Many small companies – especially family-owned or “owner/operator” businesses – have the same directors and shareholders. In these companies, it is common practice for shareholders to have a “shareholder current account”, also referred to as “drawings”.
The current account is a debt that can be claimed by the Company against the shareholders. While most shareholders do not view their drawings this way, when a liquidator takes over a company, shareholders may suddenly find themselves being pursued for an overdrawn current account.
Calculating the Value?
In practice, the value of the shareholder current account is the net balance of transactions between the Company and the shareholder. When a shareholder injects funds into the Company, this results in a credit in the shareholder’s favour. If the injection is greater than any previous drawings, the Company will owe money to the shareholder, meaning the current account is a liability of the Company. On the other hand, if the shareholder withdraws more money from the Company than he or she puts in, then there will be a debt in favour of the Company. This would be an asset of the Company (so long as the shareholder was able to repay it if required).
It is not unusual for a company to convert all of a shareholder’s drawings into a salary at the end of the financial year. If done correctly, this can “wipe” any outstanding debt. However, directors need to be careful that doing so does not make the Company insolvent. In order to be valid, directors also need to comply with a number of bookkeeping requirements in the Companies Act.
Where is the Current Account?
If you operate a small company, the first suggestion is to check that your company’s current account features in your company’s annual accounts. When it does appear, it is normally listed as a non-current asset (or liability – depending on the balance). However, the current account may simply be included in the shareholders’ equity – meaning it is not always clear what the balance is at a particular point in time.
This can cause problems on two levels. First, because the current account is an asset (or liability, depending on whether you have injected cash) of the Company, directors must consider it when making judgments about the Company’s solvency and its overall value as a business. Second, it means that a shareholder who does not have a clear understanding of the current account may find themselves being pursued for a surprisingly large debt if the Company is liquidated.
The importance of good bookkeeping
Current accounts are a useful way of keeping track of how shareholders are drawing money from a company and ensuring that any money is accounted for, but they can also create problems for shareholders if a company becomes insolvent. In order to protect themselves, directors need to make sure that they keep accurate records and that they are proactive in declaring salaries. Otherwise, the current account can become a major risk for the shareholders.
This article was written by Blair Shepherd for Rotorua Now Magazine.
You may also like ...
What protection do you have as a business purchasing goods? Contract and Commercial Law Act
Everyone knows about the Consumer Guarantees Act 1993 (CGA), which provides a “consumer” with remedies if a business has failed to provide goods or services to a reasonable standard. But what happens if you are a business purchasing goods? The answer is not found in the Consumer Guarantees Act 1993; it is found in the Contract and Commercial Law Act 2017 (the CCLA).
The CCLA implies seven conditions and/or warranties in a contract for the sale of goods:
right to sell;
conformity with description;
fitness for purpose;
merchantable quality;
conformity with samples;
rights of examination, and;
acceptance.
Not every breach of contract allows for rejection, but a trivial breach of a condition does. This means that a buyer can return goods supplied to a seller. Importantly, whether a term is a condition or a warranty depends on the construction of the sale of goods contract.
An important implied condition is “fitness for purpose”. This means that goods must be reasonably fit for purpose. But, unlike the CGA, this condition will only apply where the buyer makes known to the seller the particular purpose for which the goods are required, and that the goods are of a description that it is in the course of the seller’s business to supply. What this means is that when a buyer of a vehicle makes known to the seller that they will be using a vehicle to tow a caravan, then there is an implied condition that the vehicle is fit for that purpose; towing a caravan. This was the case in Finch Motors v Quinn (No 2) [1980] 2 NZLR 519. Mr Quinn, the buyer, told the seller that he wanted a car for towing a boat on extended trips. The seller, Finch Motors, told Mr Quinn they had the ideal car for the job. Not long after the sale, Mr Quinn used his car to tow the boat when it overheated. This, the Court found, was a breach of the implied condition that goods are fit for purpose.
There is also an implied condition that goods are of a “merchantable quality”. This is similar to “acceptable quality” under the CGA. The test for whether goods are of a “merchantable quality” is found in an old case, Taylor v Combiner Buyers [1924] NZLR 627. In that case, the Court asked the following question: Are the goods of such a quality and in such a state and condition as to be saleable in the market, as being goods of that description, to buyers who are fully aware of their quality, state, and condition, and who are buying them for the ordinary purposes for which goods so described are bought in that market?
Unlike the CGA, the CCLA allows contracting parties to vary or exclude the implied conditions and/or warranties. This includes fitness for purpose and merchantable quality. To do this, the contract must be clear as to the conditions and/or warranties that it purports to vary or exclude. In Wallis, Son & Wells v Pratt & Haynes [1911] AC 394 (HL), for example, the seller’s terms and conditions stated that there is “no warranty express or implied”. The Court found that this did not exclude implied conditions, only implied warranties. If the seller wanted to exclude the implied conditions, including fitness for purpose and merchantable quality, they had to do so expressly.
Holland Beckett has experience advising buyers and sellers. This is a complex area of law and Holland Beckett is available to assist.
With Strings Attached – Exit Strategies for Small Business Owners
It is not an easy time to be selling a small business. High inflation and waning consumer demand has lead to compressed margins and reduced revenue for many.
Uncertainty in the global markets due to wars, protectionism and the changing geopolitical landscape has blunted the confidence of prospective purchasers.
Closer to home, sub 3% interest rates are now a fading memory and house prices have come off their peak, so fewer aspiring business owners can easily ‘top up their mortgage’ to fund the purchase of a business.
