Insolvency is a situation that no business owner wants to contemplate. It’s a difficult and challenging decision for both individuals and businesses, and it can have significant consequences.
In this blog, I’ll discuss the potential benefits of insolvency, such as legal protection and debt relief, as well as the potential drawbacks, such as public record, loss of assets, and long-term business and personal consequences. Read on for guidance on what to expect if your business goes insolvent.
What is Insolvency?
Insolvency is a financial situation where an individual or a business is unable to pay their debts as they fall due. When you are insolvent, you may be at risk of legal action by your creditors, which can be a daunting and stressful experience. If you are in this situation, I recommend you seek professional advice immediately to weigh up the potential consequences and options for your future.
Why Consider Insolvency?
Being in business is challenging. Although you may have a profitable product or service, there are many reasons why things don’t work out the way you hoped. The business failure rate in Australia is estimated to be around 20% in the first year of trading, rising to 60% by the end of year three.
Businesses fail for many reasons – perhaps they are poorly managed, maybe the market contracts significantly, or they simply run out of cash. If a business has no money and cannot pay its debts as they fall due, it cannot continue trading. Insolvent trading is illegal, so if company directors are aware or suspect that the business can no longer pay its creditors, trading must cease.
You may consider insolvency if you are facing severe financial difficulties and have no options for future funding. Perhaps the reasons for insolvency aren’t within your control; maybe you incurred unforeseen expenses, a significant loss of income, or there was a global downturn in the economy. However, in some cases, insolvency is due to poor decision-making and financial management by the business owner, such as not spotting the warning signs, overspending or trying to grow too fast. Some businesses become insolvent because of fraudulent activity by directors or other employees.
When you’re facing insolvency, it’s a challenging and emotional experience. It can be difficult to know where to get support. However, please remember that there’s professional support out there to help you get back on track.
The Pros of Insolvency
There are some benefits of insolvency which can alleviate the financial predicament.
Legal Protection
One of the most significant advantages of insolvency is legal protection. When you enter into an insolvency agreement, you’re protected from legal action by your creditors. Any existing legal proceedings are halted, and creditors are legally barred from taking any further action against you.
This protection provides immediate relief and breathing space for individuals or businesses struggling with debt. You can focus on getting your finances sorted out and addressing the root causes of your difficulties.
Debt Relief
Insolvency enables you to obtain debt relief such as via bankruptcy, debt agreements, voluntary administration and the Small Business Restructuring process.
Bankruptcy is a legal process that allows individuals or businesses to discharge debts and start afresh. It provides a significant level of debt relief and can help you get back on your feet. Debt agreements, on the other hand, allow you to negotiate a payment plan with your creditors to pay off a proportion of the debt. This can help you manage your debts and avoid bankruptcy.
There are also additional options, such as voluntary administration and the Small Business Restructuring process. Voluntary administration affords companies a temporary reprieve from debt repayments while a way forward is charted. The Small Business Restructuring process, meanwhile, provides a streamlined approach to restructuring debts while allowing businesses to continue operating. Both options can help a company navigate its financial challenges and seek a path to recovery without resorting to bankruptcy.
Professional Guidance
Insolvency practitioners can help you understand your options and make informed decisions, preventing you from making costly mistakes or falling prey to scams. They’ll help you negotiate with your creditors, prepare documentation, and ensure you meet all the legal requirements for insolvency.
The Cons of Insolvency
Insolvency may seem like the perfect way to get out of your current stressful financial situation but seek advice from an insolvency expert before you choose this path, as there are some major drawbacks to consider.
Public Record
Having your finances as a matter of public record means anyone can access the details of your insolvency proceedings, including creditors, customers and even family members; your finances are no longer your own.
When everyone knows your financial situation, this can cause problems getting credit, issues with applying for certain jobs, not to mention shame and embarrassment. It’s another reason why you should think hard about filing for insolvency and talk to an expert about your options.
Loss of Assets
The insolvency process may require you to sell your assets to pay off your debts or sell your company or business. When you’ve worked hard and made sacrifices to build your business, it’s a painful experience to lose your property, other belongings and investments to set your finances straight. However, it is important to remember that it’s not a certainty that you will lose your assets during insolvency proceedings. Depending on your situation and the type of insolvency agreement you enter into, you may be able to retain some or all your assets.
Long-term financial consequences
Insolvency can have a huge impact on your future financial and professional goals. For example, as of 2023, if you file for bankruptcy, this can remain on your credit report:
‘2 years from when your bankruptcy ends or
5 years from the date you became bankrupt (whichever is later).’
If you are a business owner, insolvency can damage your business’s reputation, cause you to lose more customers or be unable to attract new ones. You may be personally liable for some or all your business debts; your personal assets, such as your home or car, may be at risk if your business enters insolvency.
The impact on your mental health
Financial problems can cause mental health issues. It’s important to prioritise your mental well-being and seek support from friends, family, or a mental health professional if you are struggling with the impact of your financial situation.
The potential for a director’s penalty notice
If your business has unpaid tax debts, you may be at risk of receiving a director’s penalty notice. This can result in personal liability for unpaid tax debts and potential legal action. Seek professional advice and address any tax debts as soon as possible.
The impact of insolvency on others
When a company becomes insolvent, it’s not just the business owners who are adversely impacted. There are many other people associated with the company who may also suffer.
The impact on your employees
If your business is struggling financially, you may need to remove costs by letting some of your employees go. This can have a significant impact on their lives. Communicate openly and honestly with your employees and provide support where possible. Make sure you write timely references and provide recommendations on platforms such as LinkedIn, make it as easy as possible for your employees to find new work.
The impact on your suppliers and creditors
Suppliers and creditors may be left with unpaid debts. This can damage relationships, making it difficult to obtain credit or other forms of financing in the future. If you are a significant customer to your supplier, it could also have long-term impacts on their business viability. Keep them informed and try to negotiate payment plans where possible.
How do I deal with insolvency in my company?
If you wish to file for insolvency, you have some options – voluntary administration, liquidation or The Small Business Restructuring Process.
Voluntary Administration
A company can enter into voluntary administration by appointing a registered insolvency practitioner to act as an administrator. The administrator will take control of the company and assess its financial position. During the voluntary administration process, the company and its creditors may agree to a Deed of Company Arrangement (DOCA) that will outline the terms of how the company will pay its debts.
Liquidation
A company can appoint a registered liquidator to wind up the company’s affairs. Liquidation involves the selling of the company’s assets to repay creditors, and any remaining funds are distributed to shareholders. The liquidation process can be initiated either voluntarily by the company’s directors or by court order.
What is Receivership
There’s a third option known as receivership, which is usually initiated by a secured creditor such as a bank with the purpose of repaying the secured debt. During receivership, a company can continue to trade. It’s possible for the company to recover from this situation to become a viable business again.
Small Business Restructuring Process
Small business restructuring involves evaluating the business’s financial health, identifying issues and opportunities, and creating a plan to address these. This plan, often involving cost-cutting, debt renegotiation, or asset sales, is then communicated, implemented, and continuously monitored for effectiveness, with adjustments made as necessary.
Getting support in insolvency situations
Remember, insolvency is not a crime, and seeking help is the first step towards getting back on track. There’s no shame in getting professional advice when you are facing financial difficulties. By working with a professional insolvency practitioner or lawyer, you can understand your options, make informed decisions, and get the support you need to make the right choices.
For advice and guidance on dealing with your financial difficulties, get in contact on 0448 000 010 or connect with me on LinkedIn.
