Why we need a better solution for insolvency

Entrepreneurs with great ideas may not always succeed. Many of our greatest companies and inventions were started by people who failed the first time. Yet, the current insolvency system is not sympathetic to honest failure and genuine prospects for recovery of the business or business owner, writes Australian Small Business and Family Enterprise Ombudsman, Bruce Billson.

Australia’s insolvency laws are being reviewed for the first time in more than three decades, and there needs to be an emphasis on optimising and preserving value in a business, instead of asset fire sales.

The current insolvency framework assumes that the failure of a business is due to poor management of that business. Yet, when a crisis shocks an economy, even the best-managed businesses will face enormous headwinds and may not survive.

The system seldom considers an insolvent company’s longer-term prospects, its competitiveness, assets, or brand value, and is geared towards closure and liquidation.

Liquidators get paid three times as much to shut down a business as they do to save it.

Why we need debt hibernation

Small businesses should have better access to ‘debt hibernation’ instead of being made insolvent when they face a crisis beyond their control, so they are better able to pursue a credible restructure, save jobs and rebuild.

A Small Business Debt Hibernation program would include a freeze on tax and other fees as well as government financial support. It would be triggered by shocks beyond the control of a small business and provide the option to hibernate their business debts, restructure and continue trading. The program could also include tools to allow businesses to assess their viability and assist with future planning.

The challenges of small business

While insolvency can occur in companies of any size, it is particularly devastating for small businesses, who face unique challenges.

We know that they often have less cash flow to mitigate against disruptions, are often underinsured, and have fewer legal protections than larger companies.

Compared to big businesses, small businesses also have fewer tools and resources, and less time to get across the full suite of legislation and regulation in relation to business management, including awareness of insolvency processes.

Small business and personal finances are typically intertwined; this blurs the line between corporate and personal insolvency. Almost 50 per cent of small business loans are secured by personal assets, such as the family home, and the most recent data shows 35 per cent of all personal insolvencies were business related.

Better business advice is needed

Small businesses need access to more timely advice – that is written in plain English – on insolvency and restructuring processes. It is also vital that enterprising men and women have access to trusted advisors with the skills necessary to manage business viability and highlight early concerns regarding the solvent nature of their business.

Small and family businesses have suffered a series of rolling disasters such as floods, bushfires and the COVID-19 shutdowns and while governments may offer support, the assistance is not guaranteed, is inconsistent across jurisdictions, varies with each shock and often delays, rather than mitigates, the impacts.

A business viability program would make it easier for small business owners to access person-to-person expert business advice and support to improve businesses’ financial acumen, forward planning skills, and understanding of insolvency processes. It would also provide an opportunity to identify cash flow or other problems early and provide tools to remedy them, such as through restructuring, which may avoid insolvency.

Pandemic support programs’ impact on insolvency

COVID support contributed to significantly lower insolvency numbers in the past two years than in a ‘regular’ year, with 4,912 corporate insolvencies in 2021-22, following 4,235 in 2020-21. In the year prior to the pandemic, there were 8,105 administrations.

With the resumption of Australian Taxation Office debt collection, compounded with soaring inflation and interest rate rises, stretched global supply chains, rising costs of materials and energy, and labour shortages, corporate insolvencies have started to return to pre-pandemic levels.

Improve insolvency outcomes

As small businesses continue to grow in Australia, there is an increasing need to review and improve insolvency processes to ensure they balance the needs of all parties, whilst being timely, affordable and effective.

Creating an insolvency framework that adequately incorporates the unique characteristics and needs of small businesses would assist productivity growth and provide for a dignified and cost-effective experience for small business exits, while preserving the entrepreneurial spirit so they have an opportunity to try again.

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