What is an SME? - Governance Institute of Australia

Governance challenges for SMEs
Tony Stumm
Carter Newell, Brisbane
What is the current environment for
• General economic conditions, cash flow pressures
due to difficult retail trading conditions.
• Considerable financial uncertainty and lack of business
• Rising numbers of business closures, corporate collapses
and bankruptcy.
• Tighter lending conditions.
• Margins being squeezed.
• Concerns on both existing and future markets.
What is an SME?
• Family businesses or close knit business structures varying definitions.
• Small enterprise = 10 to 100 employees.
• Medium enterprise = 100 to 500 employees.
• Annual turnover up to $10M qualifies as SME.
• Corporations Act guidance section 45A. A large
proprietary company must meet two of these three tests:
– Consolidated annual revenue of $25M or more; and/or
– Consolidated gross assets of $12.5M or more; and/or
– 50 or more employees.
• A small proprietary company is the converse.
Problems affecting SME’s in Australia
• Findings of CPA Australia and Canada July 2010
• SME’s need access to funds.
• Cut unnecessary red tape.
• Straight forward tax system.
• Reduced consumer spending restricting margins.
• Compliance fatigue.
• Improved basic management needed.
• Ability to respond.
Special characteristics of SME’s
• Lack of financial and human resources, including
managerial resources.
• Limited personnel in comparison to larger companies.
• Lack of strategic vision and long term planning.
• Outmoded work planning practices.
• Reliance upon owners.
2012 PWC Family Business Survey
• The results of PWC’s 2012 Family Business (World)
Survey show that family firms are robust, vigorous and
successful – they’re ambitious, entrepreneurial, and
delivering solid profits, even in the continued uncertain
• These businesses are making a substantial but undervalued contribution to stability and growth.
2012 PWC Family Business Survey
Unique characteristics:
• “When you are a privately held company you have the
ability to change the direction rapidly and do not have a
board of directors that dictates what you have to do”.
• “We have a more autonomous decisionmaking capacity and especially more
flexible management”. (France)
2012 PWC Family Business Survey
• “In a family owned business you tend to think on a long
term basis, not a short term basis. You tend to think
about your business over generations and not just only
based on profits” (Austria).
• “A lot of our customers like doing business
with us because we have good values.
We can adapt more readily to customers’
needs because we are so flexible” (USA)
2012 PWC Family Business Survey
• Even more crucially, family businesses often face
difficulties accessing significant levels of new capital to
fund expansion.
• The three issues identified by most respondents were
market conditions (54%), competition (27%) and
government policy and regulation (27%).
• The recruitment of skilled staff and shortages of labour
have become more acute challenges than they were in
2012 PWC Family Business Survey
• 59% of survey respondents cited price pressures as a
likely future issue.
• Anticipating and addressing regulatory requirements
and changes are a particular concern.
• “Corporate governance standards are an issue – if we
want to grow then our standards will need to be up to
speed with international best practice – in India the
majority are not up to speed”. (India)
2012 PWC Family Business Survey
Unexpected Data:
• Taken overall, more non-family members on the board,
a figure which increases to 75% for firms with turnover
of more than $100m.
• “Family businesses do not place enough importance on
proper procedures and governance”. (Middle East)
2012 PWC Family Business Survey
• “[We need to] bring outsiders onto the board of the
company, and learn how to deal with that. Also the
organisation of internal processes to streamline our
operations. In other words, the professionalization of
management”. (Brazil)
• Fewer than half of family businesses plan to pass the
business fully (ownership and management) to the next
2012 PWC Family Business Survey
So what are family businesses looking for?
• Family businesses – like all businesses – want to see a
reduction in red tape, a more stable economic
environment, low interest rates, a more flexible
labour market, further incentives for employment and
training, a more consistent tax and regulatory
framework, and investment in infrastructure.
2012 PWC Family Business Survey
• Around 97% of all private sector business in Australia are
SME businesses.
• SME’s provide around 50% of Australians with
• SME’s have corporate governance needs – but different
to those of public companies.
2012 PWC Family Business Survey
• Financial management tools and understanding.
