Not waving but drowning
If you put this book’s guidelines into operation at the right time, fewer of you should need this chapter than the average small business. Nevertheless, there are those who will. Some businesses will go to the wall.
Few people can appreciate before the event how traumatic the slide into failure can be. Gradually hemmed in with fewer and fewer avenues of escape, you have to come to terms with the crushing of your hopes and expectations. For natural optimists, such as entrepreneurs, it is appallingly difficult to do. At what point do you realise that your business is not going to survive? When do you accept that to carry on is to put other businesses in jeopardy and to impose the same pressures on them as on you? At what point does it become illegal to carry on?
That point may be easy to recognise for an outsider, who is calm and rational. But it is incredibly difficult to recognise when you have been fighting for weeks, or even months, to avoid it. You may find that you slid past the point so gradually that you did not have time to notice. Sometimes, matters are taken out of your hands by an outsider, such as a creditor or a bank, beginning the steps to close your business.
The problem of acceptance is made worse by the usual existence of somewhat schizophrenic behaviour. To avoid rumours and doubts emerging about the future of your business, you may well be putting on a brave face to the outside world. And you are doing this while knowing within yourself that it does not ring true. Here’s the analogy. You are swimming in the sea and to someone standing on the cliff, you are happily waving. But the reality is different – you’re sinking under the waves of debts and demands. This aptly summarises the dilemma for someone whose business is in financial difficulties.
Further emotional difficulties are caused by society’s harsh attitude towards the failure. Even though thousands of businesses fail during a recession, many of them through no fault of their own, there is often little sympathy for those that do.
This chapter tries to help you to recognise the point at which you have to say: ‘Enough is enough.’
The Insolvency Rules (England and Wales) 2016 are now in force. The intention is to streamline the process of insolvency and make it cheaper.
Note that the rules for Scottish companies are somewhat different.
What is in this chapter?
The warning signs of failure
Chapter 24, ‘Staying afloat’, describes how to control your cash to avoid an ignominious end to your business. At some point, you may unfortunately find:
- you only pay a supplier when a writ is issued, and your suppliers are refusing to sell you any more goods;
- you are near or above your overdraft limit at the bank;
- you are unable to raise any more money;
- your liabilities are greater than your assets.
Once your business has reached the point that liabilities (what you owe) are more than assets (what you own), the business is insolvent. It may become insolvent at an earlier stage, when current liabilities are greater than current assets: in other words, when the amount you have in cash and debtors is less than the amount you owe to creditors. This may occur even though you have sufficient fixed assets to cover what you owe. These fixed assets may take too long to sell, at other than a knockdown price, to satisfy your creditors.
As well as insolvency occurring as a result of sales being too low or costs too high, outside events can force it on you. For example, you may be owed a large sum of money by a customer who is slow in paying and may even be unable to pay. A common complaint for small businesses is that some large companies are prone to do just that – be very slow payers – and this can start the vicious circle ending in failure.
Earlier warning signs can be detected that identify businesses that are at a high risk of failure. Studies pinpoint, among other things, these faults – not all of them relevant for the self-employed and small businesses:
- The boss takes no advice.
- The managing director and chairperson is the same person.
- The board of directors does not take an active interest.
- The skills of the business are unbalanced.
- There is no strong financial person.
- There is no budget, cash flow plan or costing system.
- The business is failing to respond to change.
If your business displays some of these characteristics, while not yet being in the advanced stage of failure, get advice now, either from your professional advisers (see Chapter 17) or through the Business Support Helpline*, National Debtline*, Citizens Advice* or equivalent organisation.
The final process
There are two constructive steps you can take: consider whether you could negotiate with creditors to pay off what you owe in instalments or to pay a smaller sum that they will accept in full settlement. Or you can enter into what is known as a formal voluntary arrangement. This is a procedure whereby you offer to pay a dividend to creditors in full settlement of your debts. You need to contact an authorised insolvency practitioner, who will require fees in advance to carry out the work. Voluntary arrangements are a formal legal procedure and have proved very effective as a means of avoiding liquidation or bankruptcy.
Limited company
You can seek to wind up your company on a voluntary basis, or you may have it imposed on you by the court or under the supervision of the court. There are also the options of administration and voluntary arrangements. Voluntary winding-up can occur if 75 per cent of the members vote for it. The resolution for voluntary winding-up must be published in the London Gazette, the official public record. If the directors make a statutory declaration, having investigated the company’s affairs, that in their opinion the company will be able to pay its debts within 12 months, the winding-up carries on as a members’ voluntary winding-up. However, if the company is not solvent, the winding-up is a creditors’ voluntary winding-up. The difference between the two is that if it is a members’ voluntary winding-up, the members (i.e. shareholders) appoint the liquidator. Otherwise, the creditors appoint the liquidator.
