Company Seven – Construction Business

OVERVIEW

ADMINISTRATION – POOR MANAGEMENT – LACK OF CONTROL – TAXATION – TRADE ON – SECURING ASSETS – INSUFFICIENT FUNDS – SALE OF BUSINESS

Building Company was an incorporated entity that had been established to essentially provide glazing services including the installation of windows and doors to the Construction Industry. The operators had traditionally been involved in the industry and with the guidance of a couple of major project contractors had identified an opportunity to provide a specialist service entity to the industry broadly. The operators were qualified tradesmen and had a reputation for good quality work, personable site involvement and timeliness. Neither of the operators had any business training or experience.

Whilst the opportunity for partial manufacture was considered it was fortunately dropped in favour of a pure installation operation. The company quickly achieved a turnover of in excess of $1 Million per annum with a reported Cost of Sales of around 2 percent. This was achieved with around 20 full time staff including the Directors all supplemented with additional sub-contractors employed on an as required basis.

In the end the Company became reliant on one major contractor for all of its work.

Whilst all seemed OK on the surface over the three years of the company’s operations the amount owing by the single supplier steadily grew and without thorough daily bookkeeping the creditors began to grow in tandem. The most significant being employee entitlements and the Australian Taxation Office (ATO) began to grow unabated. Other creditors, fuel, vehicle and equipment repairers, tool and consumable suppliers, etc were generally small and noisy so essentially got paid on a regular basis.

Ultimately the debt to the ATO reached in excess of $250,000 and the ATO finally issued a Directors Penalty Notice (DPN) to the directors without having taken any prior action.

It is worthy to note at this point that the guidance received at the start-up stage, was as we frequently find, all related to initial set activities such as tax registrations, insurance, licences, etc with little or no guidance relating to the overall all business plan or the preparation of a budget or even a proper costing analysis.

The impact of a DPN is best summarised as follows:

  • Company Directors have a responsibility to ensure that Employee Pay As You Go Withholding, and Superannuation Guarantee Charge are met;
  • Failure to meet these liabilities and obligations will result in the Director becoming personally liable for amounts outstanding to the Deputy Commissioner of Taxation (“DofT”);
  • The DofT will issue a formal Notice to the Director(s) detailing the nature and liabilities outstanding, and the requirement to satisfy same.
  • The Notice will specify that the Company has twenty-one (21) days to action one (1) of the following:-
    • Pay the amount in full;
    • Enter into a payment plan with the Australian Taxation Office; or
    • Place the Company into a formal External Administration appointment.
  • Generally, if a Company is unable to satisfy its trading and taxation liabilities, the Directors will resolve to place the Company into a Voluntary Administration appointment as it is an easier process, and provides greater avenues/outcomes for the Company.

Clearly such notices are not the most preferred wake-up call that a director should receive. Regrettably in this instance the notice was ignored until virtually the last moment leaving essentially no alternative but to immediately appoint an Administrator. It is always better that a proper analysis be conducted but there are instances where this is not always possible.

The immediate steps taken were those required to continue the operations whilst a detailed analysis could be conducted. This involved:

  • Taking control of Company Assets, particularly, Company Bank Accounts;
  • Obtaining all relevant Books and Records, including Management records to correctly prepare cash flow forecasts, budgets, collections etc;
  • Notifying Employees of the appointment of the Administrator, their duties and continued trading;
  • Notifying Debtors and Suppliers of appointment and continued trading; and
  • Other required tasks, for example, understanding business operations, identifying Company obligations (i.e. rent, fees, etc) and attending to statutory compliance task imposed on the Administrator etc.

Once those steps were locked down it was then possible to begin to conduct the initial detailed investigations. These effectively fell into two broad areas, firstly the company’s ability to operate going forward and secondly what assets actually existed or had recently been owned by the company.

We were able to quickly discern what real assets existed and whether any of these had been dissipated inappropriately over the period of the company’s operations. This was easy simply because there had not been any attempt at fraud or removal and that the company’s books correctly reflected the overall operations. It very quickly became clear that the only really valuable asset was the debt from the major customer. This meant that ceasing to trade would most likely result in a complete or virtually complete loss of this asset.

At the same time we were conducting an assessment of the businesses operational capacity and profitability so as to establish what funding could be available from future operations to enable the creation of a fund for the existing creditors to be paid from. It was during this process that it was determined that the business had effectively been operating on a zero margin. With a turnover of in excess of $1.3 Million the shareholders would be lucky to reap $20,000 a return of less than two percent provided nothing went wrong. The customer also would not review pricing under any circumstances.

It was very quickly clear that the business in its existing shell and the directors were essentially advised that unless we were able to sell the business then it would cease operations within the week.

The directors immediately sought the advice of new external advisors who shortly advised that it was their intention to arrange a purchase of the business notwithstanding that such an action was against our better advice.

The business was sold and the best possible value of the existing assets were obtained for the old entity, which went to meet some costs and part of the employee entitlements; but no more.

There are many trades and others that are placed into this situation where they are essentially forced to incorporate a job, rather than realistically create a business. In these situations it is invariably the government that is the biggest loser.

Interestingly to look at the issue from an external perspective, if an agency such as the ATO were to establish a review team that conducted regular reviews of businesses operating within such environments, whilst they were still operating so as to determine the commerciality and more important the sustainability of such arrangements and forcing the cessation of those that are not would go a long way to achieving the following:-

  • A reduction in unclaimed monies by the government
  • The significant loss of personal wealth by operators that should never have been business owners, and
  • The tidying up of an industry renowned for it significant involvement in insolvency.

Remember it is not the process in this case study that is at fault but two key factors common to many such situations.: –

  • One or very few customers who call ALL the shots, and
  • A commercially unsustainable pricing structure that drives the subcontractor to use ATO funds to remain operational, at least until the time that the ATO commences action.