If your business cannot pay its debts as they come due, the business is insolvent. Under insolvency law, a business is also insolvent (sometimes referred to as "technically insolvent") if its liabilities exceed its assets. In either case, the consequences both for the business and for the individuals concerned can be severe.
Fortunately, it is possible to take steps to minimise the risk of insolvency and the problems insolvency causes. Even when insolvency is already threatening, an active approach can make a substantial difference to the outcome.
Minimising the risks of insolvency
For many business owners, business insolvency and personal insolvency are interlinked - if the business fails, personal assets are on the line. Incorporating as a limited liability company or a limited liability partnership helps protect your personal assets, provided that business debts are not covered by a personal guarantee.
If you, your family or friends are putting money into a business, you can reduce your risk by investing in a less risky way: for example, by giving the business a secured loan rather than buying shares. This kind of protection, however, limits the ability of the business to borrow from other lenders.
Cashflow forecasting and credit control are vital ways of reducing risk. Good credit control helps improve the balance sheet of the business, reducing the chances of insolvency. Regularly updated cashflow forecasts provide an early warning system of any potential cashflow shortage.
When insolvency threatens
If insolvency seems likely, or if your business is already insolvent, you should act quickly. The first step is to assess the outlook for the business.
If the business has good long-term prospects, you may be able to take short-term steps to tide you over. Improving credit control by managing your creditors or selling off non-essential assets can provide an immediate cash injection. For example, a discounted sale of old inventory can increase cash balances - even if the stock is being sold at below cost.
If you have a convincing business plan, you may be able to raise finance by approaching investors or lenders for additional funding. Your chances of success are far better if you do this before the business is in trouble.
Where the outlook is less promising, you should consider appointing a licensed insolvency practitioner to look at your options. Doing nothing, or trying to protect your personal position at the expense of other creditors, is not an option. The consequences can include personal liability for the business debts or even a charge of fraud.
Your insolvency practitioner can advise you on the best way to deal with your debts and help you through the process. This depends amongst other things on your business form (such as limited company) and what the prospects for the business are. Options can include negotiating a voluntary agreement with your creditors, entering some form of administrative arrangement, winding-up the business and/or personal bankruptcy. The Insolvency Service can provide information and forms.
If possible, you should act before you are faced with court action or a statutory demand for repayment from creditors trying to protect their own interests. Taking early action yourself increases the likelihood that you will be able to rescue something from the situation.