As the credit crunch deepens into what looks like an unavoidable recession, directors are asking us what they can do to protect themselves personally should their business be affected.
The events since the Lehman Brothers’ collapse have been frightening for most, if not all, SMEs and family-owned businesses. During the first few weeks of October, it seemed as if money had completely frozen, with few businesses making any payments at all. Thankfully, this seems to have relaxed somewhat and money is flowing again but most businesses are predicting a downturn in trade as confidence across the economy falls.
Whilst no amount of legal or business advice can guarantee survival in these troubled times, it is worth knowing the most common mistakes that directors make so you can ensure that you avoid them to help protect your business and your personal assets as much as possible.
Mistake 1 – Not Having a Good Management Accounting System
Most businesses fail due to cash-flow problems rather than anything else. It is easy for directors in SME and family-owned businesses to concentrate on what they do best, which is often getting the orders in and making sure they are fulfilled efficiently. As the recession bites harder, directors will inevitably have to concentrate more on sales but this will be a waste of time unless a close eye is being kept on the finances too.
These days, with the many computerised accounting systems available, there really is no excuse for not having a good management accounting system. However, we still see clients who do not have adequate systems or who fail to input data correctly or frequently enough. The best thing to do here if you’re not sure is to get advice from an accountant.
Mistake 2 – Not Monitoring Cash-Flow Closely Enough
The days of easy credit have gone; if you reach your overdraft limit and then go to the bank seeking an extension, the chances are that they will say “no”. It has never been more important to stay within agreed overdraft limits and to keep on top of credit control. See the Cousins Business Law article Avoiding Bad Debts during the Credit Crunch – the Zero Tolerance Approach.
Mistake 3 – Spending Too Much Time Working in the Business and Not Enough Working on the Business
It is important to spend time regularly in taking a step back and planning ahead.
Business plans should not just be seen as a chore that has to be done before approaching lenders. They should be seen as a vital road map of where the business is going, how, and what detours it should make to avoid problems ahead. They should be updated frequently, especially in these turbulent times.
You should try to look ahead and predict what areas of your business are likely to grow and what areas shrink. You should also look at your resources and whether cutbacks and redundancies will be inevitable. The sooner these difficult decisions are made, the better.
Is there some area of your business that is making a loss whereas others are making a profit? If so, it might be time to move away from these loss-making areas.
You will also need to look at managing your risk as far as credit control is concerned. If you can’t renegotiate terms with important customers, you need to consider whether the risk of continuing to offer them credit (how would you cope if they suddenly went bust?) would be just too much for your business.
Mistake 4 – Putting Personal Money into a Failing Company
You need to be realistic about whether your company is going through some short-term financial problems or whether it could be failing. Whilst injecting funds into a basically healthy company can help overcome some short-term cash-flow issues, it is not a good idea to use such funds to shore up a failing company.
If you do inject funds into the business, as either capital or a loan, you are likely to lose these if the company does become insolvent (see Mistake 5).
Mistake 5 – Paying Off Some Creditors in Preference to Others
When a company gets into cash-flow problems, a mistake we often see is a director making a short-term loan to the company and then repaying it a month or two later. If you do this and the company later goes into some form of insolvency, then the court could order you to pay back those funds into the company.
The law says that, once a company is technically insolvent, it is often unlawful to pay one creditor in preference to another. Dangers can particularly arise when a director pays back a loan he made or pays off the bank, perhaps in trying to avoid losing money under a personal guarantee.
For more information on this, see our article, Directors’ Responsibilities in Times of Financial Trouble.
Mistake 6 – Transferring Assets or Contracts to a ‘Phoenix Company’
Sometimes insolvency seems inevitable. Maybe you’ve got a good business but a large customer has just gone into liquidation owing you too much money for you to survive.
In such circumstances, it might be advisable to invoke some form of insolvency procedure and perhaps start trading through a new company. The mistake that many directors make, however, is in not taking advice early enough about how to do this while minimising their personal risk.
Transferring assets or contracts to the new company, for example, can result in having to pay back money to the old company, unless they were bought by the new company at a fair market price.
There are also various procedures to achieve the result you want and the sooner you take advice the better.
Mistake 7 – Not Keeping an Eye on Fellow Directors
We see this again and again: the sales or production director is busy getting on with their work and leaving the financial side of the business to the financial director. Maybe they don’t really understand company finances or maybe they’re just too busy to keep a close eye on them?
The problem here is that all directors are held responsible if a company fails and it is no defence to say that you left financial matters for the FD to sort out. Their mistakes could cost you dearly.
If you don’t like the way your fellow directors are running the business, you should say so and insist on it being minuted. There are advisable procedures to follow to safeguard you as much as possible, so early legal advice can be vital.
For advice on your responsibilities as a director or your concerns about the legal responsibilities of your company in tough financial conditions, contact Gary Cousins of Cousins Business Law on 0845 003 5639 or by email here.