Date posted: 17/12/2020 8 min read

Why insolvency is not the only option, post-lockdown

The economic fallout from pandemic lockdowns was a body blow for many businesses. So, what happens after the plague?

In Brief

  • As support is being wound back, business owners are being forced to face the reality that the worst is probably yet to come.
  • Insolvency practitioners have been experiencing an unprecedented downturn in inquiries as ‘zombie’ businesses were kept alive by government support.
  • By delaying seeking advice and taking on new debt, businesses may be decreasing their chances of a successful restructure.

By Deborah Tarrant

The year 2020 kicked off on a high for Brent Spillane, the managing director of New Zealand’s largest trade show organiser, XPO Exhibitions.

After acquiring competitor North Port Events in October 2019, he was anticipating an outstanding year with 18 major events encompassing 3500 exhibitors and some 150,000 visitors. But by March, COVID-19 had struck.

This year, the 20-year-old family business has cancelled or rescheduled 16 events due to the preclusions and unpredictability of lockdowns and social distancing. And, despite wage subsidies, the company has almost halved its number of employees (from 41 to 21) while managing desperate exhibitors, many of whom rely on trade shows as their shopfronts.

Businesses must adapt to survive

XPO has changed its lens on the business. “It’s not about profitability anymore, it’s just about cash flow and getting shows moving… The key is survival,” says Spillane.

“It’s not about profitability any more, it’s just about cash flow and getting shows moving… The key is survival.”
Brent Spillane, Managing director, XPO Exhibitions

Its restructure involves running a flexible business model with online offerings that draw on its huge database of buyers and sellers in niche industries.

Drawing on its long relationship with JDW Chartered Accountants, and an in-house finance function headed by Anthony Trigg CA, XPO had a series of cash-flow scenarios from best to worst in hand when it applied for a NZ$5 million low-interest government-backed business loan in September, with a view to securing working capital to the end of 2021.

“The challenge we have as a business is that a lot of our shows take more than 12 months to organise, promote and engage the sector to understand their latest relevant issues,” explains Spillane, who says he’s been asked by many about the viability of the business.

As uncertainty reigns, Spillane remains confident, not least due to the benefits of having good advice. JDW worked on the North Port acquisition, which was part-funded by XPO’s directors, and longer term has been focused on protecting the company’s balance sheet from unpredictable events – such as COVID-19.

“Had we loaded the business with debt for the acquisitions, we’d be in a much worse position,” he says.

Meanwhile, the company’s management is picking up some of the excess work, taking calls as the finance team keeps moving on restructuring contracts with thousands of exhibitors, many of whom want refunds.

What’s spurring Spillane on is a belief in the future of face-to-face exhibitions “where people can kick the tyres of an exhibitor’s business to fully understand the integrity of the people behind the products and their supply chains before investing”.

Why insolvency is not the only option, post-lockdownPicture: A cafe owner stands outside his premises as his first customer enjoys a coffeee in Sydney's Neutral Bay in May 2020.

Is the worst still to come?

XPO is a stand-out example of a business that’s moved fast to adapt in the face of extreme pandemic-induced adversity in a year of great angst for business.

With lockdowns, border closures, disrupted supply chains and consumers prevaricating on whether to spend or save, the economic fallout of the COVID-19 health emergency has been catastrophic for many.

Governments have stepped in with a raft of stimuli, while banks have deferred loan payments, tax offices are holding off on debt obligations and some landlords are being considerate to help people cope.

In Australia, as well as backing for business loans and JobKeeper wage support, cash-flow boosts and now instant asset write-offs, the government has allowed company directors exemptions for personal liability for trading while insolvent until December 31.

In New Zealand, iterations of the Wage Subsidy Scheme have worked together with small business loans and the Business Finance Guarantee Scheme, and temporary “safe harbour” protections for directors.

However, as support is being wound back, some business owners are being forced to face the unpalatable reality that, difficult as 2020 has been, the worst is probably yet to come.

Why insolvency is not the only option, post-lockdownPicture: XPO Exhibitions was anticipating an outstanding 2020 with 18 major events on the books.

Bracing for a wave of insolvencies

Predictions abound of a ‘tsunami’ of zombie businesses – unviable enterprises bolstered by handouts and special concessions that should have shut down but have continued to trade. Insolvency practitioners have been experiencing an unprecedented downturn in business.