• No suitable model for adapting ‘big business’ corporate
governance to SME’s.
• On going affordable access to professional advice.
• Sound, affordable, planning i.e. for expansion,
succession planning.
What can Corporate Governance do
for SME’s?
• SME perception:
• Why do SME’s need more rules?
• What protections does Corporate
Governance provide?
• What are the cost benefits?
• Corporate governance won’t improve profits.
Corporate Governance challenges for
SME’s - Insolvency
Issue No. 1 – Insolvency
• Without regular data retrieval and reporting, i.e.
financial management tools, insolvency can be a real
• SME’s need to be conscious of “tell tale” signs
indicating financial stress on a business that can lead
to insolvency.
• Difficult trading conditions heighten need for vigilance.
What is insolvency?
- Inability to pay debts when they are due for payment.
The “tell tale” signs of insolvency
• Discussed in detail in ASIC Regulatory Guide 217 and
ASIC Information Sheet 42.
• Limited cash flow (including reasonably projected cash
flow) to pay debts and commitments (including future
commitments) a classic symptom.
• Frank assessments are required.
What if an SME collapses due to
• A director of a company has a duty not to allow their
company to trade whilst insolvent.
• If their company collapses and is liquidated, the liquidator
can recover against directors the value of all debts incurred
whilst the company traded whilst insolvent.
• There is “relation back” of personal
liability on directors to the date found
to be the insolvency date.
• Section 588E – deemed insolvency
because of improperly kept financial records.
Other consequences for corporate
• Civil penalty against directors i.e. fine up to $200,000.
• Disqualification from being a director.
• Possible criminal offence where insolvency caused by
dishonesty of a director (penalty up to $220,000 or
imprisonment up to 5 years or both).
Defences (see section 588H)
• Reasonable grounds to expect solvency.
• Reasonable grounds to believe a competent and
reliable person providing reliable information about
the solvency of the company.
• When the debt was incurred, the director did not take
part in the management of the company, due to illness
or some other reason.
• The director took all reasonable steps to prevent the
company from incurring debts.
Seeking forgiveness
• Section 1318 of the Corporations Act allows the Court
to absolve a director from liability. Recent example:
Stakeman Pty Ltd v Carroll 2009.
Does D&O Insurance or Company
Indemnity help?
• For an insolvent company, any indemnity rights which
a director has against the company are typically
• Provided the director didn’t wilfully breach the duty to
prevent a company becoming insolvent, D&O cover
should respond.
• Civil penalty order and compensation not covered by
• Directors can take out statutory liability insurance as
Corporate governance challenge for
SME’s – financial literacy
Issue No. 2 – Financial Literacy
• Ability of directors to interpret financial statements
and data plus basic understanding of accounting
standards needs improvement.
• Recent survey findings highlight above as a significant
• The National Safety Council case was the first “wake
up” call.
Corporate governance challenge for
SME’s – financial literacy
• The Centro case left many observers wondering about
directors’ liability for inaccurate financial statements.
• The implications suggest financial literacy of many
directors (SME’s or otherwise) needs improving.
How does financial literacy improve?
Education at high school level a recent ASIC initiative.
Training initiatives of CSA, AICD, CPA etc.
TAFE short courses.
Difficulty with imposing mandatory learning or testing.
Financial literacy an issue for:
– Consumers.
– Retirees.
– Australia.
Corporate Governance Challenges for
SME’s – Personal Taxation Liability
Issue No. 3 - Personal Taxation Liability
• The ATO has a collection hit list for SME’s: GST, super
contributions and PAYG tax payments.
• Generally SME’s have concerns about the
consequences of a tax audit.
• Personal exposure of SME directors to unpaid
superannuation guarantee amounts and unpaid PAYG
tax is a big issue, particularly since June 2012.
Increasing directors’ liability from 29
June 2012
Before 29 June 2012
After 29 June 2012
Director penalty notice regime in place
affects directors of companies who did
not pay PAYG withholding tax to ATO.
They became personally liable for the
amount that should have been paid
plus penalty.
Liability extended to make directors liable
for unpaid superannuation guarantee
amounts for employees.
