Disadvantages of liquidation
If you can understand the disadvantages liquidation has, this can prevent you from making poor decisions which cost, especially in already unfavourable environments.
This helpful guide will explain these disadvantages to you. But, to begin, we will take a look at the three types of liquidation, and when they are likely to come into play.
What is liquidation?
It is the process which facilitates a companies closure and apportoning of assets, by agreements or litigations.
What are the three types?
- Creditors' voluntary liquidation (CVL): The most common type. It occurs when your company can no longer pay its debts and you involve your creditors in the liquidation process.
- Compulsory liquidation: Your company cannot pay its debts (often with creditors chasing significant late payments) and an application is made to court for the company to be liquidated.
- Members' voluntary liquidation (MVL): Your company can settle the current debts, however you still wish to close it.
This article will focus on the disadvantages of liquidation in relation to the CVL model.
What are the disadvantages of liquidation?
1. Some payments may still remain
Liquidation is generally a cost-effective option that will prevent you from having to make further payments.
However, there are some instances where you will still be held liable for settling outstanding amounts:
If you've given personal guarantees to creditors regarding company debt repayments, you (or your guarantor) will be held legally liable for settling these amounts.
Alternatively, if you've borrowed money from the company in the form of dividend payments, you'll need to pay this back.
This is known as an 'outstanding loan account'. It's most likely to occur when directors have drawn dividends while the business wasn't profitable.
2. Valuable assets will be lost
Though you are likely to be shielded from most costs via liquidation, assets linked to the company will be used to settle your debts.
Your company assets will be sold to settle your debts (unless you have a 'Pre pack' agreement in place). Pre pack means your assets will still be sold, but can be bought by a 'newco'.
Company assets often have more value in combination, when they facilitate an entire process or procedure. When separated, these are likely to offer less value, both in terms of re-use and re-sale.
This means the returns are likely to be much lower than your initial expenditure. And, it means you will not be able to use these assets again for future ventures.
With redundancy, your employees – and their shared expertise – will be split up. This will make it harder to re-establish these skill sets elsewhere. However, you can avoid this by selling part of the business as a going concern.
Any tax losses in the company cannot be used against another company.
3. Director's conduct investigations
The Insolvency Practitioner will report any proven instances of misconduct to the Insolvency Service. The insolvency practitioner has a duty to investigate the conduct if they think there has been an instance of malfeasance or fraud on the part of the directors.
This could lead to director disqualification, liability for company debt or even a custodial sentence in extreme circumstances.
With all of these considerations to bear in mind, you should not enter into liquidation lightly. However it should be remembered that liquidation is really the only option for the company if there is no money left to pay creditors. If the company or directors cannot afford to pay an insolvency practitioner to liquidate the company via a creditors voluntary liquidation then there are two options depending on the size of the debt. If the debts are small then it may be possible to dissolve the company. If not, then it is likely that the creditors will seek to wind the company up. i.e a compulsory liquidation.
The disadvantages of this type of liquidation are as follows;
- It can take a long time 6-12 months which means that ex employees will not be able to claim redundancy until the process has finished
- The official receiver has a mandatory duty to investigate the directors conduct, whether or not they have suspicions malfeasance.
- You will need to go to court.
- It doesn’t look good on your company/personal credit record if someone does an extended credit check. This is most likely if you are involved in heavily regulated industries or national security