The idea of having to put a business into an insolvency process is disheartening for entrepreneurs that have started up a new venture, especially if they have invested significant amounts of their own time and money. However, insolvency does not necessarily mean that it is the end.
How do early-stage businesses usually start?
Often, early-stage businesses are started when the owner or manager has a good idea, which is based on the owner’s area of expertise or a unique specialty.
Entrepreneurs have an innate enthusiasm for their business idea, then they pull together some financial backing for their business, win their first contract and it is at this point that they start to realise that, to make their idea a success, they will need to develop a wide range of skills to carry out work in areas including recruitment, contract negotiations and lender management, in addition to ensuring that the right systems are in place and the processes for managing finances, especially cash.
What should you consider before insolvency?
Not many start up business plans go into details such as how and when the directors may decide to exit and what action will have to be taken if the business begins to experience difficulties with its cashflow.
However, having this level of information when starting a business can make it easier for the directors of a limited company to handle challenging financial situations if they arise. It’s always best practice to ensure that you have a Plan B just in case.
Early Warning Signs
It is likely that there will be some early warning signs that show if the business is on the wrong course. For example, if the business misses its sales targets this could result in insufficient revenues being generated which could lead to late loan payments. This could be an early sign there is a cashflow crisis looming.
On the other hand, if debts from customers are mounting up, they may be causing a negative impact on cashflow, but an efficient approach to credit management is the only intervention needed. Small businesses may lack the capability to be able to maintain a constant 360-degree view of the business, but this could be vital to ensuring their success.
Predict Growth Trajectory
Before starting a business, it is logical for entrepreneurial founders to predict a growth trajectory and set pricing levels that will return a healthy profit. Accurate data relating to the costs and capital expenditure requirements should be put into the model.
In the current environment another thing that should be factored into the model is a high rate of inflation, including wage inflation. At the early stages of a new operation viability tests should be carried out. This can help to bring attention to any financial problems that might need to be addressed as the business grows.
Temporary cash flow problem vs Insolvent Business
Business owners should know how to identify the difference between a temporary cashflow problem and an insolvent business, so that they can seek the relevant advice as early as possible. The Insolvency Act defines insolvency broadly as a situation wherein the assets are surpassed by liabilities or the business is incapable of paying debts when they are due.
Ahead of a business getting to this point, directors should seek a professional Insolvency Practitioner for advice, as they can explain all their options. A common misconception is that the directors of a limited liability company will be disqualified as a result of entering an insolvency process. However, this is not true and often the individuals involved will bounce back and go on to have successful business careers.
What is the most common outcome for an insolvent business?
Creditors’ Voluntary Liquidation (CVL)
By far the most common outcome for a business that has become insolvent is a Creditors’ Voluntary Liquidation (CVL), which is where the insolvency processes commenced by the directors and shareholders. In this situation, the business is now at a point of no return and the only option is to wind-up the business.
However, there are alternative options available which could result in a more positive outcome if the economics are right. For example, businesses which are financially challenged will sometimes be placed into administration and the appointed administrators may explore any opportunities to sell as a going concern or to only sell some of its tangible or non-tangible assets, this includes intellectual property rights.
Do not ignore it!
From the owner manager’s perspective, insolvency may be an option that is easier to ignore rather than to face head on. However, initiating a Plan B at an early stage to better understand the available insolvency processes is a painless and practical move that could assist in systematically planning and implementing the best possible solution. Intervening in the early stages can minimise the financial fallout and help owner managers to progress with their next entrepreneurial career move with confidence.
For more information on our business viability test, download our ‘Managing The Road to Recovery’ Guide below: