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What does the term liquidation mean for UK businesses?

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The term liquidation essentially means realising assets to repay funds to creditors and distribute any remaining money to the shareholders of the business. This route is typically taken voluntarilyor forced, depending on the financial health of the business. If your business reaches its natural end as a result of needing to refocus your efforts elsewhere or entering retirement, you may decide to extract funds and close your business in the most tax-efficient way. On a different note, if you are experiencing financial difficulty, your last step may be to repay creditors before shutting shop.

The rules governing business closure in the UK are strictly bound by the Insolvency Act 1986 which provides the legal basis for personal and corporate insolvency matters in the UK. There are three liquidation routes for businesses in the UK; Creditors’ Voluntary Liquidation, Members’ Voluntary Liquidation and Compulsory Liquidation.

What are the warning signs of insolvency?

If you are unsure as to whether your business is insolvent or nearing insolvency, the balance sheet test and cash flow test can help interpret the financial state of your business. If you have experienced a dive in sales and are unable to fulfil the likes ofCorporation Tax, VAT, PAYE, Bank/Credit Card Loans and Overdrafts, this could be a warning sign of a business in financial distress.

As a result, if you are missing payments and defaulting on loans, this could have a drastic effect on your future lending eligibility. In addition to this, the balance sheet and cash flow test can help build a wider picture of the health of your business, helping you determine whether it’s time to seek a rescue plan.

Balance Sheet and Cash Flow test for insolvency

A balance sheet test for insolvency indicates whether the business has more in liabilities than assets. This also takes into consideration invoices that are due to be made, outgoing payments that are pencilled in for the future and your ability to make repayments over the long-term.

A cash flow test for insolvency shows whether the business has enough in funds to meet liabilities and act in the best interest of creditors. If you fail to do so, you run the risk of trading while insolvent which is a sign of a company director neglecting their responsibilities.

Compulsory Liquidation

If you are forced to close your business as a result of legal action taken by a creditor, such as a winding-up petition, your business will be pushed into compulsory liquidation. A winding-up petition is the last resort a creditor can take and is only pursued if they wholeheartedly believe that it will generate a substantial repayment as the process can be costly and time-consuming. It is a formal appeal to the court to force your business into liquidation as a result of unpaid debts.

A creditor can only turn to this path if the debtor owes over £750 and has taken other formal avenues to demand payment or issued a County Court Judgment (CCJ) against the business. The petition by the creditor is then heard in court and if successful, the winding up petition will be granted and an Official Receiver or Liquidator will be appointed to realise assets and distribute funds to creditors. The company will then enter dissolution and will be struck off Companies House, ceasing in existence. If you believe that you have grounds to object a winding up petition by accessing the necessary funds to repay creditors, seek urgent advice from a licensed insolvency practitioner.

Creditors’ Voluntary Liquidation

A Creditors’ Voluntary Liquidation is a voluntary insolvency procedure marking the inevitable end due to the build-up of debt. If the business has no chance of a future, a Creditors’ Voluntary Liquidation is a suitable solution which consists of appointing a licensed insolvency practitioner to liquidate assets and wind up the company. Company directors can purchase assets from the company however this should be done so at market value and the sale administered by an insolvency practitioner. As established by the Insolvency Act 1986, there is a priority order through which funds should be distributed to creditors, ranging from:

  • Secured creditors holding fixed charge
  • Preferential creditors (HMRC after 6 April 2020)
  • Secured creditors holding a floating charge
  • Unsecured creditors
  • Shareholders

During the Creditors’ Voluntary Liquidation, an investigation will take place into the conduct of the director to ensure that no fraudulent activity or wrongdoing contributed to the downfall of the business. A company director is legally required to actively promote the business in the best light and act in its best interests. This is typically a standard procedure undertaken as part of the closure process of the business.

Members’ Voluntary Liquidation

If your business is solvent and you wish to extract the profits and close shop, you can turn to a Members’ Voluntary Liquidation which is a cost-effective exit tool. A Members’ Voluntary Liquidation consists of treating funds as capital, therefore subject to Capital Gains Tax, rather than income which would be subject to income tax due to receiving dividends. If you qualify for Entrepreneurs’ Tax Relief, you could benefit from Capital Gains Tax at a flat rate of 10 per cent, giving you further tax relief which is what makes this an attractive option for profitable businesses looking to close.

If your business turns to liquidation as a result of insolvency, whether voluntary or forced, you may be entitled to Redundancy Pay which is a statutory entitlement. The average claim for director redundancy is £9,000 and the claim can be made pre-liquidation or during the process of liquidation. As a company director, you are entitled to redundancy pay, just as any other employee would be.

If you believe that your business has a real chance of turnaround or requires a cash injection, seek advice to establish a rescue strategy for your business. Commercial finance, such as invoice and asset finance can help provide the necessary funds to ease company cash flow if you typically experience longer payment terms or if you’re looking for a suitable funding option. If your business is struggling to keep up with payments and has a recurring cash flow problem, it’s vital to seek advice early from a licensed insolvency practitioner to prevent your financial situation from worsening.

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