Typically, about 2000 Australian companies each quarter go into some form of external administration, however numbers have been down by about 70% since the pandemic hit, explains Andrew Barnden FCA, chair of CA ANZ’s Insolvency Management Committee and a director of international insolvency network. Rodgers Reidy. Now, they are bracing for an upsurge in activity.

By pre-COVID standards, Barnden estimates that at the end of December 2020 about 4500 businesses should require restructuring or winding up in Australia. And that’s not factoring in those impacted by COVID-19 and the recession.

Earlier this year, Deloitte Access Economics calculated stimulus withdrawal could cause about 240,000 Australian businesses to fail.

John Fisk FCA, managing partner at PWC New Zealand and chair of Restructuring Insolvency and Turnaround Association of New Zealand (RITANZ), sees a similar giant wave of insolvencies looming.

Businesses that were already struggling or in industries experiencing disruption before COVID-19, such as retail and commercial property, are at particularly high risk, he suggests.

While Fisk notes that “zombie companies compound the problem by taking business away from other companies that should be viable,” Barnden believes tipping points for many will come with landlords applying pressure for the payment of full rent – and the ATO debt collection regaining pace.

Delaying action is not an option

“Take action early!” is the catchcry of accountants and insolvency practitioners for ailing businesses. But with stimulus and deferral of payments to creditors, too many may have missed the moment.

Smart businesses have used this time – when liquidity has been good and directors’ duties lightened – to plan and understand their risks and options, says Fisk.

Formal appointments have been down, but some have been quietly planning and working on informal restructures behind the scenes.

Jonathon Colbran FCA, a partner at Canberra restructuring and recovery firm RSM and a CA ANZ Public Practice Advisory Committee member, says his phone “lit up like a Christmas tree” when lockdowns were announced, but his priority list of 15 urgent appointments rapidly dwindled to nothing as businesses tapped the stimulus. Instead, he’s been working with directors, sophisticated investors, financiers and creditors mapping out “plan Bs”.

Barnden also reports larger listed corporations have shown an appetite for restructuring and reviewing, discussions with senior debt players and using “safe harbour” provisions.

“They’ve been looking at impacts on traditional income streams and changing their models, products and services – by improving their online presence, cutting costs, diversifying and increasing prices if it won’t affect sales levels, selling surplus assets, making better use of the balance sheet and, in some cases, making redundancies.”

Small and medium enterprises, however, are a different story. Most are taking a precarious wait-and-see approach.

“I’m seeing mum-and-dad businesses with sub $5 million of debt just sitting on their hands, hoping to get by with very little strategy,” says Colbran.

“I’m seeing mum-and-dad businesses with sub $5 million of debt just sitting on their hands, hoping to get by with very little strategy.”
Jonathon Colbran FCA

Many have been “kicking the can down the road with the sugar hit of wage subsidies [which stopped in New Zealand in October],” observes Fisk. “Other measures have loaded debt onto companies that may not have the capital to cope with it.”

By delaying seeking advice and taking on new debt, they may be digging a deeper hole and decreasing their chances of a successful restructure.

Making tough decisions to survive

In August, Barnden was appointed by the directors of a 20-year-old Sydney-based training college specialising in English and vocational courses in business, fitness and childcare as it watched enrolments of international students from key markets – Japan and South America – plummet. The directors made the hard, but necessary, decision to opt to place the company into voluntary administration.

Key moves included cutting cash burn by exiting leases for CBD and suburban premises, moving from classrooms to online learning, refining the group’s offering and negotiating with competitors to take on students enrolled in unprofitable courses, together with reducing staff numbers. As a result, creditors were paid 100 cents in the dollar through a deed of company arrangement (DOCA).

“The business can survive on a reduced basis in the short term and now is considering a merger. It’s about being able to continue to operate, albeit on a smaller scale, rather than doing nothing and dying a slow death,” says Barnden.

Colbran, however, sees risks lurking for accounting practitioners who – in the wake of 29 recession-free years in Australia – may have little experience in insolvency. One sole practitioner recently asked him to look over a plan that unwittingly was a textbook case of an illegal phoenix – transferring assets from company A to company B with no valuation and leaving the debts in the old company.

