What is business insolvency and how do I deal with it?

Every year thousands of companies face business insolvency and the risk that they may have to close down.

Insolvency tends to happen in one of two ways: either the business can’t pay its bills on time, or it has more liabilities than assets on its balance sheet.

The good news is that if you identify the threat of insolvency in good time, there are steps you can take to prevent it.

With the right approach and professional help, you can even lift your business out of insolvency.

Here’s what every business needs to know, no matter how financially secure it may be now.

What is insolvency in business?

Being insolvent means you can no longer pay your debts as they fall due.

Insolvency can happen in either of two ways, or both at once.

The first kind is cash-flow insolvency, where the business doesn't have enough accessible cash to pay its debts, but does have illiquid assets.

Cash-flow insolvency is easier to fall into, but fortunately is usually more easily resolved (e.g. by selling off assets or simply negotiating a debt extension while you wait for the cash flow situation to improve).

The second and more serious kind of insolvency is balance-sheet insolvency.

This is where your company's total debts are greater than its total assets (liquid or otherwise).

You may in fact have enough cash to pay some bills, but insolvency law will usually forbid you from paying some creditors and not others.

This is classed as 'trading while insolvent'. The usual procedure in the event of balance-sheet insolvency is to cease trading immediately and address the insolvency problem.

What might cause my business to become insolvent?

The journey from business stability to the brink of insolvency can be alarmingly quick, so learn to spot the warning signs.

For instance, delaying bill payments because the money isn’t there can be the start of a slippery slope, as then debts will begin to pile up.

Some of the most common factors that may lead to insolvency include:

• A cash flow crisis caused by a large unforeseen expense, tax bill or purchase
• Loss of business from increased competition
• Loss of an important customers
• An unexpected drop in sales (or an inconsistent period of sales)
• Key employees leaving

Two of more of these in combination can easily trigger a crisis, and sometimes it only takes one.

What does business insolvency mean for me?

The exact consequences of insolvency for you and your business will depend on a number of factors, in particular the business structure.

Some structures leave you more personally exposed, while others grant a degree of protection.

Sole trader insolvency

For sole traders, becoming insolvent means that you personally are no longer able to pay your business or personal debts.

Usually you will have to close your business and sell its assets to pay the debts, and you may need to declare bankruptcy.

Going bankrupt can resolve some problems (such as having most types of debt eventually written off) but it also has many disadvantages, so it’s not a decision to make lightly.

Limited company insolvency

Company insolvency can take place in a few different ways.

One form of company insolvency is a voluntary liquidation, which involves employing an insolvency practitioner to close your business.

They will take charge of selling your company assets, paying your creditors and dealing with any outstanding affairs.

This process includes two main types: a creditors’ voluntary liquidation (CVL) and a members’ voluntary liquidation (MVL).

• Creditors’ voluntary liquidation (CVL): This occurs when the company’s directors recognise the business is insolvent and choose to initiate liquidation themselves. An insolvency practitioner will manage the sale of company assets, pay off creditors, and address any outstanding affairs. The business’s debts are written off once the company closes, but any personal guarantees or debts owed by directors will still need to be addressed.
• Members’ voluntary liquidation (MVL): This is used when the company is solvent, and the directors wish to close it down and distribute the assets to shareholders.

If you can’t afford an insolvency practitioner, you may need to undergo a compulsory liquidation.

By applying for a court order to close your company, you ensure the court will use a liquidator to shut your company down.  

Alternatively, you can apply to Companies House to strike your company’s name from their register if you haven’t been trading for three months.

You must inform all relevant stakeholders (e.g. creditors), but if no one objects, your company will cease to legally exist, and its debts will be written off.  

Partnership insolvency

When a partnership goes into insolvency, the individual partners will be asked to pay the debts.

If a partner cannot pay off their share of the debt then he or she may have to declare bankruptcy.

If the debts in question were incurred before you joined the partnership, or after you left, you will not be held liable to pay them.

Limited Liability Partnerships (LLP)

LLPs are considered in a similar way to companies for the process of insolvency. The options of voluntary and compulsory liquidation are available to LLPs. 

What to do if you’re facing balance-sheet insolvency?

To face balance-sheet insolvency can be very stressful, but don’t give up hope while your business is still running.

Think carefully about the best course of action, and if you truly want to fight on and try to save your business, you have several options available.

Administration

Going into administration means that you hire an insolvency practitioner to restructure your company and allow it to stay open.

While this is going on, you are protected from legal action by creditors looking to recover their debts.

The administrator will present you with a proposal of measures to get your company back on its feet, along with arrangements with creditors and perhaps plans for selling off assets.

It is up to your creditors whether they accept the proposal, and your business may end up looking very different.

Company voluntary agreement

This is a legally binding agreement between you and your creditors that outlines how you are going to pay your debts (either wholly or in part) over an agreed period.

Informal agreement

This is like a company voluntary agreement, but is reached on an informal basis and is therefore not legally binding.

This is only really a viable option if your relationship with your creditors is very good.

Corporate recovery

Another option available to you is corporate recovery. This involves a professional accountant stepping in to help you save the business.

A corporate recovery specialist will try to arrive at a solution tailored to your business.

This could involve working towards refinancing or restructuring your debt, guiding you through the liquidation process, or helping you get a company voluntary agreement.

Business insolvency is likely to be a confusing and emotionally draining time, so the support of an expect can be great reassurance.

Business insolvency is also likely to involve hard choices and tough times, but it doesn’t necessarily spell the end of your ambitions.

The lessons you learn could leave you with a much stronger foundation for future growth, or for your next venture.

Get expert financial advice

Insolvency can be a daunting prospect for any business owner, but it does not have to mean the end of the road.

By understanding the types of insolvency and the options available to you, whether it's restructuring, liquidation, or reaching an agreement with creditors, you can make informed decisions and take proactive steps to manage the situation.

With the right guidance and a clear plan, it's possible to navigate through insolvency and come out stronger on the other side, ready to rebuild and seize new opportunities.

Let Unbiased match you with a financial adviser for expert financial advice on navigating the prospect of business insolvency, exploring restructuring options, or planning for a stronger financial future.