There are currently 2.3 million small to medium businesses in Australia, compared to approximately 4,000 larger companies. SMEs are both essential to our economy and the biggest employer. Unfortunately, they’re also high risk.
According to recent statistics, 20 per cent of businesses will fail in the first year, and 60 per cent will go bust within three years. A common reason for SME failure is debt, with short term cash flow issues making it difficult to pay on time.
A big issue we see is that when a SME first starts out or falls on hard times, the owners often loan money from their personal savings, a personal loan, or redraw on a mortgage loan over their primary residence, putting themselves at risk.
To protect an SME client in this situation, one option is to document the loaned money in a formal written agreement to give them a security interest over the company’s assets then register that security interest on the PPS Register.
It’s certainly something worth considering.
Benefits of registering your security on the PPS Register
There are double-fold benefits to registering on the PPSR.
Firstly, it gives the owner extra rights in the property registered. This is important if the business subsequently goes into administration or liquidation.
Secondly, and most importantly, registering on the PPSR can give them priority over ordinary unsecured creditors and some other security interests in the event the business fails and enters a formal insolvency appointment.
Essentially, this means they’re a secured creditor of their own business. In practice, it means they can be confident in making further business investments safer in the knowledge that they may recover some or all of their debt if things go bottom up.
Turnaround, Insolvency and PPSR
If a company goes into liquidation, the owner would be one of the first in line to receive a payout from the proceeds of certain asset realisations.
In addition to improve your client’s chances of recovering the loan in the case of liquidation, by registering a secured loan on the PPSR, they’re also in a better position to turnaround their business and negotiate with creditors or propose a Small Business Restructuring Plan (SBRP) or deed of company arrangement (DOCA).
This is because having a commercially acceptable and viable SBRP or DOCA (part of the voluntary administration process) requires them having enough money behind them to keep creditors happy. As a secured creditor, this is more likely.
In this scenario, the owner keeps their secured position if a SBRP or DOCA is accepted.
The power an owner has in administration or SBRP proceedings as a secured creditor also allows them to seek advice early and to plan for a smooth, quick process helping their company survive and thrive.
It can also reduce the cost, allow them to continue trading, and give them greater bargaining power with the bank or private financiers.
Below is a simple example of the potential financial benefit for your SME client.
In this scenario:
- Company assets are $135,000
- Secured bank debt is $60,000
- Director loan is $65,000
- Unsecured creditors are $100,000
|SEED FUNDING||Shares||Undocumented / unsecured loan||Documented / registered loan|
|Value of assets realised by liquidator||$135,000.00||$135,000.00||$135,000.00||$135,000.00||$135,000.00||$135,000.00|
|Secured Creditors (usually the bank)||$60,000 bank||$60,000.00||$60,000 bank||$60,000.00||$60,000 bank + $65,000 Director||$125,000.00|
|Unsecured Creditors||$100,000 unsecured||$75,000.00||$100,000 unsecured + $65,000 director||$75,000.00||$100,000 unsecured||$10,000.00|
|RETURN TO FOUNDER||As Shareholder||$0||As Unsecured Creditor||$29,545.45||As Secured Creditor||$65,000.00|
While SMEs may still be higher-risk, if a client’s credit loans are documented in a formal agreement and registered on the PPSR, they’re in a much better position to turn things around or protect their investment.
If your client’s small to medium business is facing financial difficulties, contact us today to arrange a confidential consultation and discuss the options.