It is common knowledge about the myth about some of the risks business face that over 80% of new businesses survive their first year), it is still true to say that many businesses don’t last much longer.
Running a company is risky and running into financial difficulties is a common problem. Bankruptcy applies to people such as sole traders and those that have given personal guarantees for loans. Winding up and liquidation apply to companies.
As a director of a business in trouble, it is up to you to decide whether your business should continue trading or cease trading. If you do not, you may end up having to pay for the company’s losses from your own pocket while being investigated by government regulators.
If a director is aware that the company is going to become insolvent but continues to trade anyway, by law the director must cease trading and liquidate the company.
If a director trades insolvent, they could be liable for wrongful trading and can only escape liability if they can prove they took steps to minimise the loss to creditors as soon as they were aware of the insolvency.
Ultimately, as a director, you can only decide to trade on if it is likely that the business will avoid insolvency.
So how do you decide whether to trade on or not – and risk getting further into company debt?
How To Reduce Business Risk
There are various ways to reduce the risk to your business, from part payment and special payment terms to trade credit insurance and factoring. We’ll explore some of these ways to reduce risk here:
Special Payment Terms
As you run your business you may find yourself with prospective clients who are higher risk than others. For such clients you could reduce your payment terms from 30 days to 7 or 14 days.
This involves getting an advance from customers (either all customers or those rated most risky) before dispatching goods or starting work on a project. The balance is then paid within your regular payment terms (for example 14 days from receipt of invoice).
Third Party Guarantees
A third party guarantee is a written guarantee by a third-party to be legally liable to pay if a customer does not.
If your business is a start-up you may find it hard to persuade suppliers to do business with you. For this reason, banks or investors with a vested interest in your business succeeding may guarantee payments to suppliers.
You can obtain text for your guarantees via credit management books, credit insurers or solicitors. The debtor should request that the guarantor issue the guarantee on their own headed paper.
Similarly, if you are doing business with new companies, it is worth restricting their credit limits and asking them to guarantee payments where possible.
Retention of Title
When it is easy to establish that the goods of a business are supplied by that business, the company can create an All Sums Due clause/condition of sale to ensure the goods remain its property until they have been paid for. This is useful in enabling a business to recover goods should a customer get into financial difficulties.
Trade Credit Insurance
It’s not just banks and lenders who run the risk of non-payment when dishing out credit. Businesses of all sizes are putting themselves at risk each time they give credit to a customer.
However, businesses can insure themselves to minimise that risk. Being insured against the possibility of a customer’s business being liquidated, a customer going bankrupt or defaulting on payments.
Businesses suffering from problems with bad debts and late payments are advised to get some trade credit insurance for their business.
Legal Expenses Insurance
In the past, some companies have been deterred from talking another business to court to claim their money, for fear of large legal costs. This is particularly true within the building/contracting industries where technical disputes can delay payment. If the company suing is unable to afford litigation, companies owing the money have even been known to keep disputes running as long as possible so that the creditor company drops the case.
However, if that company is insured, legal expenses such as these will be covered and disputes are likely to be resolved quickly without the need of going to court. Contact a broker to negotiate terms.
Sometimes you may find you have lots of money due (that you have invoiced for) but no working capital until those invoices are paid. Factoring is a method of managing and financing credit which gives businesses the chance to improve their cashflow by receiving alternative working capital to use while they wait for payment of those invoices.
For example, a factor agent buys your outstanding invoices, otherwise known as ‘accounts receivable’. They then pay you an advance of up to 90% of what those invoices are worth, and repay the remainder of the outstanding invoice amount when your clients pay those invoices (minus a commission fee and any interest on the advance). The factoring company will usually take over the running of your sales ledger, including chasing payments. Therefore, if you’d prefer your customers didn’t know a factoring company was involved, you could try invoice discounting instead (see below).
Factoring and invoice discounting are ideal ways to improve cash flow and generate working capital to ensure you have enough money in the business to pay bills and creditors. So if you need some cash fast, and are willing to pay a commission on your outstanding invoices (anything from 0.5-4.5%), factoring could be a solution to your cash flow problems.
Essentially, factoring enables businesses to expand without exhausting cashflow, as finance is made available in line with the level of its sales.
Invoice Discounting is an alternative method of factoring that enables you to keep the arrangement from your customers (so they are unaware that a factoring company is involved). Invoices are still funded by the factoring company, but you are responsible for collecting payment of them.
Reasons For Business Failure: Why Do Businesses Fail?
Half of the UK’s small businesses fail within the first three years because of cash flow problems. They either run out of money or run out time. Consumer debt may be rising and personal bankruptcies increasing as a direct result, but company insolvencies are also on the increase.
So why do businesses fail?
The main reason is money: lack of it, or lack of it when it’s most needed (for example, work may have been completed and invoiced for, but that invoice may not be paid for up to 60 days, and creditors may want their own payments from you immediately. There are many solutions to help businesses improve their cash flow, from factoring and invoice discounting to more effective budgeting, but many businesses leave it too late. And it is small businesses who suffer most, as they are less easy to rescue than larger companies.
