1. 8 Tips for Avoiding
Insolvency Land Mines
James K. Baer &
2. Budget for Future Payables
Although the general rule is that a company’s board of directors and
shareholders are not liable for a company’s debts, the following are
exceptions to this rule with specific issues to consider –
Payroll and payroll taxes
Unfunded retirement accounts
Latent personal guarantees
Theses are all areas of concern for potential personal liabilities.
3. Additional concerns arise regarding the company's ability
to pay D&O insurance, employee severance and accrued
employee vacation. While accrued vacation may not
necessarily be a personal liability leaving these promised
benefits and insurances unpaid would certainly damage the
company’s public image and the reputations of those
associated with it.
Budget for Future Payables
4. A thorough and transparent analysis must be
conducted to determine if there are sufficient
funds to cover projected or extended costs.
Boards of directors and investors need to
meet with their company's CEO and higher
management to get an accurate portrayal of
the company’s true payables, and make sure
that all current and future expenses are
accounted for in the event that a shut down
is on the horizon.
Budget for Future Payables
5. Be Careful of Personal Guarantees
All corporate officers should be extremely aware of any personal guarantees for which
they may be liable. For instance, it is common for credit card companies, such as
American Express ™, to not issue a card to a startup company without requiring the
social security number of the CEO. The CEO will be liable for corporate debts incurred
on the card regardless of awareness.
While company boards and venture capitals do not want the company’s management to
be stuck with these liabilities, this can lead to improper preferences in paying off the
Not taking heed of hidden liabilities creates precarious situations that would best be
avoided by paying attention and planning accordingly.
6. Notice Where Priorities Lie
It is human nature for people to want to pay off those expenses most near and dear to
their hearts. For instance, if there are loans to insiders or relatives, those obligations may
be paid off first, even if those funds should ethically or legally be allocated proportionally
to all creditors. This occurrence becomes especially true for companies where six months
or less of burn remains and the prospect of next-stage funding is meager.
Boards and investors should examine where cash is flowing, particularly in those crucial
final months. Hiring a consultant can be an especially valuable tool for such evaluations.
7. Pay Attention to Regulatory Issues
Stay informed of governmental rules and regulations.
Such issues may include violations of state or federal
law, such as the Worker Adjustment and Retraining
Notification (WARN) Act, or federal securities laws.
In some cases, if the company does not have enough
cash to meet payroll, it may in effect be forced to
violate the law.
8. Get the Backing of
If there is a secured creditor, the first question
to ask is whether there is enough money for the
company to pay off its debts in full. Always
have a plan for dealing with your creditors.
9. Engaging in open discussions
and coordinating with your
secured creditors will ensure
that your company will be in
the best position to allow for
an organized and systematic
close out process.
Get the Backing of
10. Avoid Litigation
In the event that something goes awry, the company may be exposed to litigation. Without
an orderly process, management will be left to their own devices. At best, they will not
know what to say to creditors. At worst, management could give creditors the impression
that they will get paid off in full when that simply is not feasible.
Overselling the company’s position, whether to creditors or late-stage investors, leads to
resentment and distrust. The same creditors, who might have been inclined to cooperate
with the smooth close out, may go so far as to bring a strike lawsuit out of sheer anger.
Similarly, disgruntled employees may seek out legal recourse, whether their suits have
merit or not.
11. Avoid Litigation
Litigation is an expensive, time-consuming
process that can have detrimental effects on
the reputations of the company and individuals
closely affiliated with it. Make sure that your
company’s management is not overstating their
ability to pay in order to avoid frivolous
12. Keep Records Orderly and Safeguarded
Whether the company’s officers and directors choose to shut down the company’s
operations, sell, or mothball it, there are a variety of records that must be safeguarded.
When the ship is sinking, it is not unusual for computers, phones, and documents to
start disappearing. Companies should be ahead of the curve, especially in terms of
ensuring that records are properly protected. Such records include payrolls, taxes,
employee records, workers comp., insurance and any information that would be
needed if litigation did arise.
13. Make sure that electronic and paper copies of
documents are accounted for. Hiring an
individual to safeguard these records and be a
fiduciary to the company is a shrewd way to
cover your bases.
Keep Records Orderly and
14. Don’t Let Time Run Out
It’s easy to rely on internal projections. Companies often underestimate how much time is
left. These underestimations are often material, though. Where your company is down to its
last six to twelve months of burn, managing its interests in an organized fashion and being in
a position to potentially restart in a meaningful way, means facing your realities sooner rather
Companies may fail to consider additional payables, such as accrued vacations, or are overly
optimistic that creditors will give them more time or discounts. They fail to appreciate that
when a company is declining receivables also become harder to collect.
15. Ultimately, it is rare that an accurate assessment of
shut down costs has been made for a small to
medium size company. A general rule to consider is,
after employee payroll, payroll taxes, D&O
insurance, and secured creditors have all been paid
off, the company will need at least $100,000 to fund
an orderly shutdown process, such as through an
The sooner you assess your realistic position, the
better off you will be.
Don’t Let Time Run Out
16. James K. Baer, Esq. is a principal and founding partner of Baer and Troff, LLP, a boutique law firm specializing
in venture capital and middle market law. Mr. Baer is also President of CMBG Advisers Inc., a firm specializing
in business restructuring and Assignments for the Benefit of Creditors (ABCs), and is of counsel at Glaser Weil.
Caitlin D. Lalezari, Esq. is an associate at Baer and Troff, LLP.