You can reduce the risk of becoming insolvent by ensuring that your business is soundly financed and keeping good control of your cash flow. These are issues you should discuss with your advisors and your bank.
Building a good relationship with creditors — for example, your bank — can help to reduce the risk that they will instigate proceedings against you if your business does run into financial difficulties. The bank (and other creditors) can be more supportive if you keep them informed and have a good previous record of prompt payment.
You must also make sure you know what is happening in your marketplace. You can soon find your business in trouble if:
- your marketplace is shrinking
- you are losing business to new competitors
- a supplier gets into trouble
- your failure to adopt some technological advance makes your products or services less attractive
Choosing an appropriate business structure will help to reduce the potential consequences should you become insolvent in the future.
A limited company offers the most protection against personal bankruptcy should the business run into difficulty: as a director and/or shareholder you will not usually be personally liable for the company’s debts unless you have given a personal guarantee or you have acted improperly. This offers you much greater protection than operating as a partnership, as partners are personally liable for the debts of their partnership if things go wrong. Taking out Directors and Officers Liability insurance can provide a further degree of protection for directors of a limited company – although the limitations on the cover provided, and the cost of premiums, often make this unattractive for smaller companies.
Alternatively, if you wish to operate as you would in a partnership, but want the benefit of limited liability for the partners, trading as a limited liability partnership (‘LLP’) can help to reduce the degree of personal risk. An LLP is a corporate entity whose members only have to contribute a pre-determined, limited amount if the LLP is wound up, but the management of which can be organised so it ‘feels’ like a partnership – for example, so that all the owners have an equal right to participate in day-to-day management. It is a particularly appropriate trading vehicle for professional practices that are unable, or do not wish, to incorporate as a limited company.
If your business structure offers some degree of protection, for example, you operate through a limited company or an LLP, you should also try to avoid giving personal guarantees to lenders such as banks. These are contracts under which you promise, personally, to make up any shortfall if your company or LLP cannot itself repay the money it owes its bank. If you must give a personal guarantee, negotiate to limit the amount it covers and how long it will last. Where several people are giving guarantees, try to avoid ‘joint and several’ liability which could make guarantors liable for all of a debt rather than just their share. In practice, however, it may not be possible to raise bank finance without giving a personal guarantee, and banks may not be willing to vary their standard guarantee terms.
Finally, as a director it is essential to keep a close eye on the company’s financial position. As well as improving your chances of avoiding insolvency in the first place, this will reduce the likelihood that you will be held personally liable for wrongful trading (see 15), or be disqualified as a director, if the company does become insolvent.
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