Poor management, poor accounting systems, poor market research – they all share the blame for business failure. And losing control of a market due to competitor strength is another key reason. Manufacturing, retail and transport and communication businesses can be affected my natural disasters in countries where materials and products are sourced from or a weak pound on the stock exchange.
Other key reasons for business failure include:
There are many more reasons, from rising stock levels and static sales to contract disputes and under pricing.
And the best way to avoid them all is to plan ahead. However, if you do find yourself facing business failure, you have two main choices, and the earlier you deal with problems the more likely you will be of avoiding insolvency.
You can either opt for company survival or for company closure. Two procedures are available for those seeking to rescue the company and two for those ending the company.
Saving The Company
If you believe you can rescue your company, there are various solutions to help you do so. Your choices boil down to putting the company into Adminstration or opting for a Company Voluntary Arrangement.
One company saving procedure is Administration which acts as a bandage, temporarily holding the business together while business rescue plans are drawn up to solve financial issues and restructure the company.
As soon as you make an application for Administration through the high court, the assets the company has are protected and the company is given immediate protection from all creditors while a plan of action is established and implemented.
Company Voluntary Arrangement
Another way to rescue a company is via a company voluntary arrangement (as opposed to an individual voluntary arrangement) which gives Limited Companies the chance to negotiate with their creditors to pay a reduced amount of their debt back to the creditor during a 1-5 year period, with a final settlement figure agreed.
This solution is far more preferable to insolvency/liquidation, as you can save the jobs of your employees and save your own credit history, as there will be no credit restrictions placed on you. Creditors prefer this option to insolvency, as they receive some of their money back, so it is worth pursuing if your company may survive as a going concern.
As soon as a CVA is agreed all creditors are binded into the agreement. Prior to being agreed creditors will have been notified and given the chance to vote for or against the company voluntary arrangement.
Ending The Company
Administrative Receivership Procedure
If a company has borrowed money secured by a floating charge, the debenture holder will then appoint an administrative receiver.
The administrative receiver will then take control of/deal with the company’s assets. The company may continue to trade if the debenture permits. The administrative receiver will then report to IS on directors’ conduct under CDDA.
Finally one of four things will happen. Either, the company will be sold as a going concern, or its assets will be sold separately; or control of the company will be returned to directors and shareholders; or an adminstration order will be made; or the company will go into compulsory or voluntary liquidation.
Receivership is when the debenture holder (often a bank) will appoint a receiver who’s duty is to assess how much the company and its assets are worth. The main goal of the receiver is to recover the value of the lenders security, so the receiver is allowed to realise the company’s assets by continuing to trade. Alternatively the company may be sold off to recoup the value.
Liquidation only happens when there is absolutely no hope of finding a solution where the company can continue to trade. If a business is unprofitable and can find no way of trading profitably, the company will be put into compulsory or voluntary liquidation.
If the director/company decides to cease trading, this is called creditors voluntary liquidation. This involves a meeting where creditors and company members meet and appoint a liquidator (which the creditors must agree with). The liquidator will then set about realising the company’s assets in order to fairly distribute them to creditors and shareholders.
If a creditor winds up a business, this is called compulsory liquidation. What many businesses don’t realise is that any creditor who is owed £750 or more can instigate this action by presenting a petition against the company to a court. An official receiver is than appointed as liquidator but a licenced insolvency practitioner can be appointed at a later date.
The only other type of liquidation is members voluntary liquidation which only applies to solvent companies that are able to pay their debts in full, and is generally used in order to restructure a company. Directors must swear an affidavit to assure creditors that the company can clear its debts within one year. A licenced insolvency practitioner is then appointed to carry out the members voluntary liquidation.
Your Responsibilities As Director
If you are the director of a company facing financial woes, you have certain responsibilities by law. For example, you are obliged to keep control of the company and seek help where required. Ultimately, you must decide whether to end the company or save the company. You are liable for the debts of a company personally if your company continues to trade once insolvent (or once insolvency is clearly unavoidable). This is called wrongful trading.
A director’s only defence would be that they took every step possible to minimise the potential loss. The penalty for wrongful trading is for the director to contribute to losses from his/her own pocket plus potential disqualification for up to 15 years! Even worse, if you intentionally defraud creditors by carrying on trading, this is classed as fraudulent trading and carries a potential prison sentence of up to 7 years. So, if a director takes orders knowing they can’t be fulfilled, for example, they could be penalised by having to make a contribution from their own pockets (limitless) and compensate creditors accordingly.
Here are some Directors’ Do’s and Don’ts:
What About Your Employees/Staff?
If your company is made insolvent, how do you deal with your employees? It’s a sad day when staff are made redundant as a company ceases trading. But, if dealt with correctly, the process can be made far less painful for all involved.
The first course of action is to advise employees of their rights.
Explain that they will be preferred creditors for up to four months’ arrears of wages/salaries, holiday pay and occupational pension contributions owed . They can also claim for some of the money the insolvent company owes them and are paid before other creditors.
The Redundancy Payments Service (RPS) will also provide them with payments immediately. However, the RPS is entitled to claim back payments it makes from money recovered by the liquidator. This means that any money owed to staff above the RPS limits must also be claimed from the liquidator and may therfore not be paid for some time and then not necessarily in full.
The RPS also has the power to pay to ex-employees specific monies owed to them, such as: