Options for directors when the business is struggling

Directors are facing a perfect storm of economic and political instability, alongside escalating energy costs, significant wage pressure, and rapidly rising interest rates. Many also have an increased debt burden post-Covid, or HMRC arrears. However, there are some actions a director can take to protect the business and maximise its chances of riding the storm.

Acknowledge the problem

Lynne Blakey, Evelyn Partners advisory consulting director, advises struggling businesses to “proactively seek help at an early stage”. Entering into an insolvency procedure should be seen as the option of last resort. The earlier that directors seek help and advice, she says, the “more options may be available to protect their business, preserve shareholder value and safeguard jobs”.

Don’t ignore the problem, advises Paul Taylor, partner at Fox Williams. “Taking action sooner rather than later could make the difference in saving a business,” he says. “Even if it can’t be saved, action at an earlier stage may reduce the risk of a director later being personally liable.”

Wrongful trading, Taylor explains, is where a company trades and takes on liabilities when the directors should have concluded there was no reasonable possibility of saving the company – which is “more likely if the directors are ignoring the problems”. There can be severe consequences for directors found guilty of wrongful trading, including being held personally liable for company debts and/or banned from acting as a limited company director for up to 15 years.

“The key is to act – either before, or at least as soon as, the director becomes aware that insolvency is very likely,” agrees RSM restructuring partner Gareth Harris. “If they don’t, there can be personal liability and risk. At that stage, if not before, they need to be taking advice from a licensed insolvency practitioner.” Simply working harder is “rarely the answer”, he adds.

Cash is king

Directors of struggling businesses have to take a step back and seriously consider the ongoing business model and its cost base. They must also ensure they have comprehensive forecasts: not only a profit forecast, but also a short- and long-term cash flow model to understand the impact of different scenarios on the business and assess viability. Having these, says Lynne Blakey, “means one can proactively identify any funding shortfall and seek to address this in advance” – and directors can take steps to improve performance.

Automatically assuming that more borrowing is the solution is wrong, advises Harris: “Borrowing your way out of a problem, particularly with high interest rates, can sometimes make things worse. Don’t take any dividends, or remove/transfer assets from the business, without seeking professional advice.”

Fellow RSM restructuring partner Graham Bushby adds: “Don’t assume any borrowing facilities will still be made available, or that your existing lender or backers will continue to do so. Banks and investors generally approach additional lending as though it were new lending, and want to know if there’s a sensible, viable plan to turn around the business.”

The end?

Where a company is insolvent i.e. the value of its assets is less than the amount of its liabilities and/or it cannot pay its debts when they fall due – then “the interests of the creditors will take priority over the interests of the members”, Lynne Blakey explains. An appointed insolvency practitioner can seek to challenge the actions of the company’s former director(s), she says, so directors’ conduct is important.

“Key decisions at this time should be carefully documented, for example in directors’ meeting minutes,” Blakey advises. “During this period, only essential creditor payments should be made, so that directors are not preferring one creditor over another without good reason. Directors who have taken responsible, reasonable, steps to protect the business and act in creditors’ interests – including seeking professional insolvency advice and following it – are less likely to have their actions challenged.”

“The key change is that director’s duties switch from primarily acting in the interests of the shareholders, to protecting the creditors’ position(s),” Harris reiterates. “That takes a mindset shift but is absolutely vital: failing to do so can potentially lead to personal liability and director disqualification. Directors still have an overriding duty of care to the company, but the shift to looking after creditors, and being mindful of not worsening their position, is key.”

Tips on improving performance or cash flow

Actions that directors can take to improve performance or cash flow, Lynne Blakey advises, can include:

• Identifying opportunities to reduce costs, e.g. through limiting discretionary spending, reviewing staffing levels, re-tendering large contracts, and making efficiency improvements.
• Improving working capital and cash position, e.g. collecting overdue debts, reviewing stock levels and/or payment terms.
• Maximising the business’s tax efficiency – ensuring all tax incentives have been claimed, e.g. cash back options for loss-making entities.

10 practical tips for directors of struggling businesses

Paul Taylor advises:

1. Do not ignore the problem
2. Take proper advice
3. Establish procedures and stick to them
4. Stay on board
5. Beware legal pitfalls
6. Consider the business’s stakeholders
7. Consider the unthinkable – all scenarios should be considered
8. Do not prefer; do not transfer assets out or pay dividends/bonuses without commercial justification
9. Consider the payment order (priority) for creditors
10. Do not lose too much sleep, if possible

This article first appeared in the March/April 2023 issue of Financial Accountant.