There is a significant distinction between the roles and responsibilities of owners and directors of small companies. As Helen McCombie points out, ignorance of the law is no defence if things go wrong.
Owning your responsibilities
When you own and run a company, it seems almost automatic to take on the role of director. Yet many Australians are doing so with little understanding of their potential financial liabilities and legal responsibilities. In the process they are putting their businesses and their financial success at risk.
There is a general consensus that the majority of owner-directors of small companies are naive and don’t seek appropriate advice before they start up their business.
“They don’t investigate their potential exposure before they take on the role of director,” says Michael Quinlan, the deputy leader of Allens Arthur Robinson Corporate Insolvency and Restructuring practice.
Moreover, he warns that the onerous obligations that relate to directors apply whether they understand them or not. “It does require a great deal of diligence and care,” says Quinlan.
Many private business owners are under the misapprehension that if they set up a corporation they will be exempt from personal liability. Quinlan says the oft held view is ‘my only risk will be the capital that I put into the company’. That, he says, is the traditional and original reason why corporations came into existence in the first place, but these days it is not as simple as that.
Accountant and business mentor, Graham Connolly, managing director of the Family and Private Business Advisors Group, agrees there is a widespread lack of understanding of the liabilities and compliance requirements of the owner as a director.
“I believe the owners see themselves first, second and third as an owner, and perhaps fourth as a director,” he says.
He sees a number of other issues for director-owners, including management standards which are inadequate for the size of the business they are trying to run, and businesses outgrowing the ability of the entrepreneurial founder to manage.
Simon Neaverson, director of CPM Solutions, which specialises in strategic and operational improvement, says people running their own companies “fall down largely in not articulating clearly what they are trying to get out of the business, and treating the business as a corner shop, as opposed to a business”.
Neaverson believes “few businesses achieve their real potential because they don’t look at it to see what is driving the profitability, they don’t do enough of the planning to reach its potential. This is where having external directors comes in. I think the external director, particularly the independent external director’s role, is to drive a level of questioning in the executive which takes them out of executive management, into strategic management”.
Even if smaller businesses don’t have a formal independent director, Neaverson thinks it is important that ‘closely-held’ business owners seek input from an outside advisor, such as their bank manager or their accountant. Essentially it is someone who is charged with the responsibility of bringing them into line, to ask them to look at strategic issues as opposed to the day-to-day matters.
Connolly is also an advocate of the external director – in his view any business with sales of over $10 million should have one. He counsels director-owners to not just automatically ask their accountant to sign on. He says: “Accountants often have never actually run a business, all they have done is sit on the side-line and look at it from a dollars and cents point of view.”
You should look for someone who has experience in your particular industry, someone who is business and financially literate, according to Connolly, someone who asks, “What’s the competition doing, where is the market going?”
It’s the financial side of the business that invariably gets director-owners into trouble – particularly in relation to their personal exposure to pay the company’s tax, if the company fails to pay it.
Allens Arthur Robinson’s Quinlan cites a Court of Appeal decision in May last year. “There were two directors and they split the management of the company between them – one director’s job was to handle production and sales, his co-director was supposed to manage the accounts and finances.”
The director that this case concerned subsequently resigned, but before he resigned, he was aware that company tax was outstanding.
“Despite the fact that he had on previous occasions made arrangements for the tax to be paid, it wasn’t paid. And so he was found personally liable,” says Quinlan.
“He thought that because he had resigned as a director he wasn’t liable, however the Court found otherwise.”
Another little-understood area of taxation is the personal exposure that individual directors can have to the Tax Office, with regard to preference action. “That arises where the company pays its tax, it then goes into liquidation within six months of having paid its tax,” says Quinlan.
“The liquidator then brings a preference action against the Tax Office, saying that the money was paid at a time when the company was insolvent and that there were reasonable grounds for the Tax Office to suspect that the company was insolvent at the time that it received the payment of the tax.”
If the liquidator succeeds against the Tax Office then it is required to pay the money back to the liquidator. In those circumstances, the Tax Office can pursue the directors personally for the money.
Quinlan says: “I don’t think many people know about that, because directors would think, I know I am going to be personally liable if the tax isn’t paid. So they make sure the tax gets paid, and then resign, but nonetheless they can be pursued in that way.”
Another cause for concern, according to Connolly, is the standard of accounting services.
