Not-for-Debt (NfD) companies: A new exemption class for innovation start-ups.

There are already a number of different regulatory types of firms available, such as sole-trader, partnerships, private companies and public companies. However, a unique characteristic of start-ups firms is that they are more likely to fail than succeed. There is no company type available within the current regulatory framework that implicitly recognises this risk profile of start-up firms.

Malcolm Turnbull wants to reform corporate regulation – particularly to soften Australia’s rather punitive bankruptcy provisions – to create new start-up friendly business laws. The National Science and Innovation Agenda Report proposes to reduce bankruptcy from three years to one year, allow directors to trade while insolvent, and stop counterparties from terminating dealings with insolvent companies.

Corporate regulation was never designed or intended to promote new business growth, but rather to control existing and particularly large, mature businesses. For the most part, it does this successfully. However, Turnbull’s proposals fail to make a fundamental distinction between two very different types of firm failure. For start-up firms, particularly in the technology sector, a high failure rate is not only normal, it is often desirable. It’s a sign of experimental undertakings and rapid learning.

Changing the bankruptcy period from three years to one isn’t much of an incentive and won’t change reputational risk associated with the stigma of bankruptcy. Bankruptcy appears on credit reports for five years and remains on a public National Personal Insolvency Index for life. Although directors of insolvent firms are protected from liability for a company’s debt, the risk of significant penalties remain. Individuals can be barred for five years from directorships if they have been a director of more than two insolvent companies within seven years. Being a director of a company that trades while insolvent can lead to criminal penalties and potentially being liable for debts incurred while insolvent.

Applying the current bankruptcy and insolvency framework to innovation firm start-ups – where failure is treated as an exception – makes no sense. Continue reading →