by Sandra Mundy
14 November 2023Article
by Sandra Mundy
The number of companies collapsing into insolvency and in critical financial distress is on the rise. Yet directors who act early can often save their business as experiences from the technology sector prove. Sandra Mundy and Sue Staunton explain in more depth below.
The Government’s Insolvency Service at the end of October reported a 10% increase in the number of businesses falling into insolvency in the past 12 months with 6,208 companies collapsing. A further 38,000 businesses are considered at risk, a jump of 25% over the last three months.
A perfect storm of soaring interest rates, increasing cost of borrowing, the repayment of Covid loans, skills shortages, increased labour, fuel and material costs, and a cost-of-living crisis dampening demand in some sectors, has proven too much for many businesses.
The data however tells a more complex story. The number of director-led insolvencies has increased dramatically, with business owners recognising their company is failing and taking steps to wind-up. Interestingly, the statistics do not suggest that creditors, notable HMRC, are taking aggressive action to wind-up businesses. With this creditor pressure absent, we ask whether if advice had been taken earlier, could some of these businesses have had more positive outcomes?
The Insolvency Service data attempts to look at the industry sectors that are hardest hit with construction, hospitality and retail sectors attracting media attention. But it is the experiences of technology companies that can offer a more encouraging picture.
It is commonplace for funded tech businesses to have sitting on their Boards both executive and non-executive directors. Non-executive directors often representing the interest of private equity investors. There is, quite understandably, a natural tension that exists albeit one driven by a common goal – the success of the business.
In normal trading conditions, whilst directors may not be personally liable for the debts of the business, they have a very clear duty to the shareholders, the business and its creditors, and that shapes behaviour just as the regulations intended.
For businesses that are in financial difficulties there are additional concerns for the directors. The prospect of wrongful trading, where directors continue to trade knowing that insolvency cannot be avoided, and other provisions of the Insolvency Act may, in the event of a formal insolvency, see the corporate veil lifted and directors (both executive and non-executive) become liable for the debts of the business.
In addition, there is the worry of disqualification proceedings restricting directors from starting new businesses. This really does focus directors’ minds to take the right steps to protect the interests of creditors.
Directors without shareholdings (executive and non-executive) tend to be cautious as there is no significant upside benefit for them in taking the personal risk of continuing to trade an insolvent business in a turnaround phase.
Investors and shareholders have no such accountability – it is their investment or shareholding that is at stake and not their personal assets or future careers or livelihoods. You would think that this leads to investors adopting a more bullish approach to the future of the business, looking to protect their investment. In our experience, investors are very mindful of the position that this puts directors in and, in particular, the non-executive director representing the investors’ interest, especially where that person is also one of their employees.
Whether pre-revenue or in rapid expansion, tech businesses can often find themselves quickly burning through cash and with uncertain future funding. Investors may inject further funds to support their investment, but this is by no means certain and will often depend on the investor’s perception of future trading and return on investment criteria.
Together, this creates an environment where directors keep a watchful eye on cash flow with alarm bells triggered perhaps six months or more before problems become acute.
It is not uncommon to see tech businesses with seemingly healthy bank balances turn to restructuring specialists early. It is a discipline that is often missing in many owner-managed businesses despite this early intervention by directors creating space to save the business.
If, however, a turnaround is to be implemented, the tensions that exist between directors, shareholders and investors need careful navigation. All stakeholders need to understand and accept why early intervention is needed, the actions that might be needed and have the opportunity to input into any changes in strategy and direction.
There is often the misconception that appointing restructuring specialists will see the business presented with a series of ‘take-it or leave-it’ options. That is rarely, if ever, the case if the problem is addressed early enough.
The role of advisers, irrespective of who made the appointment, is never to take sides. It is to work alongside the business and its stakeholders helping them find the right solution to their situation.
There is rarely one silver bullet that will solve all the problems a business faces. Businesses will typically need a mixture of more funding perhaps from existing or new investors, cost cutting, delayed capital expenditure, or a sale.
In some instances, the best option may be an orderly wind down and solvent liquidation preserving the intellectual property that has been developed. With all creditors paid and no personal liability, directors will not face the risk of disqualification that would otherwise restrict their ability to start a new business.
It is, in our experience, much rarer for a tech business to enter into an insolvency process than find an alternative solvent solution.
With the economy continuing to look tight for many, business owners should look to the experiences of tech entrepreneurs and take advice early. Use that window to forecast and scenario plan the potential outcomes to the business and how they might be mitigated. It might just help your business avoid being another Insolvency Service statistic.
To discuss this further, please contact one of our Turnaround, Restructuring & Insolvency team members.