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Tackling the spectre of insolvency

Roughly one in four start-ups will fail within a year, and half of them within four years. The reasons for failure are many and varied; they include the wrong business model, lack of planning, lack of execution, cash shortages, disagreements over direction, inadequate demand, heavy initial expenditure and even loss of energy or motivation. But failure is not the sole preserve of new market entrants . As we have seen in recent years, a declining trend in the high street retail sector has seen the demise of established businesses that have traded for decades, and in some cases, centuries. In the world of business today, things change, often at a frightening speed, so what are the steps and precautions that you should be making your client aware of? 

Although not every business fails due to finances, bottom lines are usually the core issue. The spectre of insolvency for a business is therefore real and for most businesses, never that far away. Help your client to understand the two situations in which insolvency most commonly arises. Traditionally these are based on a cash-flow test, where your client has an inability to pay debts, or a balance-sheet test, where their liabilities exceeds their assets. Both these scenarios are enshrined as tests under the Insolvency Act, as developed in case law.

Any insolvency process, whether that’s liquidation, administration or bankruptcy, will clearly have serious consequences for the business. However, it’s important to communicate with a client that in some cases these issues can become more personal. Where there is a large deficiency in a liquidation, directors can face personal liability for wrongful or, worse still, fraudulent trading and misfeasance. This can lead to the threat of disqualification for directors for a lengthy period of time. Personal guarantees can also be called in.

If your client is a partner with unlimited liability or a sole trader, this could also lead to personal financial ruin. It is therefore essential that the warning signs for insolvency are spotted as early as possible, communicated to the client and remedial action is taken urgently.

Make it clear that these difficulties can often start from the outside. Sometimes key customers can start to wobble, and suddenly a “safe” receivable becomes a bad debt. In these cases staff still need to be paid, the landlord will still expect rent and the council will continue to seek business rates. Your client should be prepared for how quickly these things can change – in no time at all, their cash-flow position could have worsened significantly. When things start to turn it can be easy to get tunnel vision, so encourage your client to think about the bigger picture. For example, they shouldn’t disregard the insolvent supplier – if they fail, then core services that their business needs may disappear overnight, causing further issues. 

Learning to recognise the tell-tale signs of a business in distress and communicating these to your client is a vital skill for the protection of businesses you work with. 

Your client  should be looking out for: 

  • Longer delays in invoices being paid
  • Credit terms being re-negotiated 
  • Future orders dropping 
  • News of redundancies or adverse changes

Clients can be tempted to bury their head in the sand when under financial stress, but it’s absolutely paramount they communicate with you. The sooner they come to you to seek advice, the better.  

In times of financial stress, independent professional input can make all the difference. It can encourage businesses to shift focus to profitable areas, discontinue unprofitable pursuits, make sensible cost cutting measures, arrange agreements with creditors and provide a general steer on restructuring your business. 

If, having taken advice, there is no prospect of saving the business, it’s still important to wind up its affairs with the benefit of professional advice, to mitigate the risk of personal liability. 

When talking to clients, encourage them to never be complacent and if they see an issue arising to tackle it head on and seek proper advice. Help them to recognise the spectre of insolvency and understand how best to control customers and suppliers, while always watching the business’ financial performance. 

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