee up to $40 billion in new lending, in a bid to further encourage new credit to SMEs.

  • The government will provide up to $100,000 to eligible small to medium-sized businesses and not for profit organisations that employ people with a minimum payment of $20,000.

2. Obtain ATO support

The ATO has announced the following relief options for businesses:

  • Your income tax, activity statements (including PAYG instalments), FBT and excise payments may be deferred for up to 4 months.

  • Your PAYG instalments for the March 2020 quarter may be varied and you may also claim refunds from the September 2019 and December 2019 quarters.

  • You may change your GST reporting cycle to monthly to process GST credits quicker.

  • You may remit interest and penalties for any tax liabilities incurred after 23 January 2020.

  • You may be able to enter in a low-interest payment loan for your outstanding tax.

3. Review your lease and negotiate with your landlord

On 25 March 2020, COVID- 19 emergency lease legislation became effective. In summary, the new legislation allows retail and residential tenants to be protected from eviction or having their leases or tenancies terminated.

4. Review your insurance policies

You should review your insurance coverage policies to determine whether you may have coverage for coronavirus and other infectious disease-related losses from a Business Interruption Insurance policy.

Business Interruption Insurance covers loss of income suffered by a business as a result of disruptions to their operations. Your business may be eligible. Insurance claims on receivables that are subsequently uncollectable from customer businesses (i.e. ones that have already ceased trading and or are insolvent) may be written off immediately and therefore claimable.

Whether you will be covered will depend on several factors—beginning with the terms and conditions of the specific insurance policy and the circumstances surrounding the alleged loss. Reviewing your policies will enable you to evaluate your options and properly document and claim any covered disruptions.

5. Reduce overheads

Look at all of your costs and reduce non-essential expenses. That may mean delaying planned activations, or product extensions, or may mean reducing your headcount.

6. Finance your assets

Banks and non-bank lenders have been granted over $150 billion in funding from the Reserve Bank of Australia to promote new lending at significantly lower rates of interest.

There are a large variety of finance products in the market which you may be eligible to seek depending on your balance sheet. The following is a summary:

  • bank loan

  • bank overdraft

  • real property loan

  • plant and equipment finance

  • trade finance

  • debtor finance

If you are considering financing your cash flow to endure the downturn, it is important you are confident your business will sustain the downturn and turn profitable, otherwise you may be diminishing the equity of your business further and exposing director’s personal wealth through personal guarantees.

7. Equity capital raise

The effect of the Coronavirus has been sudden and unexpected, leaving successful businesses before the crisis occurred now looking at possible insolvency.

You could consider raising capital by finding new investors for your business. Although your business may not seem great in the current environment, it may look very attractive once the downturn ends. Finding additional shareholders will help you source further capital.

8. Informal creditor arrangements

The effect of the Coronavirus has been sudden and unexpected, leaving successful businesses before the crisis occurred now looking at possible insolvency.

You could consider raising capital by finding new investors for your business. Although your business may not seem great in the current environment, it may look very attractive once the downturn ends. Finding additional shareholders will help you source further capital.

9. Safe harbour

Safe harbour protection provides directors with the opportunity to restructure their business outside of a formal insolvency appointment, with protection for directors from insolvent trading offences should the restructuring be unsuccessful, and the company end up in liquidation.

In order to be afforded safe harbour protection, the following requirements must be met regarding the company:

  • books and records in order and a financial position determined

  • compliance with employee and tax reporting obligations

  • employee entitlements must be up to date

  • advice is obtained from an appropriately qualified advisor

  • the directors must properly inform themselves of the company’s financial position

  • the directors must develop, implement and document the restructuring plan that is likely to lead to a better outcome as compared to the alternative of an immediate wind-up and or a process of undertaking a voluntary administration.

The advantage of safe harbour over the government’s recent insolvent trading relief is that it offers protection beyond the 6-month period.

10. Pre-pack sale

The downturn has resulted in significant losses and damage to businesses that may have previously been profitable. An option to maintain the value and goodwill of a business may be to transfer it to a new entity and let a liquidator deal with the old company shell that previously owned the assets. This could be achieved by a pre-pack sale.

A pre-pack is a sale process of a company’s assets and business of an insolvent company which is agreed prior to the appointment of an insolvency practitioner and then ratified by the insolvency practitioner.

A successful pre-pack will have these essential elements:

  • the assets and business need to be valued by a registered valuer

  • the sale of the assets and business to another entity needs to be at fair market value. Interestingly, fair market value in today’s environment will likely be a lot lower than before the downturn

  • the employee entitlements are properly transferred to the new entity

  • all financial leases and PPSR creditors are properly dealt with

  • the sale is documented by a sale agreement

  • the sale is the best outcome for creditors

  • the sale is ratified by an insolvency practitioner after their appointment.

It is important to note that the insolvency practitioner is not allowed to advise on the sale before their appointment otherwise they will not be deemed independent when investigating the sale. As such, consultation with our team and lawyers prior to the sale is strongly advisable.

A pre-pack usually allows the preservation and goodwill of a business which achieves a better return rather than immediate closure.

11. Voluntary administration and holding DOCA (deed of company arrangement)

A voluntary administration is an effective tool to allow a company in financial distress to assess accurately whether the company can remain trading or should be liquidated. A company is able to take the necessary time to make this assessment due to the financial moratorium imposed upon creditors, landlords, and other stakeholders (who could otherwise take action against the company for non-payment of dues) when a company enters voluntary administration.

A voluntary administration can help a company in distress by imposing a moratorium on all trading and debt recovery processes. This allows an external voluntary administrator to review the company and possibly reduce the impact of — or avoid — the following:

  • Severe Director Penalty Notices (DPN) from the ATO where the director can become personally accountable to tax liabilities within 21 days.

  • Liquidation, where the company has no choice but to be wound-up and have all assets redistributed to creditors.

  • Landlords taking possession of leased property.

  • Creditors pursuing personal guarantees against directors.

Holding DOCA during the current volatile and uncertain market conditions

A holding DOCA is a legal restructuring mechanism that allows a business to remain in existence and freeze creditor claims whilst the company explores recapitalisation and restructuring options for an extended period of time rather than the small window afforded under a normal voluntary administration process.

12. Liquidation.

If your circumstances are not repairable or you do not wish to take a risk in sustaining the downturn and incur any further debt, then a liquidation may be your option.

Any outstanding debts that cannot be paid from the assets of the company can be written off and the company can be closed down.

However, it is important to note that placing a company in liquidation may expose directors for insolvent trading and personal guarantee exposure for debts they have personally guaranteed.

Take Action

It is important for business owners to take immediate action, otherwise, the consequences could be catastrophic.

It is important to note that there are a lot of businesses in the same position, so the attitude towards directors taking steps to restructure and mitigate their losses will be a lot more empathetic.

Source, Author and Credit: Mackay Goodwin

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