Date posted: 03/02/2020 10 min read

How to save companies from insolvency: 6 steps to a turnaround

When a business’s finances go pear-shaped, insolvency and restructuring experts can make a difference to its survival.

In Brief

  • Experts say that accessing advice early makes all the difference when businesses encounter financial problems.
  • February and March are crucial months, as a business’s revenue may have stalled during the Christmas-New Year shutdown.
  • It’s up to the CA in public practice to start the conversation with a client if they suspect a business is in trouble.

By Deborah Tarrant

From Air New Zealand’s historic turnaround almost two decades ago, to the 2017 restructure of Australian luxury accessories brand OrotonGroup after it teetered on the cusp of insolvency, there’s ample evidence of the positive outcomes that can be achieved from a well-planned and timely restructure.

February and March are crucial months. In the wake of the Christmas-New Year shutdown, businesses may be caught short due to stalled revenue flows and outgoings for holidays and loadings. Those businesses trading with Asia also contend with the Chinese New Year shutdown.

So what should businesses do if the financials start going pear-shaped? The resounding message from seasoned turnaround and restructuring experts is to act early if there are signs of trouble

Act early before things get worse

“Early intervention is definitely the biggest issue – trying to identify, deal with and resolve the problem before it gets too big,” says Andrew Barnden FCA, the NSW director of international insolvency network Rodgers Reidy and chair of CA ANZ’s Insolvency Management Committee.

Unfortunately, small-to-medium-sized businesses tend to leave things too late.

“Often business owners are too busy on the tools, as well as quoting and attending to other administration tasks, and their financial information may not be up to date or they may not understand the financial literature,” says Barnden.

A desire to preserve brand value, directors’ reputations and the confidence of customers is also why business owners don’t seek help early. However, those that do maximise the chance of the business being able to move forward.

Signs that a business is in trouble

Bruce Gleeson FCA, a principal of Sydney-based insolvency and business recovery practice Jones Partners, says a flag that a company is in serious trouble is when management starts to spend more time focusing on its financial crisis than managing the business.

Bruce Gleeson FCAPicture: Bruce Gleeson FCA.

“At that point, it’s almost destined to end up in external administration because the management is so distracted, plus it’s not their core expertise to manage a financial crisis,” he says.

There are plenty of reasons why businesses strike trouble. It could be the loss of a customer, the appearance of a sharper competitor, or the business growing too fast or outgrowing its founders’ know-how.

But whatever the cause, there are some shared characteristics when a business’s solvency is in question.

Typically, cash flow has tightened or become a crisis issue, forecast targets are being consistently missed, accounts payable days are stretching from 30 to 90-plus, and superannuation and tax obligations are likely to be sliding.

John Fisk FCA, partner at PwC New Zealand and chair of RITANZ (Restructuring Insolvency and Turnaround Association of New Zealand) talks about “the demise curve” which covers degrees of corporate financial distress, from cash-flow difficulties to the formal processes of voluntary administration and deeds of company arrangement, aka DOCAs, receivership and, at the end of the line, liquidation.

John Fisk FCAPicture: John Fisk FCA.

The demise curveFigure 1. The demise curve.

How CAs can help businesses in trouble

When it comes to dealing with business owners, it really is about recognising the early warning signs that a business is in trouble.

“Depending on the situation, it’s up to the CA in public practice to start the conversation with their client. ‘We have noticed you haven’t done X, or Y has come to our attention. Is there some underlying problem? Is it a short-term cash-flow issue or something more in depth that we need to look at?’” says Barnden.

“Subject to the client’s answers, the CA should consider approaching someone like myself or a member of ARITA [Australian Reconstruction Insolvency and Turnaround Association] or AIIP [Association of Independent Insolvency Practitioners] who specialises in the area of turnaround, reconstructions (including safe harbour) and insolvency.

They understand the complexities of the law and can give guidance on whether you need to and can legally, formally or informally, restructure the business.”

A big concern, adds Barnden, is that CAs often only see their clients once a year or on an ad hoc basis.

“It’s a balancing act for a CA to keep their clients’ businesses healthy and growing, however, also making sure that the costs of providing this advice isn’t stifling their clients. CAs should also be looking at being a trusted business adviser to their clients.”

6 steps to a successful turnaround

1. Determine if the business is worth saving and why; at what costs?

2. Identify the root cause of the problem. Can it be fixed?

3. Consider the options available, from informal processes to a safe harbour agreement or voluntary administration.

4. Seek advice from a licensed insolvency practitioner.

5. Evaluate if major stakeholders will support a restructure.

6. Implement and monitor the plan closely and expect to amend it along the way.

Starting a turnaround plan

Before any restructure or turnaround is attempted, critical questions must be explored. What is the root cause of the problem? Is the business worth saving? And, importantly, what do the directors want?

