Bankruptcy
It’s a dirty word. No one likes to hear it – but hey, it happens. Bankruptcy is the term that is used when referring to an individual who can no longer service their debt covenants (that’s fancy legal talk for any loan or borrowing repayments). Typically when that happens, an individual can declare bankruptcy to protect themselves from further legal action from the people they owe money to.
However, declaring bankruptcy comes at a cost as well. The effects of being declared bankrupt differ from country to country, but generally speaking, once you declare bankruptcy, you can be rest assured that it will be a stain on your credit history and banks will be less likely (or make it harder) to give you a loan in the future. You are generally bankrupt for a period of time and if you are looking for some info on what it means to be bankrupt in NZ you can check this link out.
Generally speaking, you don’t want to be bankrupt. But that being said, being bankrupt isn’t the end of the world but how you can work through it is a discussion best had with your accountant in your respective country as country laws differ on this.
So what does this mean for small business owners? Well, if you recall last week, we talked about business structures right? Sole traders and Partnerships will have their owners personally liable for any debt taken by the business – this means that if the business cannot service the debt, the creditors (accounting-ese for people you owe money to) can come after the business owner’s personal assets which can lead to them declaring bankruptcy.
For a company however – shareholders are 100% protected from the company’s creditors. That is unless you are a director. Now, a director usually cannot be held liable for the company’s debts BUT if they continue operating the company as usual with FULL KNOWLEDGE that the company can no longer pay their debts/wages/suppliers and the creditors of the company can prove this in court – then yes, a director can be held personally liable for the company’s debts. But yeah, if you’re just a regular shareholder you can chill. So my advice is this: If you are a director and you know for certain your company can’t service their debts – quickly pull the plug on it, declare insolvency (which is accounting-ese for when a company goes bankrupt) with the authorities and come clean with the company’s creditors.
In any insolvency or bankruptcy proceeding, a liquidator (a fancy word for a special type of accountant) is elected by the courts to liquidate (which means to sell your assets for cash) your company’s or your personal assets to pay off your creditors. These personal assets can include your bank account balance, your car, any shares you hold, properties you own and yes, even your family home.
Now, it is important to stress that insolvency/bankruptcy should only ever be used if there are no other options. It is not a get out of debt free card. Some people can (and have) lost their family home as part of their bankruptcy proceedings. So that being said, what can we do to avoid bankruptcy?
Never take on more liabilities than you can manage.
Generally speaking, you don’t want your liabilities to be higher than your equity – simply because an over-reliance on liability finance puts you at the whims and fancy of your creditors. Also, Interest rates are difficult to predict and more often than not, banks will try to squeeze you for every last cent.
Make sure you can afford to pay your team.
Guess who you owe money to every time payday comes around? That’s right! Your employees! Your beloved team! And do you know what happens if you don’t pay them what they are contractually owned? That’s right! They can file a complaint with the authorities and if you still can’t pay them what they are owed you may be declared bankrupt! To avoid this you need to make sure you have the capacity (that’s manager-speak for having enough work and money to go around) to hire team members. If you expect to not be able to pay a team member, its best you have a discussion on how both of you can work through the issue together.
Talk to your creditors
So everything has been said and done and despite your best efforts you still can’t afford to repay your debts, you can still reach out and talk to your creditors to see if you can negotiate repayment terms. This can mean extending the debt, getting a better interest rate or paying only the interest portion for a period of time. Whatever it is, most creditors are more than happy to talk things over peacefully (unless you borrowed from a loan shark – in which case, good luck!) because if you declare bankruptcy, they are likely to get much, much less than what you owe them in the end. If you are in NZ, consumer protection NZ has a really good site with info on this.
Generally speaking, if you are a financially savvy business owner who has a keen eye for finance and knows how to budget accordingly, you shouldn’t have to worry about insolvency or bankruptcy. But if you are in a position where due to lack of financial knowledge and/or riding the industry hype train you can’t service your debts, talk to your creditors first and see what options are available for you. Remember, those who fail to plan, plan to fail!