Business owners protecting investment like a bank

When small business starts, its owners are required to put in a significant amount of their own money into the company to get things going. It is not uncommon for small business owners to need to invest $200,000–300,000 in the first 12 months of incorporation. When a company faces insolvency, its bankers are the only stakeholders that do not stand to lose, because the bank is properly protected with security. On the other hand, owners stand to lose everything because they are last in line to receive anything from the realisation of assets on liquidation.

1. Asset protection

Small business founders invest a significant amount of their own money into their businesses, at the time that they start and over the years. That investment is usually not properly protected. The first thing that small must do is to incorporate their business. Use this link to read about the benefits of incorporating your small business.

When a business becomes insolvent, the bank directs the process and gets the best outcome because its loan is properly secured over the assets of the business. It is a like a mortgage over a house to secure a loan. The bank never loses. On the other hand, owners generally get nothing back on their investment and lose their business because they are not properly protected.

If a loan is not documented or registered on the Personal Property Securities Register (PPSR), when a company becomes insolvent, a liquidator may not recognise the loan and the owner is likely to get nothing back.

Owners have traditionally had to go to a lawyer to have legal documents prepared to provide this level of protection. That has typically cost from $5,000 and upwards of $10,000, which is often thought to be too much from the pot of money needed to start the business, for something that most think they will never need. Unfortunately, the statistics paint a very different picture, which points to the fact that this protection is vital.

2. Insolvency

A business becomes insolvent if it does not have the cash on hand to pay its bills when they are due and payable. Use this link to read more about the various forms of insolvency in Australia. We know that is Australia, up to three quarters of businesses fail within their first three years.

Good businesses that have been around for 5–10 years can suddenly have a drop in their cash flow at which time they will be insolvent. The impacts of the Coronavirus pandemic is a stark example of an external force having a sudden, unexpected and dramatic effect on existing “good” businesses.

There are significant differences in the owner’s position in insolvency depending on whether or not they have a secured loan:

It is important to keep in mind the waterfall of payments to stakeholders from the realisation of assets in liquidation:

· Secured creditors (eg banks)

· Priority creditors (employees & liquidator)

· Unsecured creditors

· Owners / shareholders

That means that priority creditors will only get paid if the secured creditors are paid their debts in full (including interest), the unsecured creditors will only get paid if the secured creditors and priority creditors are both paid their debts in full (including interest) and so on.

Below are examples of the different returns to owners in insolvency, depending on whether their seed investment in the company is in the form of shares, unsecured / unregistered loans or a registered secured loan.

3. Restructuring

Protecting significant personal investment gives owners a significant “bargaining chip” in either getting back some or all of their personal investment; but, also in potentially keeping their business through a deed of company arrangement (DoCA) or through a restructuring plan. We will soon post with respect to the Federal Government announced new streamlined restructuring plan for small businesses due to start on 1 January 2021 (new restructuring regime).

The reason that it is beneficial, and probably necessary, for owners to have a bargaining chip in either a DoCA or under the new restructuring regime is that the creditors of the company must vote in favour of either a DoCA or a plan under the new restructuring plan. That means it is important to make the choice for creditors such that if they do not vote in favour of either plan they will be worse off. Refer to the table above that shows the difference for the unsecured creditors if the owners are protected by a registered secured loan or not.

4. Solution

In every scenario that arises when a business encounters financial difficulty, including insolvency, the business and its owners will be in no worse position and will very likely be in a better position, if the owners have protected the personal investment they make as a secured loan registered on the PPSR.

krodok provides a suite of documents that allow owners to protect their investment like they are the bank, with a loan agreement, a general security agreement over all of the assets of the business and a registration of that security on the PPSR. This solution is efficient and inexpensive for a one-off payment of $788, including GST and the registration on the PPSR. Ideally this protection should be put in place when the company is incorporated, but it also protects money that is required to be put in after that. It can even protect money that was put in some time ago but for which security was not put in place.

Go to www.krodok.com.au to learn more and to get the protection that all small businesses need.