Businesses aren’t going broke. Experts are worried it will create a bigger problem

As the pandemic roared in during early 2020, rapid and astonishing shifts were made to prop up an economy sledgehammered by lockdowns, restrictions and fear.

‘Safe harbour’ insolvency laws were written to protect companies unable to predict future turnover.

The Australian Tax Office (ATO) stopped pursuing debts as the pandemic unfolded. Tens of billions of dollars in stimulus were pumped into the economy.

And, as a result, businesses stopped going broke.

However, even as the economy recovers to a new kind of normal, the number of businesses going into administration each year is thousands below pre-pandemic levels.

“There are definitely businesses that, in ordinary times, would have gone under that were able to continue trading,” Scott Mason of credit reporting agency Equifax says.

However, the drought of insolvencies doesn’t mean that companies are necessarily doing better.

Instead, there are distressed companies still operating that should have been killed off long ago — taking people’s money even as they circle the drain.

And Scott Mason says that’s a big problem for their customers and suppliers.

Insolvency drought

Since 2020, the Australian Taxation Office (ATO) hasn’t been chasing outstanding debts.

That knock on the door is often the trigger for a company to enter administration, so there’s been a drought of insolvencies, a slump so stark many insolvency practitioners had to access the JobKeeper wage subsidy themselves to keep their doors open.

Australian Securities and Investments Commission (ASIC) data reveals that in the two-and-a-quarter years since the pandemic began in Australia, just 10,530 businesses have entered administration.

That’s fewer than went under in the separate financial years of 2008, 2011 or 2012. The 10-year average of companies going into administration is 9,300 a year.

“I think, over the coming months, we will start to see some movement in insolvency,” says Robyn Esrkine, partner of insolvency firm Brooke Bird, “and I think that’s going to be upwards.”

She says law changes, programs like JobKeeper and the ATO giving companies a reprieve from paying tax debts changed the usual cycle of business that sees almost 10,000 go under in a normal year.

That means a likely increase in companies going into insolvency, Ms Erskine says.

“I think that those businesses that haven’t been able to pay their debt — and we know that there is a lot of unpaid taxes, there was a lot going into COVID — those businesses now are going to be asked to pay.”

Big numbers

In the ATO’s 2020-21 annual report, total debt was $58.8 billion, and just 65 per cent of that — $38.5 billion — was “collectable”, meaning likely to be paid.

Most of that owed, achievable debt is owed by small-to-medium enterprises (SMEs).

Previously, secret documents revealed public and media pressure stopped the tax office going harder in pursing debts owed by small businesses struggling through the COVID-19 pandemic.

The reports — obtained using the Freedom of Information (FOI) process — reveal the ATO set up a softer approach during COVID, sending text messages, sending blue rather than “firmer” orange letters, and a move away from “stronger action” in “favour (of) help and assistance” for small business.

However, the amnesty is now over. The tax office wants its money.

Also revealed in the documents, a successful threat to dob in companies with tax debts to credit-reporting agencies, which could cause those companies’ clients to stop doing business with them.

“The outcome we are seeking is behavioural change and engagement rather than actual disclosure,” the document reads, outlining the gambit.

It worked. Notices of the threat were sent to 70 companies in August last year.

All but one paid up, a total of $6.5 million came in, and no companies were dobbed in.

As of August 31, 2021, the tax office had issued 842,845 reminder letters, with around 55 per cent of them going to small business.

At the time of contacting the ATO for this article, it had sent out letters warning about outstanding debts to 29,552 businesses.

A further 52,319 letters warning about the potential for Director Penalty Notices (DPNs) were sent to people in charge of these companies.

Texts and letters

Tax commissioner Chris Jordan told senators in February that the ATO was taking a measured approach.

“We are concerned that the longer businesses stay out of engagement with us, the more problematic the collection of those debts is,” he told the Senate.

“We have to focus in as empathetic way as we can, but it is something we just have to get on with.”

Danger for customers

Scott Mason is general manager of commercial and property services at Equifax, one of the companies that would have been “dobbed to” had the ATO’s gambit been unsuccessful.

He sees danger ahead as companies that should have gone under a long time ago are forced to wind up.

“A lot of those companies continue to survive where, ordinarily, they may well have gone under,” he says.

In the past two years there’s been a lot of discussion of so-called “zombie businesses”, artificially propped-up by the JobKeeper wage subsidy, low interest rates and the tax debt moratorium.

Now rates are rising and those supports are gone, so the pressure is on.

