Insolvency guide for small businesses

Any business can run into financial trouble. Problems such as an inability to pay back owed debt, cash flow struggles, and inadequate financial forecasting can all contribute to the risk of business insolvency.

Unforeseen circumstances, such as customers defaulting on payments, can also affect a business's financial position to the point of closure.

In the third quarter of the 2022 financial year, 5,595 UK businesses were registered insolvent, 40% higher than in the third quarter of 2021.

What is insolvency?

Insolvency is a state in which a business can't pay its debts.

For example, insolvent companies either can't pay their bills when they are due or have more liabilities than assets on their balance sheet (known as being 'balance sheet insolvent').

Examples of debt that could lead to insolvency include an inability to pay taxes owed to HMRC or make payments to suppliers for goods and services when they come due.

Difference between insolvency and bankruptcy

Insolvency and bankruptcy are commonly used interchangeably, but the terms have some important differences.

For example:

• insolvency is a financial state, whereas bankruptcy is a legal process
• unlike insolvency, bankruptcy applies just to individuals, not businesses.

Insolvency can lead to bankruptcy, but the terms do not mean the same thing.

Dealing with the threat of insolvency

Insolvency is rarely a simple fix and can result from a company facing difficult circumstances.

If your company is on the brink of insolvency, you can take steps that may allow you to keep trading.

Take action

If your company is at risk of becoming insolvent, don't ignore it; take action.

Determine your company's situation and how it got there.

It can be sensible to actively try to minimise the loss to your creditors.

Creditors may be more likely to accept a creditor repayment arrangement if they believe your company is doing its best to pay them.

Seek further advice

If your business is struggling to fund growth or cover a short-term cash flow issue, you could seek additional finances from bank loans or investors.

This could help pay supplier and creditor debts or help to buy much-needed equipment to stimulate growth.

If your business has only a small amount of debt, seeking further finances could be a viable option to help improve your cash flow.

HMRC Time to Pay arrangement

Falling behind with HMRC tax or VAT payments can result in financial pressure for a business.

HMRC does offer tax repayment plans for businesses struggling financially, known as Time to Pay arrangements.

Arrangements are tailored to the business's financial situation, with HMRC determining what you can afford and how much time you'll need to pay.

Time to Pay arrangements are also flexible.

If your expenses increase, the arrangement can be lengthened to suit your situation.

At the same time, if you fail to make your payments, the agreement can be cancelled.

For more information, read our guide on Time to Pay arrangements.

Creditor liquidation explained

If your company has creditor debts, you may wish to organise a Company Voluntary Agreement (CVA).

A CVA is a binding agreement between a company and its creditors that sets out a repayment plan for some, or all, of the company's debt over a set time.

Typically, creditors will accept a reduced payment, so the company can continue to trade, and the creditor still receives the ongoing business.

A CVA means your company can still operate and try to turn finances around.

Visit the government website for details about applying for a CVA.

Business liquidation explained

If unable to keep trading, your business may face closure.

There are three types of company liquidation.

1. Creditors' Voluntary Liquidation (CVL)

A CVL is when an insolvent company voluntarily closes as it cannot pay off all of its debts or continue trading.

Of the 5,595 businesses registered as insolvent in the third quarter of 2022, 86% of UK businesses went through a CVL.

A CVL will deal with any outstanding debts as part of the closing down process.

The company assets will be assessed and sold to pay off creditors.

Once the CVL completes, any debts will be written off unless you have signed a personal guarantee agreement.

In this case, the individual will be responsible for paying the remaining debt to the creditor.

A business can only enter into a CVL under the guidance of a licensed insolvency practitioner.

2. Members' Voluntary Liquidation (MVL)

If a company is solvent (able to pay its debts) but decides to close down, it may opt for an MVL.

To enter an MVL, the board of directors must make a declaration of solvency.

This includes:

• a statement outlining the director's belief that the business can pay its debts
• a statement of the company's assets and liabilities
• the name and address of the company
• a timescale to pay off its debts (which cannot exceed 12 months).

Similarly to a CVL, you can only enter an MVL through a licensed insolvency practitioner.

For help finding a licensed insolvency practitioner, look for a firm recognised by a professional body.

3. Compulsory liquidation

Compulsory Liquidation is an insolvency process where a company is forcibly closed down.

A petitioner initiates Compulsory Liquidation by filing a 'winding-up petition' to court.

The petitioner must provide proof of the business's inability to pay £750 or more of debt.

The petitioner could be a shareholder liable to contribute to the company's assets if it becomes insolvent.

Creditors might also file a winding-up petition if owed money and all other recovery attempts have been unsuccessful.

For example, HMRC could file petitions against businesses that owe taxes.

If you are given a winding-up order from the court, they will send a copy to your business's office and start the liquidation process.

On receiving an order, you won't be able to stop your company's liquidation; your business's bank accounts will be frozen, and the business will cease trading.

For more information, visit our page on managing bankruptcy and closing down businesses.