Closing a Business with Debts
Just as individuals may find themselves over extended and in debt, so can a company. A company may have a line of credit, which is similar to an overdraft, credit cards, bank loans, car loans for company cars, and also leasing of office space or a building, in addition to business rates to the local council. It can all add up. The biggest decision a company has to make if they are struggling with debt(s), is can we turn this around, or is it time to wind the company up. That is a difficult call to make. The options a business has when struggling with bills and debts, can depend on how the company is structured, and who has signed for the accounts/loans. If the company is a sole trader, then just the “trader” him or herself will be responsible for any debt. A company that is a partnership, where two or more people are partners in the firm, may have one person responsible for one debt and others responsible for other debts; or all the partners may have signed and are equally responsible for the accounts. In a LLC or limited (LTD) company, the company itself becomes a third party or entity within itself. The company can have loans and accounts in its name, however, in many instances a Director of the company may be asked to sign, or guarantee the loan. We will discuss more on Directors guaranteeing loans later on. Restructuring a company to be more profitable and pay off its debts, especially if it is debt heavy, can take time, and is not an easy thing to do. It also requires any creditors the company has and owe money, to consent and work with the company. This is crucial. If any creditors will not work with the business during this time, they can be the ones to put the company out of business. Not an inclusive list, but here are some options available to businesses struggling with debts. It will be mentioned more than once here, but documentation, showing the company can be turned around is imperative if any creditors are going to work with the company. Documents such as an updated business model or cash flow sheet may be required outlining how the company will become profitable again, and also the time line it will take to do this. Pay Interest Only If a company has a lot of debt, this means thy could also be paying a lot of interest, in addition to paying some of the principal of the debt. By just offering to pay the interest only of a loan, it can reduce the monthly payments. In many instances this will not reduce the payments by a large amount, as with many loans in the first years you are paying more interest that principal, however, the banks or lenders still get paid, and they also know they as of yet, have not lost money. This is a short-term solution as many lenders are not going to allow a borrower to just pay interest for a long period of time. However, it is an option to reduce outgoings for a period of time. Sell Future Receivables If your company is owed money, or if you are billing clients and expect payments within a reasonable period of time, using your future receivables/invoices as a pledge to repay loans, is a way to improve cash flow. Again, documentation is the key. You will need to show how much money is owed to you, and when you expect payment of the invoices. Using these future receivables can buy time in repaying some loans. The thing to remember is that by using these as payment, the company will then not have them as cash or income. Critical that you can show the company can still continue after these are paid. Payment Holidays Just as it says, ask the lender for a payment holiday. While used in mortgages, it can also be used for any type of loan. The company simply asks the bank/lender for a period of time to not make monthly payments. It may be one month or three months, whatever it takes for the company to turn itself around. Usually a few months is the maximum a bank will allow, if they even entertain the idea. Again, the company needs to show that those months will improve cash flow and allow the company the space it needs to turn itself around. The bank/lender losses out on the monthly payment, but in the end gets paid as the business does not go bust. Banks may charge a fee for this and add it onto the loan. Settlements Settling a debt is where the borrower pays less than what is owed on the outstanding balance of an account, and the creditor accepts the reduced amount and marks the account as paid. Settlements are usually considered when a company is being wound up and closing, and there is not much hope of getting paid the full balance. Settlements are also only helpful if the company in question has a lump sum they can offer, and the account(s) are in arrears. A bank/lender is rarely going to accept a settlement if an account is being paid as agreed. Usually the more in arrears an account is, the more a creditor will entertain the idea of a settlement. CVA/Company Voluntary Arrangement Just as an individual with debt can enter into an IVA/Individual Voluntary Arrangement, companies can enter into CVA’s or Company Voluntary Arrangement. All the Directors of the company must be agreement in order to do this. Just as with an IVA, an Insolvency Practitioner will put forth a proposal to all creditors outlining the business’s expenses and earnings. The proposal also outlines reduced monthly payments of what the business can afford. The creditors get to vote as to accept the proposal of reduced payments, and as long as 75% agree, the proposal is binding to all. If the creditors reject the proposal, the business could be then looking at liquidation Director Guaranteed Loans As previously mentioned, with some LTD companies that request a loan, the bank or lender may feel that as a new company, there is no experience or credit history there, so the lender may state that in order to grant the loan, the Director or Directors, need to guarantee the loan. What this does is that if the company for any reason cannot repay the loan, the loan then becomes the responsibility of who guaranteed it; the Director(s). This reduces the risk to the bank. If the company defaults on the loan, the Director or who guaranteed the loan is liable. While common practice in the banking industry, Directors need to be aware of their responsibilities should the company not make the payments, or go under. What To Do When Closing a Business With Debts In many instances if a company goes bust, they are going to owe someone money. So what happens then? One way to deal with any debt is again, negotiate a settlement. However, again the company has to have the cash on hand to do this. If a company is insolvent, and cannot pay any of its creditors, it can go bust, or enter into some form of liquidation, either voluntary or compulsory. When the company is liquidated, any assets will be used to repay the creditors as much as can be paid. If there are no assets, then no one gets paid. Any debts in the company name will be discharged and no longer owed. Any accounts that have been guaranteed by a Director or anyone, will then be the responsibility of the guarantor. In some instances this can cause the Director, or guarantor to be forced into insolvency and bankruptcy. There are other ways for a company to deal with high debt levels, increasing sales is an obvious way, and so is restructuring the accounts, such as extending the terms to reduce the monthly payments. But again, this will require the approval of the bank/lenders.