Case study – Someone to fight your corner

I was once contacted by a potential client who thought that they were probably insolvent and needed to cease trading.

Insolvency isn’t our business. We have plenty of people we can put you in touch with if your business is past the point of no return, but people trust us when they are in trouble. So, we’ll always have a look at the situation.

This was an interesting one. On the face of it, the company was in trouble. For industry reasons completely outside of its control, turnover had fallen significantly. They were a long way off break-even point and didn’t really have much of a plan on how to get back there.

The word “insolvent” has two meanings. I call them the “Taxman’s definition” and the “Official Receiver’s definition”.

The “Taxman’s definition” can be found by simply looking at the end of year Balance Sheet. Do the liabilities exceed the assets? If so, then you are in negative territory. Any dividends you take are technically illegal and can trigger tax issues for you.

But this can be misleading.

For example, there might be two businesses who are identical in all but one respect. One has purchased its goodwill from a previous owner of the business and the other has built the business from scratch.

The first will probably be showing goodwill as an asset on its Balance Sheet whilst the second won’t. And that could be the difference between appearing to be insolvent and not being.

The other definition (the Official Receiver’s one) is “can the company meet its debts as and when they fall due?”.

This is a hard one to answer sometimes.

Everyone has a cash flow problem at some point. Maybe a big customer hasn’t paid you on time. Maybe you put down a huge deposit on some new premises and are now a bit stretched.

And what does “due” mean anyway? If one supplier hasn’t been paid by the date specified on their invoice, have you failed the test?

In reality, this only ever gets considered “after the event”. With the event in question being a liquidation.

But anyway, back to the company in question.

On both definitions, the company was not insolvent. But it was in trouble. Losing money. And given time, it would eventually be insolvent; one way another. Or both.

The directors were thinking of putting in personal money to prop the company up. We advised that this was a bad idea until we had looked at all the possible angles.

We dug a little deeper and started asking questions about costs.

One of the big ones was a regular monthly payment being paid to a company owned by a former shareholder. As part of his negotiations to leave, he had committed the company to paying a percentage of turnover to his other company for marketing services. This was not a good deal. Especially as hardly any of their turnover was arising from any of these so-called marketing services.

And worse than that, he was also providing services to deal with the company’s bookkeeping and financial reporting. This was not a good deal either.

And even worse than that, he was using his position in both of these roles to make decisions on behalf of the company and even instruct the staff.

It was like he’d never left!

But the deals seemed to be watertight.

We talked about a worst-case scenario. What if they just ceased trading as soon as the company was insolvent by one definition or another? What would be the costs of setting up again?

At this point, a bit of game theory comes in handy.

We walked through how things would roll out. The deal they would probably be able to cut with the liquidator of the company, the funding they would need to get going again. The real break-even point of the new business. Without the involvement and costs of the ex-director’s marketing and finance companies.

It looked like a much better alternative than pumping their own money into a lost cause.

Once we had a fall-back plan, it was time to work on Plan A. Time to talk to the ex-director about these unmanageable costs.

At first he wasn’t very receptive. It was a great deal for him, and he wasn’t prepared to give it up.

We patiently explained the current financial position. Which was of course what one of his companies was actually being paid to do.

We provided some projections demonstrating the point at which money would run out.

And then we highlighted what would happen if the company failed. And perhaps most significantly, we outlined our opinion that he was acting as a shadow director.

Game-changer.

Shadow directors are treated far more harshly in liquidations than actual directors are. I don’t know the history of this, but I presume somewhere along the line someone in power got really upset by people running companies without actually appearing as directors anywhere.

Suddenly we were negotiating. A deal was done.

At this point, the current directors did use their personal money for the business. Now that it had a future, it wasn’t good money after bad, it was good money after good.

Weekly targets were set for sales. A small re-organisation took place. The marketing was overhauled and a strategy based on both referrals and inbound was implemented.

It was tough and there were some tricky moments. But the business did more than just survive. It thrived.

If you need someone to fight your corner in whatever situation you find yourself in, give us a call.