What Happens When a Business Goes Under

What Happens When a Business Goes Under

In 2023, more than 75,025 businesses in the UK were made insolvent in just the third quarter—a trend resulting from factors such as customer demand to the economic climate.

The process that needs to be followed when a company realizes it is sinking is complex and involves many steps. While in many cases these can be done voluntarily, there are instances where companies are forced to close by the courts.

In this article, we’ll examine what happens when a business starts to fail. This includes the early warning signs that may indicate a problem or technical insolvency and the steps that occur when a business closes its doors—voluntarily or by force.

Early Warning Signs

There are many indicators that a company may be failing or needs to relook at its core strategies to realign with a successful business plan. Some of these strategies may be to streamline operations in terms of manufacturers or boost customer support for services like online casinos. 

Lacking in certain areas, such as service, could cause consumers to look online at review websites. In the case of social casinos, for example, customers often flock to sites like casinos.com and the guide they created to find alternatives—further straining the relationship a business has with its customers. Some of the most common warning signs include:

Overuse of Credit Facilities

Businesses holding credit lines are part of standard practice. Commonly referred to as trade or 30-day accounts, these allow companies to purchase materials from suppliers and pay back the money after it has been recovered. An early sign that things may not be going well is if a company is relying on credit facilities and maxing these out without trying to ensure stable cash flow.

Late Payments or Defaults

The next most obvious sign of a failing business is not paying creditors on time or defaulting on loan payments. This is an early indicator of cash flow issues and can cause trouble for companies should creditors begin restricting credit lines or applying for court orders to recover money. 

Trading Losses

Another clear indicator that things aren’t rosy is when a company experiences trading losses over an extended period. While this could be temporary due to changes in the economy, it can have significant impacts on a company, particularly in terms of cash flow. 

When these early warning signs are visible, there are steps that a company can take before becoming properly insolvent. 

Pre-Insolvency

When these early warning signs are visible, a company can take two steps before becoming properly insolvent. These can help the company correct its path and, hopefully, avoid going under.

Company Voluntary Arrangement (CVA)

A company voluntary arrangement permits a company to continue business as normal under its current management. However, the company is required to sign formal agreements with all creditors to repay outstanding debts over a certain period.

While this may sound ideal, there are limiting factors. A CVA will only be allowed should at least 75% of creditors (by value) agree to repayments and the initiation of a CVA. Furthermore, the CVA will need to be supervised by an insolvency practitioner licensed to oversee such proceedings.

Administration

Unlike the process above, administration requires a change in a company’s management, which is taken over by an appointed administrator. This manager will see the company as a going concern and attempt to achieve more favourable results than immediate liquidation of assets.

Unlike a CVA, administration is overseen directly by the courts and becomes a legal process. As such, entering administration protects the company from legal actions launched by creditors.

Liquidation

Should any pre-insolvency attempts fail, the final step for a company is to file for liquidation. This can be done in two ways, each resulting in the company ceasing and all assets being liquidated to pay outstanding creditors.

Voluntary Liquidation

A company that is turning profit but merely desires to cease operations can initiate voluntary liquidation. This form of liquidation, called Members’ Voluntary Liquidation (MVL), is uncommon and rarely initiated. By contrast, Creditors’ Voluntary Liquidation (CVL) is common and is the method of liquidation many failing companies opt to file for.

Under CVL, directors are required to call a meeting and propose liquidating a company due to failing pre-insolvency measures. At least 75% of shareholders must agree to liquidate the company during this meeting.

Once a vote has been made, the company will have 14 days to meet with all creditors and inform them of the action. At that point, a licensed insolvency practitioner will need to be appointed for the process. This practitioner will oversee the liquidation (or sale) of all assets and the dispersion of this money to creditors based on an asset distribution hierarchy. 

Mandatory Liquidation

For companies not willing to give up, liquidation may be initiated via court order. This occurs when pre-insolvency measures have failed, and creditors seek legal routes to reclaim their money, causing the courts to examine a company’s viability.

In this process, creditors file a winding-up petition, which is heard by the courts in a hearing where the company may argue its case. Should the court side with creditors, a winding-up order will be issued that places the company under the control of an official receiver.

After this, an insolvency practitioner is appointed to the company to oversee the sale of all assets. From here, the process follows that of a voluntary liquidation in that all assets are sold and the proceeds are distributed using a hierarchy of creditors and used to pay liquidation costs. 

Legalities

Despite many insolvency proceedings being overseen by a licensed practitioner, directors still need to fulfil obligations (in instances where they are not replaced by the court) to ensure all legalities are followed.

The insolvency practitioner monitors these obligations, which include that the director needs to continue acting in the best interest of creditors during the insolvency, maintain accurate records of all proceedings, and cooperate fully with the liquidator.

Conclusion

Despite many attempts to remain solvent, the path of insolvency outlined above is a stark reality. However, while businesses may fail and cease to exist, there is some hope that they will be resurrected, as with Razer in Singapore and the US. 

Should this occur, companies can grow exponentially from nothing and find a firm footing in their industry. However, this is a large undertaking that requires copious amounts of careful planning, management, and hard work.