In Australia, ‘safe harbour’ amendments to the Corporations Act, introduced in 2017, allow directors of companies facing financial difficulties to implement a turnaround plan while being protected from the risk of “lifting the corporate veil” and becoming liable for insolvent trading.

“There are situations where, if a director can continue to keep a company afloat, it means there isn’t investigation into their activity – and that can be very valuable for a director,” says Alice Ruhe CA, an insolvency and turnaround specialist at SMB Advisory.

However, if directors enter into a formal deed of company arrangement or formal turnaround “where creditors are going to be better off and they’re left alone personally, then that has a lot of value. You can sometimes see that ticking around in their heads,” she adds.

Crucial to every restructure is whether or not major stakeholders of the business will support any plan. “There’s little point in going down that path if you don’t have their support,” says Barnden.

Major stakeholders are the business’s banks/financiers, suppliers (if a business owes them money they might just cut off the supply), employees (a vital asset, who are concerned about their jobs and their super payments) and landlords (who need to work with a business, particularly if it’s in vital locations).

The benefits of entering voluntary administration

While voluntary administration (VA) is more common in Australia where there’s stricter insolvent trading legislation involving director liability, it is an option in New Zealand, too.

“It’s used for business rehabilitation in such instances where you want to preserve leases because it creates an immediate moratorium on creditors taking action, including landlords,” explains Fisk.

Entering into voluntary administration has its benefits, such as standstill arrangements with creditors. That allows time for an insolvency practitioner to understand the nature of the business, its margins and staffing arrangements, and to make a financially honest or ‘sober’ assessment of its status. The practitioner may bring in new equity for restructuring the asset side of the balance sheet and realise some assets.

For a successful turnaround or restructure, a strong dose of realism and commitment to the plan is essential, Fisk adds. “Sometimes we get appointed to an insolvency where the director is affected by what’s happening in their personal life. They might have had a death in the family, a drug problem or a marriage break-up – and the knock-on effect can be significant.”

Building a second chance requires good communication

When a company is identified as financially distressed, communication is key, says Gleeson.

When he was appointed voluntary administrator of residential home builder Wincrest Homes in 2009, more than 100 customers’ houses were in various stages of construction. There were 50-plus employees and numerous contractors and subcontractors.

A committee of creditors was formed to represent each interest group and they ultimately accepted a reduction on their debt so the company could keep trading.

Having the right advisers that can help directors understand their options and the legalities is very important, but there’s an element of counselling involved in the process as well. Emotions run high.

“We can’t lose sight of the fact that every financial difficulty has a human being attached to it,” insists Gleeson. “Mismanaged finances are not always due to malicious or fraudulent intent.”

“We can’t lose sight of the fact that every financial difficulty has a human being attached to it. Mismanaged finances are not always due to malicious or fraudulent intent.”
Bruce Gleeson FCA

Often directors have their house on the line, Barnden explains, “and stressed people make bad decisions”. This leaves them vulnerable to unscrupulous operators. Companies that may have a chance of being turned around may then fall prey to the quick fix of phoenixing.

“Stressed people make bad decisions.”
Andrew Barnden FCA

Phoenixing involves stripping assets from a company, liquidating that company and then restarting the business under a different name. This is done to avoid paying creditors money owing to them

The risks from unscrupulous operators

ASIC commissioner John Price warns that unregistered pre-insolvency advisers monitor the internet and ASIC databases looking for financially troubled companies and individuals.

These advisers “often contact people out of the blue offering to fix their financial problems,” he says. “They recommend transferring assets out of companies, offer the services of a ‘friendly’ liquidator and tell directors to destroy financial records.”

Another common ruse is to tell the director to backdate their resignation from the company and appoint a “dummy” director to the company.

“All are indicators you’re dealing with someone who is untrustworthy,” says Price, emphasising that both company directors and their accountants should beware.

In the 2018-19 financial year, ASIC banned or disqualified 62 directors from managing companies, and took 55 actions against auditors or liquidators.

ASIC regulates corporate insolvency practitioners (liquidators, receivers and administrators) in Australia, while in New Zealand a licensing regime will come into effect in June 2020.

RITANZ and CA ANZ, which will be the accreditation body, have collaborated on a voluntary model, “which allows for minimal cost for government in terms of the Registrar of Companies overseeing it,” explains Fisk. A suite of reforms will also be introduced to address problematic issues, in particular for voluntary liquidations where phoenixing occurs.

Building trust in the profession is paramount, Fisk says, and he sees licensing as an important foundation in that process.

The life and death of businesses

Barnden admits that working in insolvency is not for everyone. “We’re often deemed the corporate undertaker... Some people don’t like the sometimes confrontational nature of the job,” he says.

But the rewards of rescuing a business and/or seeing employees get paid their entitlements is very satisfying, he adds.

“One day you’re running a truck stop in Cobar in far west NSW, the next matter might see you running women’s fashion brands or involve a not-for-profit in regional NSW – or even selling a timeshare resort. It’s an interesting and exciting area of accounting.”