Keeping your investment secure – tips for business owners.


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Keeping your investment secure – tips for business owners.

How do business owners feel when they are told to join the queue to recoup some of their own money in the event of a liquidation?  Their loans could be at risk and business owners could see their hard earned money being lost if they do not take the necessary steps to protect their interests.

 

It’s very common for shareholders of a company in its infancy to regularly advance significant amounts of money to their company, in order to provide working capital – particularly as banks and other traditional lenders are unwilling to fund start-up businesses.

Once a company has a trading history and a proven record of profit, banks are more willing to lend, but will still usually require security registered on the Personal Property Securities Register (PPSR) to reduce their credit risk.

This risk mitigation strategy relied upon by banks should also be used by shareholders as an added level of protection.  Unfortunately this step is usually skipped as optimistic shareholders are unlikely to be thinking of the possibility of liquidation at this early stage of the business.  A valid security registration can act in a similar manner to a life insurance policy, becoming vital in the event of the death of the company.

What Is PPSR? 

PPSR is an online national register which is searchable for a fee.  In most cases a security interest is required to be registered on the PPSR to be valid.  The PPSR operates on a first in best dressed basis, meaning the first registered security in time has priority except in the case of a Purchase Money Security Interest (PMSI).

PMSI’s provide a super-priority over other security interests. The basis for this is to stop the earlier registered secured party receiving the benefit of the property provided by another party.

What should be done?

  1. To become a secured creditor and receive payment ahead of unsecured creditors, the first step is a security agreement evidenced in writing (and preferably prior to the transfer of funds), in which the company grants the registration of a security interest on the PPSR.
  2. The second step is registration which can cost as little as $6.80 on the PPSR done via the PPSR website (https://www.ppsr.gov.au/register-security-interests).

Case Study

The following case study outlines various scenarios and the distribution of funds in the event of a liquidation in accordance with the Corporations Act.

Barry is the sole shareholder and director of Barry’s Printing Pty Ltd and he loans $500,000 to the company to purchase a large commercial printer to start operations.   A couple of years later, as a result of a down turn in the printing industry, the business ceases to trade and a liquidator has been voluntarily appointed by the shareholder of the company.

The liquidator sells the printer at auction and realises $100,000, as well as $50,000 of trade receivables – total of $150,000 available for distribution.    Trade Creditors are owed $250,000

So what happens to those monies?  Let’s look at the impact of different security interests on the distribution of the funds.

Scenario 1 – Barry advanced funds as an unsecured loan to the company.

Barry will rank equally with other unsecured creditors, all receiving a 20 cents in the dollar distribution.  Barry (as a creditor) received $100k and the balance of $50k to trade creditors.
Scenario 2 – Upon advice from his accountant, Barry registered a security interest over All Present and After Acquired Property (ALLPAAP) of the company.

Barry will receive all of the available funds as the secured creditor of $150k.  As Barry’s claim of $500,000 has not been repaid in full the trade creditors will not receive a dividend.
Scenario 3 –  ABC Bank has a prior registered security agreement for an overdraft of $100,000 and Barry also registers a PMSI over the printer as collateral, but this does not grant him an interest in the company’s trade receivables.  The bank also holds a higher ranking security interest.  Barry will receive the printer sale proceeds of $100k and the bank will receive the proceeds from the remaining assets, in this case the $50,000 from trade receivables.  There are no distributions to trade creditors.

 

As shown in the above scenarios, the method in which security is handled results in various outcomes in a liquidation.   It is important to obtain a security agreement and get it registered when setting up a company and prior to lending money to protect business owners in the event of a liquidation.

Don’t wait until a company runs into financial difficulty to register security interests, as it may be too late and possibly be voided by the liquidator!

If uncertain about what to do, shareholders should seek advice on the selection of the appropriate security prior to advancing funds to their company, to ensure their interests are protected.

For any questions regarding this article, please contact the dVT Group on 02 9633 3333.