How can sellers respond?
Business owners looking to sell and wanting to achieve the best price for their business may need to consider options to reduce a purchaser’s reliance on third party finance to fund the acquisition of their business. This may include:
Asset restructuring: Premises, plant and equipment are restructured to reduce the capital investment required by a purchaser. For example, valuable machinery could be retained by the seller and leased to the purchaser, meaning that the purchaser does not have to finance the upfront cost of purchasing that asset.
Vendor finance: The seller advances a portion of the purchase price to the purchaser to be repaid by the purchaser over time. Vendor loans vary widely in terms of whether they bear interest, whether they are amortising (repaid gradually over the term) or repaid in a lump sum on a fixed date.
Earn Outs: The purchaser agrees to pay part of the purchase price in instalments contingent on the business achieving certain financial targets. Payments could be fixed or adjusted based on the level of revenue generated by the business.
Vendor Shares: The vendor retains shares in the business. The vendor might give the purchaser options to acquire 100% of the shares over time.
Objectives and Risks
From a seller’s perspective, the most common objective of using any of the above mechanisms is to achieve a better price for their business.
Compared to fully bank or finance company debt funded transactions, vendor funded transactions generally expose the seller to risk of purchaser default over a longer period. This is because repayment of vendor loans or achievement of earn-out targets depend on the success of the business under new ownership. These risks can be reduced by, for example:
Requiring the purchaser to pledge security to the seller (mortgages, personal guarantees, registered security interests).
Giving the seller a right to appoint a director for so long as they continue to hold shares in the business.
Contractual provisions that exclude artificial reduction of gross profits for the purposes of earn out calculations.
Complexity and Cost
If not managed well, transactions that include vendor funding mechanisms can be more complicated and take longer to negotiate than similar deals that are not vendor funded (and increased legal costs as a result). Also, the downstream consequences of vendor funding arrangements need to be carefully thought through to avoid unforeseen negative consequences. For example, if the vendor registers a security interest in the business assets, how will that affect the purchaser’s ability to raise finance or obtain trade credit moving forward?
In our experience, the best outcomes typically start with a well-designed structure. Convoluted and legally complicated structures are generally less effective in practice than more straight forward, logical structures. Complexity can often be avoided if the transaction is properly designed from the outset.
Business owners considering vendor funding options should:
Discuss potential structures with their business broker or lawyer to identify fit-for-purpose options that could be offered to potential purchasers;
Focus on the characteristics of the business and the specific circumstances and objectives of the seller and buyer when designing a transaction structure - do not start with a particular structure in mind and adapt it to fit the circumstances (this is a recipe for legal complexity); and
Try to aim for a structure that makes commercial sense and avoids risks being transferred to a party who cannot control it or who would not naturally be exposed to it.
A well designed vendor funding structure should be easy for all parties to understand and give the purchaser sufficient freedom and control to ensure the business remains successful while minimising the default risk faced by the seller.
Our commercial team at Holland Beckett is experienced in business sale transactions from $50,000 to $100 million including vendor funding arrangements of all types and would be happy to discuss how to make the sale of your business a success for you and your purchaser.
Incorporated Societies Act 2022 – How do I reregister?
The Incorporated Societies Act 2022 (“New Act”) came into force on 5 October 2023. The New Act replaces the Incorporated Societies Act 1908 (“1908 Act”).
All existing incorporated societies must apply to reregister under the New Act before April 2026 if they wish to continue as an incorporated society. Failing to do so will result in the society being deregistered.
The online registration process is now open to existing societies on the Companies Office website.
What do I need to do?
In order to reregister, the society must first:
Update its constitution to comply with section 26 of the New Act.
Develop a membership record and membership consent form to comply with section 76 of the New Act;
Have at least 10 members to comply with section 74 of the New Act;
Hold consent in writing from each of the committee/board members (officers) to be an officer and ensure that each officer meets the criteria recorded in section 47 of the New Act;
Provide at least one person’s contact details to enable the Companies Office to contact the society.
What must the constitution contain?
Section 26 sets out all matters which must be included in a constitution. These matters are largely administrative. One of the most important additions is the requirement to have a dispute resolution procedure. The compulsory provisions include:
The name of the society.
The purposes of the society.
How a person becomes a member of the society, including a requirement that a person must consent to be a member.
How a person ceases to be a member of the society.
Arrangements for keeping the society’s register of members up to date.
The roles, functions, powers, and procedures of the committee/board.
How the contact person or persons will be elected or appointed.
How the society will control and manage its finances.
The method by which the constitution may be amended.
Procedures for resolving disputes, including providing for how a complaint may be made.
Arrangements and requirements for general meetings.
The nomination of a not-for-profit entity, or a class or description of not-for-profit entities, to which any surplus assets of the society should be distributed on a liquidation of the society or on, or to enable, the removal of the society from the register.
It is also an opportune time for you to review the society’s objects and any procedures that may no longer be fit for purpose.
How do I vary/replace the constitution?
You must refer to your current constitution. Most constitution contain a ‘variation/amendment’ provision describing the procedure that must be followed to formally vary or amend the constitution. You are likely to find that the proposed changes must be circulated prior to a general meeting and can only be adopted if a resolution is passed by the majority stipulated in the constitution.
How can Holland Beckett assist?
Holland Beckett can assist you with reviewing and updating your constitution, reviewing and developing policies to comply with the New Act and navigating the reregistration process. Please do not hesitate to contact us if you require assistance with this transition.