Mr Mason says small operators are dipping into their personal finances, a sign of growing stress.

“So, clearly, there’s some pressure down at that end of the market.”

Construction demolition

The problem is acute in the construction industry.

Iconic firm Grocon collapsed in 2020 and this year mega-builder ProBuild — with its $5 billion pipeline of work — fell over.

Since then, ABD Group, Privium Home, Condev and, most recently, Next, went under.

Equifax data suggests that, while the overall rate of insolvencies in March 2022 was up 5 per cent on last year, construction insolvencies were 28 per cent higher.

In the first quarter of the year, compared to the same period in 2021, 270 construction companies filled for insolvency, a 21 per cent jump.

Stretched global supply chains have fed into soaring costs for materials.

Ongoing border closers boosted a hot labour market, meaning tradespeople have been charging more.

“It’s created a ‘profitless boom’, with many construction companies committed to projects that are no longer financially viable, thanks to major price increases for building materials,” Mr Mason says.

Anneke Thompson, the chief economist for credit reporting firm CreditorWatch, agrees.

“Over the last few years margins have really compressed,” she says.

The issue with construction is that intense competition meant some companies won contracts that left them with only thin profit margins.

With skyrocketing costs — and being unable to recoup them — they’re losing money on the deals.

“Fixed pricing is a real problem for the sector,” she says.

“In other industries, when their costs rise or fall, they can change their pricing.

“You see the evidence of that at the supermarket. When you buy fruit and vegetables, the prices are changing, based on their costs.

“The construction industry can’t do that.”

The danger for consumers — and people working in construction — is that it’s often hard to tell if a company is in trouble, until it’s too late.

“It’s difficult to see from the outside,” Ms Thompson says.

Research from CreditorWatch suggests the hospitality and entertainment industries are currently the sectors with companies at the greatest risk of default, ahead of even construction.

Money forward

For OptiPay chief executive Angus Sedgwick, a surge in new customers is a sign companies are stretched.

“Particularly, the construction industry is under pressure because of, obviously, the supply chain issues and the inflationary pressure that [have] caused increases in the cost of materials,” Mr Sedgwick says.

“And many of these builders and developers have entered into fixed-price contracts, so that they’ve got to absorb all these increases in costs.”

However, Mr Sedgwick is confident the tax office will take slow steps.

OptiPay is in the business of invoice financing.

Here’s how that works: Dave’s Concreting has done a job for a big client and is owed $10,000 in two months. An invoice financing company buys the debt, pays Dave 90 per cent of it in cash immediately and eventually receives the invoice’s value, profiting from the 10 per cent leftover.

It’s very common in the US and UK, and is a long-standing way for companies to improve their cash flow that helps to get money coming in more quickly to balance payments going out.

“If you are selling your goods or services on credit, you’re effectively giving your goods or services away for free for that credit period,” Mr Sedgwick explains.

But it’s not without controversy, most recently the focus was on the collapse of globe-trotting firm Greensill Capital.

The increasing popularity of this type of business goes some way to explaining why the victims of corporate collapses in the field of construction are often small-to-medium-sized subcontracting companies — “subbies” — that are not household names.

“Most subcontractors — whether they be plumbers, chippies, whatever they might be — generally have two to three months of their own expenses into a job before they put in their progress claim,” Mr Sedgwick explains.

“So they’re always running about two to three months of expenses and bills and subcontractors’ wages, etc., that they’ve got to fund before the debtor — whoever that may be, that they’re doing the work for — actually pays them.”

The model means the subbies are outlaying money — services, staff and supplies — and relying on companies to pay them months after the costs have been sunk.

This means a host of small companies can spend a lot of money before the music stops and things fall apart.

What now?

Equifax’s Scott Mason is confident about what will unfold as the tax office restarts its normal business collecting revenue owed to it.

“What you have seen is — on the good side — you’ve got still a lot of availability of funds [and] people are still trying to lend. We’ve got a lot of good consumer confidence still, and business confidence in the market,” he says.

Ms Erskine — who sits on the board of INSOL, a world-wide federation of insolvency experts — is not bracing for a rush of troubled companies.

“I think it might be a slow burn,” she says, seeing the turnover of unviable firms as a healthy part of the economic cycle.

“These zombie businesses suck resources,” she argues.

“So, it is in everyone’s interest that viable businesses are supported, that they have an even playing ground — that they’re not competing against businesses who are not paying their taxes and not paying their employees — for our country to move forward and prosper, which is what we all want.”

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