Owners can use their personal investment to protect their business


Owners can use their personal investment to protect their business

There are approximately 2.3 million small to medium businesses (SME) in Australia.  SMEs are considered to be businesses with 19 or fewer employees and represent the biggest employment sector in the Australian economy.  Approximately 1.2 million SMEs are operated through a company structure. In a trend that has lasted for more than a decade, between two-thirds and three-quarters of SMEs do not survive more than three years.

The initial investment

In almost all cases, SME businesses start with the owner’s personal investment both in terms of “sweat” equity and personal wealth. This can be a significant initial amount or can add up to a significant amount over time. The investment is used, amongst other things, to start the business, pay wages, buy plant and equipment, and to enter into a lease.  The average amount that SME owners invest in their companies in the first three years is between $200,00 and $250,000, with some businesses needing to inject more than that. That money will typically come from personal savings, a personal loan, personal credit cards or redrawing on a mortgage loan over a property.

Protecting that investment

Owners may never recover the time and opportunity cost of their “sweat” equity, but they can at least take steps to protect their investment. To get the maximum protection for the owners’ investment and the assets of the business, the money injected into the company needs to be by way of a loan, which is in written form, with security and which is registered as a security interest on the Personal Property Securities Register (PPSR).

This provides protection to business owners throughout the life of their business.  It will give confidence for the owners to continue to make investments in their business when it is required.  It also provides comfort that if the company fails, they are in the best position to recover some or all of their investment or the assets of the business. This could mean the difference in the owners being able to continue to pay their bills and to start again.

Why advice is not reaching SMEs  

There are a significant number of accountants and advisers who advocate to SME-owner clients that they should protect the money they invest in their company as a loan.  However, the evidence suggests that advice isn’t following through to those owners registering a security interest on the PPSR.  There are likely to be several reasons for this, including:

  • people opening new businesses are not seeking advice before starting a business
  • the advice does not extend beyond noting the loan in the books and records
  • the advice suggests that the loan and security is documented but does not extend to registering a security interest on the PPSR
  • the advice is not followed because getting a legal specialist to prepare documents and register the interest on the PPSR is too expensive

The result

There is a concern, as there is a significant difference as to what an owner would recover on the realisations of assets by a liquidator, depending on whether there was either no loan, an unsecured or unregistered loan, and a secured loan registered on the PPSR.  This is due to the priority set out in section 556(1) of the Corporations Act.  The following table highlights those differences in a scenario that is typical in the liquidation of an SME:

Mark table 1Click here to view table

Timing is key

In early 2021, the Small Business and Family Enterprise Ombudsman issued a research paper that encouraged small business owners to protect themselves and the assets of their businesses in this way. It is best practice to protect the investment of owners as soon as it is made. If the amounts that were invested by owners several years ago were not protected as a written secured loan and/or were not registered on the PPSR, it is still possible to do that. However, the key to protecting that investment is to do so as soon as possible. The closer to insolvency that owners’ investment is protected in this way, the more likely they may be set aside by a liquidator.

It is important to keep in mind that it will be necessary to deal with the priority of security at such time as the company approaches the bank for a loan. The bank will insist on its security having priority over the security of the owner’s loan. If the owner’s investment is made after a secured bank loan is in place, the bank’s loan will likely require that the consent of the bank be obtained before further security can be placed on the company’s assets. This is in place to stop third-party lenders taking security. However, it is still strictly a requirement, whether or not the bank would take any action on learning of the further security.

Special thanks to Matt Kelly

This article was written with the help of Matt Kelly, the Managing Director of Krodok. Matt used to be an insolvency and restructuring lawyer who has worked with some of Australia’s biggest firms for nearly 20 years. During that time, he was confronted by a number of SME owners who came to him in the face of financial distress and said “I think I have a problem. What can I do about it?” The response was often that those businesses had a big problem and there were few options other than to wind the company up. This was often because owners sought help too late, and they hadn’t protected the investment in their company as a secured loan registered on the PPSR. Krodok was founded to help owners put this protection in place in a quick, easy and inexpensive way.

If you would like to explore the various options discussed in this article or your financial circumstances generally, please contact Mark Robinson at dVT Group on (02) 9633 3333 or by email mrobinson@dvtgroup.com.au