Now that the credit crunch has given rise to recession directors are asking us at Cousins Business Law 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, small to medium businesses.
In early October it seemed as if the supply of 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 still predicting a downturn in trade as confidence across the economy falls.
While 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 avoid them, and 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.
Most businesses fail due to cash-flow problems rather than anything else
It is easy for directors in small to medium 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 have inadequate systems or 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, the chances are the bank will decline an extension request. It has never been more important to stay within agreed overdraft limits and to keep on top of credit control.
Read the Cousins Business Law article 'Bad debt: the zero tolerance approach' to find out more.
Mistake 3
Spending too much time working in the business and not enough on the business
It is important to regularly take a step back and plan ahead.
Business plans should not just be seen as a chore to be done before approaching lenders. They are a vital road map of where the business is going and the detours it should make to avoid problems ahead. They should be updated frequently, especially in these turbulent times.
Look ahead and predict which areas of your business are likely to grow and which will shrink. Also look at your resources and assess whether cutbacks and redundancies are inevitable.
The sooner these difficult decisions are made, the better.
Is one area of your business making a loss while others make 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. While 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 Directors’ Responsibilities in Times of Financial Trouble at www.business-lawfirm.co.uk.
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 financial director 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 visit our website.
