Table of contents:
- Overview: Which businesses does voluntary administration suit?
- Reason 1 why voluntary administration is unsuitable for SMEs: Poor record keeping and systems
- Reason 2 why voluntary administration is unsuitable for SMEs: Poor management
- Reason 3 why voluntary administration is unsuitable for SMEs: Non-viable business models proliferate
- Reason 4 why voluntary administration is unsuitable for SMEs: Personal guarantees
Voluntary administration is a relatively expensive restructuring option, meaning that it is often better suited to larger businesses with a more significant asset base. But what do industry insiders think about the matter? We look at recent research drawing out the views of industry insiders on the topic.
Overview: Which businesses does voluntary administration suit?
Professor Jason Harris recently surveyed individuals in the restructuring and turnaround industries to canvass their views on a range of issues, from the costs of voluntary administration, to the roles of different participants (e.g. the ATO, secured creditors and lessors), to how success is judged. The survey also included a comparison between the way voluntary administration operates for large companies and the way it operates for SMEs (see pp. 152-155).
General observations include:
- SMEs have smaller debts, but smaller asset bases. Given that there is a relatively stable component to the voluntary administrator’s fees and expenses (they won’t drop their hourly rate simply to serve a SME), it is more difficult to secure the payment of those fees and expenses from the smaller pool of assets that the company holds.
- ‘SME’ is an overly broad group. Micro businesses (0-4 employees) require a different restructuring approach to medium-sized businesses (20-200). In almost all cases, a micro business will not be able to afford a voluntary administration.
- 93% of Australian businesses have a turnover of less than $2 million per year, with 74% having a turnover of less than $200,000 (p. 180). This suggests that the overwhelming majority of Australian businesses will lack sufficient assets to make voluntary administration worthwhile.
For a general analysis of the restructuring options available in Australia for smaller businesses see The complete guide to working out whether your troubled business should go into Voluntary Administration, Small Business Restructuring or just be liquidated?.
Below we consider some of the more specific insights revealed in Harris’ research as to why voluntary administration may be unsuitable for SMEs.
Reason 1 why voluntary administration is unsuitable for SMEs: Poor record keeping and systems
A common feature of SMEs that end up in an external administration process is that they have poor record-keeping and accounting processes within the business. This presents two problems for a potential voluntary administration. First, the voluntary administrator in these cases is often be appointed too late to be able to turnaround the business (i.e. poor systems mean that solvency problems in the business have not been signposted early enough). Second, any voluntary administration that were to proceed would be much more complicated (as records would need to be gathered and analysed before the voluntary administrator could take any further steps).
The voluntary administrator is required to give an opinion to creditors on what should be done at the final meeting of creditors, so if they don’t have enough evidence to support a positive view about future prospects, they will revert to the default — that the business is not viable and that it should be liquidated.
Reason 2 why voluntary administration is unsuitable for SMEs: Poor management
Sitting alongside poor record-keeping and accounting processes, more often than not, SMEs are subject to poor management (whether of people or finances). Where management is poor (a) the business is less likely to be worth reviving and (b) co-operation is more difficult, dragging out the process. We’ve all undertaken something in our lives where we are out of our depth and a business may be one example.
The reality is that many directors of SMEs are intimidated by dealing with insolvency practitioners, as they may feel that they will be put ‘on the spot’ to justify and explain their past decisions, as well as the future prospects of the company. However, from the perspective of the voluntary administrator, this is a major stumbling block, as cooperation is crucial to a successful outcome. Voluntary administrators often encourage directors to allow a company to be wound up if they have formed the view that the business isn’t viable because the directors are out of their depth.
Reason 3 why voluntary administration is unsuitable for SMEs: Non-viable business models proliferate
In broad terms, the bigger the business, the more likely that its business model is viable. Or, at least it would be viable after a balance sheet restructure because the business’ ongoing profit and loss (P&L) can be more effectively controlled. Often a larger company has gotten into difficulty because it has taken on loans that it is unable to service (for example, the business may have tried to expand too early), not because the company’s core business is unprofitable.
By contrast, smaller businesses are usually price takers in the market and unable to achieve scale or efficiency – so they may not be able to control the P&L side of the business. Even with a balance sheet restructure, they still might not be a viable business.
Reason 4 why voluntary administration is unsuitable for SMEs: Personal guarantees
It is very common for the directors of SMEs to have company debts backed by a personal guarantee by themselves or a family member, sometimes with their family home as collateral. When voluntary administration is initiated, there is a moratorium on enforcing these personal guarantees (see section 440J of the Corporations Act 2001 (Cth)).
However, that moratorium does not extend beyond voluntary administration to the Deed of Company Arrangement (DOCA) process. This means that, once a voluntary administration is initiated, creditors will be notified of the company’s situation and directors will be on notice that a personal guarantee will be enforced as soon as the voluntary administration is finished.
Some directors of SMEs would rather take the risk of liability for allowing insolvent trading than initiating a voluntary administration and eventually losing the house, or being made personally bankrupt. This is, however, likely to be a short-sighted tactic to deal with financial distress.
Reason 5 why voluntary administration is unsuitable for SMEs: Poor advice
Directors of larger companies are well-connected and may have legal and advisory staff on hand who they can consult on potential restructuring options, or, at the least, seek advice on who to consult.
Directors of SMEs usually don’t have this luxury. In fact, the only business professional they may have had regular engagement with is their own tax accountant. They are unlikely to regularly engage a business advisor that is competent in voluntary administration and other types of restructuring.
This means that directors may not be making properly informed decisions when they decide to initiate a voluntary administration, and may do so in situations where it is not a wise course of action.
It’s not simply a choice between voluntary administration and liquidation
Voluntary administration is generally not a suitable process for SMEs in Australia. It is an expensive and complicated process that is best suited to larger companies with a significant asset base and the prospect of ongoing viability.
It is for this reason that the new small business restructuring process was introduced. This allows the directors of smaller companies (with debts less than $1 million) to remain in control of the business while an independent restructuring practitioner helps develop a plan to turn the business around. The reduced cost and simplicity of the process could mean that it has better outcomes for smaller Australian companies than voluntary administration.