The liquidators will normally pay debts in the following order:
- Loans and debts that have been secured on a fixed asset (a debenture needs to be registered at Companies House*).
- The costs of the winding-up.
- Amounts owing to employees.
- Loans and debts that have been secured (as above in 1) with a floating charge on the assets, that is, secured on assets in general, not a specific one (though part of the assets may be set aside for unsecured creditors).
- From April 2020, government and HMRC debts will rank higher than other trade creditors.
- Creditors without security over assets, such as trade creditors.
- Shareholders.
If you do not start proceedings to wind up the company on a voluntary basis, you may find it forced on you if a creditor applies to the court for a compulsory winding-up because you cannot pay your debts. If you do face compulsory winding-up, the court will appoint a liquidator, who is usually the Official Receiver. The Official Receiver is an officer of the Insolvency Service, which is part of the Department for Business, Energy and Industrial Strategy*.
The secretary or director of the company must provide the Official Receiver with a statement verified by affidavit, listing the assets or liabilities of the company. The Official Receiver will contact creditors to decide whether to appoint a liquidator or whether the Official Receiver will carry on in that role. The liquidator will pay off the company’s debts in the same order as that outlined for the voluntary winding-up.
One of the provisions of the Insolvency Rules could mean that a director is made personally liable for a company’s creditors. This could occur if the director has allowed the company to go on trading even though there is no way it can avoid insolvent liquidation (that is, the assets of the business cannot be sold to provide a sufficient sum of money to pay everything owing to all the creditors).
An alternative to winding-up may be to seek a company voluntary arrangement (CVA) – this is a structured agreement with your creditors to repay at least some of your debts gradually over a specified period. It can be used to give a viable company a breathing space in which to recover and return to solvency. New money lent to a company in a CVA has priority status (thus removing a disincentive for lenders).
Sole trader
A creditor may force bankruptcy on you by beginning proceedings for payment of a debt. It is very easy for a creditor to make you bankrupt. If you owe someone more than £5,000 they can bankrupt you quickly. And, even if you pay the debt demanded, if the court thinks you have other debts you cannot pay, you may well still be made bankrupt. Contact the Citizens Advice* or National Debtline*.
A possible alternative to bankruptcy could be an individual voluntary arrangement (IVA). All or the majority of your creditors must agree to the IVA and typically you pay off a percentage of what you owe over a period of five years. At the end of that time, the remaining debts are written off. The main advantage of an IVA is that it may enable you to retain major assets, such as your home, which would almost certainly be lost through bankruptcy. But, increasingly, creditors are seeking a large final settlement payment towards the end of the IVA period which is likely to necessitate borrowing against or selling your home.
As soon as you realise your debts are no longer manageable, get help from an independent debt advice agency, such as Business Debtline*, Citizens Advice*, National Debtline*, StepChange* or PayPlan* for help and advice.
If you do go bankrupt, you will normally be discharged after just one year. For more information, contact the Insolvency Service*.
Partnership
With a conventional partnership you have an added problem to that of a sole trader. Each partner is responsible for all the liabilities of the partnership, regardless of what the profit-sharing arrangements are in your partnership agreement. If you have more personal assets than your partner, it is you and your family who will suffer the most.
With a limited liability partnership, the options open to the management or to creditors are much the same as for a limited company.
What happens afterwards?
While you are an undischarged bankrupt, restrictions apply that make your chances of starting another business limited. These restrictions now normally last just a year but can be extended and last up to 15 years if you are found to have acted dishonestly. Be aware that, even though you are likely to be discharged after just one year, a note of your bankruptcy will stay on your credit record for longer – usually six years – and this will make it harder and/or more expensive for you to borrow in future. A voluntary arrangement also stays on your credit file for six years after it comes to an end.
If you are a director of a company that is wound up, you can usually be a director of another company unless you are subject to a disqualification order, bankruptcy restrictions order or undertaking.
Summary
- Watch out for the warning signs.
- See if your creditors will agree to your paying off what you owe by instalments or see if they will accept smaller payments in settlement.
Other chapter to read
24 ‘Staying afloat’ (p. 323).