There are many very small companies in New Zealand, where the sole director and shareholder is also the sole employee, or a couple are the directors and shareholders and one is the sole employee.
These companies don’t have some of the issues faced by bigger companies in the normal course of business, such as dealing with employees and paying wages, but do have to deal with suppliers and clients and maintain workflow and profitability.
In this article, we look at a couple of the issues facing very small companies and how the Covid-19 lockdown period could provide a chance for review.
One of the problems for the directors of these very small companies is that they can get so involved in the operation that they can’t see the forest for the trees. Their time and energy is put into the day to day operation and they don’t take the time to stand back and look objectively at what they are doing, how they are doing it, and whether it could be done better to achieve what they want.
One possible upside of the lockdown period imposed in response to Covid-19 is that it could provide the opportunity for that objective review.
It is likely that the business has suffered as a result of the lockdown – being unable to trade means little to no income for the people involved and no money coming in from which to pay mortgages, business loans, rent etc – so the director is likely to be looking closely at the business anyway.
Various support packages are available from the Government and the trading banks but before going to the bank to borrow money to support the company through the lockdown, the director needs to look closely at the financial position of the company. If the company was insolvent, or marginal, prior to the lockdown, the bank may not agree to a further loan.
While doing that assessment, directors should take the opportunity to go back to basics and look at why they are in business, what they are doing, and how they are doing it. Some things to consider are:
- Is the company’s business purely to provide a wage for the director or is it an investment to provide a retirement fund?
- If it is an investment, what plans are in place to sustain and grow the business so that there is a going concern business to sell when the director is ready to retire?
- Are the job costing or product pricing systems current and set at the right level?
- Is the manner in which the work is done up to date and efficient?
- Are the advertising / promotional strategies currently being used proving to be cost effective?
Another issue that is particularly relevant to very small companies is the blurring of the line between what is company business and what is the director/shareholder’s personal business.
It is not uncommon in small businesses for the director to take drawings from the company rather than paying a regular salary and deducting and paying PAYE, etc. Sometimes, the mortgage over the family home is paid from the company’s bank account and the company vehicle is paid for by the company and used for both business and private travel.
If the company remains solvent, the merging of the private and business assets and activities won’t cause any issue but, if the company becomes insolvent and is placed into liquidation, the director’s actions and the shareholder’s current account will come under scrutiny.
The shareholder’s current account records the funds introduced into the company and the amounts taken out in drawings by the shareholder. If more is taken out than is introduced, then the difference is a debt owed by the shareholder to the company and it is repayable on demand.
During an objective review of the company, directors and shareholders should look at whether they are creditors or debtors of the company and how the money they are taking from the company is being treated such as:
Are drawings being taken instead of or in addition to a salary?
- Are the drawings taken as a regular fixed amount or is the company bank account used for all personal expenses?
- Is there an overdrawn shareholder current account? If yes, how big is it?
- Have the annual financial accounts for the company credited a salary to the shareholder each year? Have the necessary resolutions been passed?
- Are there any personal assets recorded in the company’s asset register?
Directors and shareholders also need to consider whether the amount that they are taking from the company is fair to the company, when looked at objectively. When salaries are taken by director/shareholders, section 161 of the Companies Act 1993 requires that the company’s board (which would be the director or directors):
- Authorise the remuneration and/or benefit;
- Record the authorisation on the company’s interests register; and
- Sign a certificate confirming that, in their opinion, the authorised remuneration and/or benefit is fair to the company and the reasons for that opinion.
If the company fails and the section 161 requirements were not met or they were met but it was not reasonable for the directors to believe that the authorised remuneration was fair to the company, the directors can be held personally liable for the remuneration paid to the director. While there is some limited relief available to the directors if they can show that the remuneration and/or benefits paid were fair to the company at the time it was given or paid, any payments above what was fair at the time will need to be repaid.
The issues faced by very small businesses can sometimes be overlooked by the directors involved in the day to day operation, but the issues are still there.
Take the opportunity to look at those issues and discuss them with your accountants or other professional business advisors.