“In the months to come, chartered accountants and business advisers who don’t have expertise around restructuring and insolvency matters must be careful of giving the wrong advice,” Colbran emphasises.

When a business fails, liquidators look first to its advisers to ascertain whether directors followed the recommended course of action. “Be sure there’s an insolvency expert who helped you map out the options in your file notes,” he advises members.

Likewise, he says it’s important for directors to understand that despite the current moratorium on insolvent trading, directors’ duties remain in place. “They will be liable for every commercial decision that’s made to incur debt via personal guarantees to the bank, suppliers and the ATO.”

Colbran says a good question for every head-in-the-sand director right now is: “How will you reply in 12-24 months when a liquidator asks what steps you took to navigate the COVID-19 crisis and the failure of your business?”

Revisiting the fundamentals

While times certainly have changed, adequate cash flow and the ability to repay debts on time remain definitive indicators of business viability.

Businesses that can’t afford to pay tax will be prevalent, according to Fisk. “If you are a bar with very small margins and you’ve gone a few months without paying PAYG and GST, it’s going to take a long time to generate the profit you need to repay that debt.”

Ironically, cash-flow forecasting is more critical in uncertain times, and more difficult.

Forecasts must contemplate seriously impaired trading positions, be regularly monitored and updated, and they start with having all books and records up to date, says Colbran. Poor record-keeping is one of corporate regulator ASIC’s top listed reasons for business failure.

Business owners will want to be really optimistic, he observes, which puts the onus on accountants to provide reality checks when reviewing clients’ financial positions – actuals versus forecasts.

There are upsides to the COVID crisis. Serena Irving FCA, partner at JDW, says it has pressured businesses into new things. “We’re doing forward projections for people who have previously been resistant,” she says, although planning three to six months out now is challenging for some.

Alice Ruhe FCA, a partner at insolvency practice Sellers Muldoon Benton (SMB), believes that even for those who have managed to date, it’s the perfect time to revisit fundamentals. She advocates SWOT and PESTEL analysis and Porter’s Five Forces framework for analysing the competitive environment, which, for every business at the end of 2020, surely has changed.

New reforms may simplify wind-ups

While the standard tools for financially distressed businesses, from informal restructures and voluntary administration (VA) to liquidation and receiverships, have been underused this year, on 1 January 2021 the Australian government will add a new measure to the toolkit for the expected rush of businesses facing insolvency.

Aimed at cutting complexity, time and costs of restructuring and winding up small businesses with liabilities of less than A$1 million, the legislation – undergoing a consultation process at the time of writing – has three significant reforms: A simplified restructuring process, using features similar to the US Chapter 11 bankruptcy regime, is intended to keep business owners trading and in control with the guidance of a small business restructuring practitioner; a simpler liquidation pathway for faster and lower-cost liquidation, increasing returns for creditors and employees; and measures to help insolvency specialists respond to high demand, including temporary waiving of fees for registering as a liquidator and establishing a new classification of insolvency practitioner for the new restructuring process.

Industry leaders believe “the devil will be in the details” of subsequent rules and regulations. They are keenly focused on the qualifications required for the new restructuring practitioners.

The success of “giving the keys back to the directors” – in contrast to VAs where responsibilities rest with professional administrators – will depend on them having the skills to make the business profitable again, explains Barnden.

All experts interviewed for this story agreed that making insolvency processes easier for small businesses is a no-brainer. However, due to the short time available for consultation on the new framework, Chartered Accountants Australia and New Zealand is calling for its review in 12 months

What will the New Year bring?

Fisk predicts big wake-up calls. “Come early 2021, reality will start biting for many businesses,” he says. “There will be people who will do well out of this situation – the ones who adapt quickly and find a new model for their business may come out of it stronger than when they went into it – and others will fail.”

“There will be people who will do well out of this situation – the ones who adapt quickly. . . may come out of it stronger than when they went into it – and others will fail.”
John Fisk FCA

Both Barnden and Fisk spy wealth on the sidelines.

“Many appear to have been waiting for a downturn,” says Barnden. “Private equity is interested in buying up businesses and injecting capital. A lot are waiting for the bottom of the market.”

Fisk also believes that insolvency practitioners’ roles will evolve beyond dealing with appointments and processes to recover debt. He sees them exploring equity solutions to properly capitalise businesses in a recessionary environment.

Watch this space.

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