Director needs to be given 21 days
notice of recovery action after penalty
notice given to the director. Director
could pay or appoint an administrator
or liquidator to the company within
that 21 day notice period.
Directors have 3 months from incurring
PAYG or superannuation guarantee
payment to either pay or put their
company into administration or liquidation.
Directors become liable if the amount is
unpaid after 3 months or within 30 days
after becoming a director.
Increasing directors’ liability from 29
June 2012
• Defence continues where a director can prove they
were not involved in the management of the company
due to illness and all reasonable steps to ensure that
the company complied with its payment obligations
were taken.
Corporate governance challenge for
SME’s – tax audit
Issue No. 4 – Tax Audit
• Even though small SME’s may not need to prepare financial
statements, all company SME’s need to keep proper written
financial records (s286).
• ATO is empowered to check compliance with tax legislation
and to examine records.
• Data matching by ATO highlights a risk of a ‘tax audit’.
• ATO applies ‘industry benchmarks’ to determine targets.
• Actual tax payable plus penalties
can be the outcome.
Corporate governance challenge for
SME’s – risk management
Issue No. 5 – Risk Management
• Many SME’s have identified ISO 9000 and ISO 9001 as a
desirable quality management system to implement.
• Benefits: Improved customer products or services,
reduced costs, improved competiveness.
Corporate governance challenge for
SME’s – risk management
• Improved record keeping (accounts), minutes (directors’
and shareholder meetings), material considered at
meetings including reports can act as a means to
activate some defences for directors.
• Broader risk management is sometimes lacking with
some SME’s. E.g. disaster planning from power shut
down, computer malfunctions, fire, flood.
Possible outcomes for SME’s with good
financial management
• Makes business easier to sell. Buyers usually impressed,
value readily seen.
• Makes a ‘buy out’ plan from management more likely to
• Creates good basis for investing equity funds and
investing in the business.
Possible outcomes for SME’s with good
financial management
• Creates a good starting point for taking a suitable
business to an IPO listing.
• Transparency created makes a succession plan easier to
• Could reduce D&O insurance premiums.
Corporate governance issues for
SME’s – independent advice
Issue No. 6 – Independent Advice
• The ASX Corporate Governance Principles recognise the
principle of listed companies having a majority of
independent directors.
• For SME’s this is a challenge because:
– Suitable candidates with some appetite for risk and
with inadequate compensation are hard to find.
– Personal liability of directors is a deterrent.
Corporate governance issues for
SME’s – independent advice
The alternatives are:
– Contracted advisers, based on hourly rates, fixed fees
or retainer arrangements.
– Mentors (who tend to be volunteers at the not-forprofit level).
Corporate governance issues for SME’s –
government intervention
Issue No. 7 – Government Intervention
• SME’s were assisted by the ‘simplification reforms in the
2003 amending Act to the Corporations legislation by
introducing ‘The Small Business Guide’ (SBG) (s111J).
• The SBG gives a general overview of the main rules in
the Corporations Act affecting ‘Pty Ltd’ companies.
Corporate governance issues for
SME’s – government intervention
• ASIC issues regulatory guides, Information Sheets
assisting small businesses and is leading a financial
literacy campaign.
• Isn’t there scope for ASIC to draft a fundamental
guidance document encouraging SME’s to at least adopt
basic financial management and risk management
guidelines as a best practice ideal for SME’s to
voluntarily adopt?
• Plenty written and said about corporate governance for
• The most telling argument for some corporate
governance for SME’s lies with SME directors protecting
themselves from personal liability in an SME insolvency.
• Theoretically, SME directors can adopt self help without
regulatory or legislative intervention. Financial
management and risk management are desirable
corporate governance initiatives for SME’s.
• No studies appear to have been done to indicate that
the lack of corporate governance for SME’s needs a
government response.
Corporate Governance will not stop
the collapse of SME’s
• Different forms or levels of corporate governance can be
voluntarily adopted by SME’s from those adopted by
larger public companies.
• It may be desirable, given ASIC’s role and initiatives, for
ASIC to consider release of a discussion paper where
some guidance is given to SME’s about worthwhile
corporate governance initiatives that SME’s could
voluntarily adopt.
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