He says many people outgrow the ability of their accountant to provide the services they need. “Because of the relationship that has been established, the client hangs on, when in fact it is probably time to move on to another accounting firm, with a greater range of services. It is unbelievable what I see,” says Connolly, “a $20 million company with a sole practitioner accountant.”
The area of occupational health and safety (OH&S) is another area that doesn’t receive enough attention. Connolly says there is an “unbelievable responsibility in terms of employee safety, and it is an exposure area where the average family business owner is not close to being up to scratch. I would not take on a directorship unless an OH&S audit was done. I wouldn’t even consider it. Because it has moved from criminal to civil liability if an employee gets killed.”
You can have all the signs up and all the procedures in place but Australians by nature continue to be ‘she’ll be right’. They don’t wear hard hats, they don’t wear protective clothing, they don’t wear goggles, and at the end of the day the courts are on the employees’ side, and it is a significant area of concern.”
Spouses who sign on as directors of companies also need to seek comprehensive advice. Being ignorant of a director’s responsibilities is no defence. Also, directors who take no active role in the management of the company do so at their own risk. This is an important issue for women in particular, given the number of wives who have become directors of their husband’s companies.
Pamela Murray-Jones, the general manager for education services at the Australian Institute of Company Directors, says there are a number of court judgements to be mindful of. She cites the case of Mrs. Morley (Morley v Statewide Tobacco Services Limited 1992), who considered herself a ‘paper’ director of the family company. Unfortunately, there’s no such thing as a paper director, she just didn’t involve herself with the business.
“She was held substantially liable for debts incurred by her son, who had run the company since her husband’s death, and she lost her house,” Murray-Jones says, “there are so many women in that situation who don’t know what their role is and what their duties are. In this case, Mrs Morley’s son had no liability, even though he ran the company into the ground, he was not liable because he was not a director. She was totally liable.”
Creditors, who are looking to get their money back, look for the person who has the assets. If one partner has taken off overseas, and can’t be located, it is much easier to find the person who is still in the family home.
Murray-Jones says: “There have been a number of individuals over the years, whose partners have deserted them and the business, and have been left the holding the debt.”
Murray-Jones points out that things have changed as now you can have sole director companies, until recently you had to have a minium of two directors so it was common for wives to be the second director. She says husbands
often think this is some way of getting their wife involved in the business, and they themselves may not realise what kind of liability they are placing on their spouse.
Graham Connolly recommends owner-directors should have:
- A documented, signed, and approved succession plan – in relation to both future ownership and future management.
- Clear management standards – including everything from business development to strategic planning.
- Five-year budget and cash flow projections – most small companies would be lucky if they had such projections for the next one to two years. Generally the budget consists of taking last year’s figures and adding ten per cent. What they should be doing is re-looking at what they are doing, why they are doing it, and whether there are other things they should be doing.
- Selection and promotion policies – family members versus outside appointments. There are advantages and disadvantages of both strategies.
- A capital expenditure policy – private companies don’t have the same access to the money market as larger companies, so they have got to be far more enterprising and innovative in their capital expenditure policy.
- An on-going review of their bank and securities policies – far too many businesses leave securities with the bank which should be released as the business has grown and prospered. It may be more appropriate for the bank to take a floating charge over the company and release personal securities.
Simon Neaverson suggests that private company directors must have:
- A strategic plan for the growth of their business – what vision do they have for the company in the future?
- Vision plus values – how will their business operate? A lot of businesses just muddle from one day to the next looking at things on an issue by issue basis, as opposed to having a strategic vision.
- A clear understanding about what’s driving profitability – the owner-director needs to have a good grasp of what drives profitability in the business. Too often people look at the traditional measures of profitability being the lag indicators of what happened last month or last year, as opposed to what is likely to drive profitability in the future.
- Knowledge of their responsibilities as directors – from a legal point of view private company directors need to acknowledge that they have responsibilities beyond the day to day management of the business.
- Develop techniques to deal with the responsibilities they have as an owner and as a director – frequently people sit down and have a board meeting, but in reality all that happens is that discussion reverts back to operational issues. They lose sight of their responsibilities to direct the business, so you need to develop techniques to remind the board participants of their responsibilities, and the difference between operational, legal and strategic issues.
Helen McCombie is a communications expert, working in a boutique media and government relations company. After a decade of reporting for Australia’s premier business current affairs program, Channel Nine’s Business Sunday, Helen now consults to a wide range of companies on media and communications strategies.
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