When is borrowing not the answer for a struggling business?

Business Loan Store helps businesses compare finance. We also believe finance is not always the right answer, and this page explains when it isn’t. If you are under pressure, the most useful next step is often a conversation with a financial counsellor, your accountant or a registered liquidator, not a loan application.

When more debt can make things worse

A loan brings cash in once. The repayments go out every week or month after that. That trade works when the business earns enough to meet them. It does not work in these situations.

The business is making losses

If your costs are higher than your income month after month, borrowing covers this month’s shortfall and adds a repayment to next month’s. The gap usually grows. The fix is to change the business: prices, costs, what you sell or who you sell to. Only then can finance help.

The business may be insolvent

ASIC describes a company as insolvent when it is unable to pay its debts when they fall due. Directors have a duty to prevent the company incurring debts while it is insolvent. ASIC says directors should consider whether there are reasonable grounds to suspect the company is insolvent before taking on new obligations, and that breaches can lead to civil penalties, compensation claims or criminal charges. A new loan is a new debt. If you are unsure whether your company can pay its debts as they fall due, get advice before you borrow.

Borrowing to pay old debts without a plan

Using a new loan to pay the ATO, a supplier or an older loan can make sense as part of a clear plan. Without one, it often moves the debt to a lender with less flexibility, higher costs and security over your assets or your home. Taking a second loan to make repayments on the first is a strong warning sign.

Repayments depend on hope

If the only way you can repay is a contract you haven’t won yet, or sales returning to where they were years ago, the loan is a bet, not a plan.

Personal guarantees and your home

Many business loans ask directors for personal guarantees or security over property. That can turn a business problem into a personal and family one.

A quick test before you borrow

Answer these with your accountant:

• Is the business profitable before the new repayments?
• Is the cash gap temporary, with a known end date?
• Does your cash flow forecast show you can meet the repayments?
• Will the loan fix the cause of the problem, or only cover it for a while?
• Are your tax lodgements, super and employee payments up to date?

If any answer is no, or you are unsure, get advice before you apply.

Alternatives to borrowing

An ATO payment plan

If you owe tax, the ATO asks you to contact it, or speak with a tax professional, before your lodgements and payments are due. You may be able to set up a payment plan. The ATO says tax debts on a payment plan continue to accrue the general interest charge (GIC), which compounds daily. You must lodge on time and pay new debts, or the plan may default and the full overdue balance become payable. See ATO payment plans for business and what happens if you can’t pay the ATO.

Negotiating with creditors

business.gov.au suggests explaining your circumstances to creditors and asking whether they have hardship provisions or payment plans, and keeping a record of every conversation. ASBFEO advises paying what you can now and offering a realistic plan, making sure any payment you offer is within your means. Your bank may also have hardship options. A financial counsellor can help you prepare for these conversations.

Cutting costs and freeing up cash

business.gov.au suggests reviewing all spending, switching suppliers where it saves money, reducing stock that is too high and selling assets you no longer need. Collecting money customers owe you is often the fastest source of cash. See what is working capital? for more ways to improve cash flow without borrowing.

Small business restructuring (companies)

ASIC describes small business restructuring as a process that lets an eligible company keep control of its business, property and affairs while it develops a plan with the help of a restructuring practitioner. ASIC lists these eligibility points, among others:

• total liabilities of no more than $1 million on the day the restructuring begins
• employee entitlements that are due and payable have been paid
• tax lodgements are up to date
• the company, and its directors, generally have not been through a restructuring or simplified liquidation in the previous seven years.

Only a registered liquidator can be the restructuring practitioner. The company generally has 20 business days to propose a plan, and creditors then have 15 business days to accept or reject it. While the restructuring is under way, unsecured creditors generally can’t begin or enforce claims against the company without the practitioner’s consent or the court’s permission.

Safe harbour (company directors)

ASIC explains that directors may be protected from personal liability for insolvent trading if they start developing one or more courses of action that are reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator. ASIC’s Regulatory Guide 217 says the protection generally depends on the company paying its employees’ entitlements and meeting its tax lodgement obligations. Advisers who can help include registered liquidators, lawyers and accountants with the right experience in insolvency. Safe harbour is not a way to keep trading and hope. It needs a real plan and qualified advice.

Sole traders and partnerships

If you run the business in your own name, your business debts are your personal debts. AFSA explains that options include informal arrangements with creditors and formal options such as debt agreements, personal insolvency agreements and bankruptcy. Each has serious consequences, so get free advice first.

Voluntary administration and liquidation

For some companies, ASIC notes that voluntary administration or liquidation may be the right step. These are run by a registered liquidator. Getting advice early means you can choose the option, rather than a creditor choosing it for you, for example through a statutory demand.

Speaking to a registered liquidator or restructuring practitioner

ASIC’s guidance is to seek professional help promptly from a registered liquidator or other qualified adviser. An early conversation does not commit you to closing the business. It helps you understand your position and your options, including restructuring.

• Check that the person is a registered liquidator on ASIC’s professional registers.
• Ask whether they are a member of a professional body and subject to a code of conduct.
• Be wary of anyone who approaches you uninvited offering to make debts disappear. ASIC warns that some dishonest advisers target struggling businesses, and some schemes involve illegal phoenix activity.

Step by step

1. Stop and take stock before signing any new loan.
2. Bring your books up to date and prepare a 13-week cash flow forecast.
3. Call the Small Business Debt Helpline on 1800 413 828 for free financial counselling.
4. Meet your accountant or registered tax agent to review whether the business is profitable and viable.
5. Contact the ATO about any tax debt before the next due date, and keep lodging.
6. Talk to your key creditors and your bank about hardship options.
7. Cut costs, collect debts and sell assets you don’t need.
8. If you run a company and may not be able to pay debts as they fall due, speak to a registered liquidator about restructuring, safe harbour and your other options.
9. Consider finance only if your adviser agrees it is part of a workable plan.

Support services

• Small Business Debt Helpline: 1800 413 828. Free financial counselling for small business owners.
• National Debt Helpline: 1800 007 007. Free financial counselling for personal debts.
• Mob Strong Debt Help: 1800 808 488. Free legal advice for Aboriginal and Torres Strait Islander people.
• Rural Financial Counselling Service. Free help for farmers, fishers, foresters and related small businesses.
• ASBFEO information line: 1300 650 460. Information and dispute help for small businesses.
• AFSA. Information on personal insolvency options for sole traders and partners.
• NewAccess for Small Business Owners. Mental health coaching from Beyond Blue, listed by ASBFEO.

When finance can still make sense

Finance can help a profitable business through a short, predictable gap, or as one part of a plan agreed with your accountant or adviser. If that is your situation, our cash flow warning signs and how much working capital do you need? pages will help you check first.

Important things to know

• Free help is free. Moneysmart warns that businesses charging fees for debt help are debt consolidation and refinancing companies, not financial counsellors.
• Unpaid tax and super carry personal risk for directors. Read what is a director penalty notice?
• Delay rarely helps. ASIC’s message to small business directors is not to ignore warning signs in the hope that things will improve.
• Look after yourself. ASBFEO notes that debt can take a heavy toll on small business owners. Talking to someone early helps.
• This page is general information. Restructuring, safe harbour and insolvency depend on your facts. Get advice from a registered liquidator, lawyer or accountant.