What is keeping entrepreneurs up at night?

What is keeping entrepreneurs up at night?

The majority of startups are not trading after just four years and in 2011 only 4% made it to their second year

Entrepreneurs who start their own business have many different priorities keeping them up at night. How to get investment, how to differentiate their offering, how Brexit may affect their business model and ability to get staff.  These are imperative. There are other important issues entrepreneurs who become directors need to be aware of. Losing focus on these legal duties could not only cost the business dearly, but also have an impact on the entrepreneur’s finances and future ability to become a director for other companies. The duties need to be taken especially seriously when the business is facing financial difficulties.

Financial pressures on (new) businesses are real.  The majority of start-ups will not be trading after the first 4 years and out of all the small businesses started in 2011, only 4% made it to their second year. Entrepreneurs may need to close their business sooner than they expected. This is not specific to start ups- company insolvencies are on the rise (16,090) with the UK seeing the highest level in 2018 (since 2014).

If the business is struggling financially then the directors need to be aware that it is not only their capital that is at risk.  Directors can be held personally liable to repay sums if a business continues trading and incurring liabilities when it cannot meet its debts. Even where an insolvency practitioner takes control of the company’s affairs, the director’s duties continue and their past decisions may well be scrutinised if they have continued operating and failed to recognise financial difficulties.

Throughout the period they are a director, the Companies Act 2006 requires directors to:

  • act within their powers and in accordance with their company’s constitution. Directors therefore need to familiarise themselves with the Articles of Association and any Shareholders Agreement to understand what they can and can’t do.
  • promote the success of the company. Directors need to act in a way which would most likely promote the success of the company for the benefit of its members as a whole. Directors will therefore need to consider a variety of different interests, particularly if there are multiple shareholders who have invested.
  • exercise independent judgement, making his/ her own decisions.
  • exercise reasonable care, skill and diligence, which would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may be expected of a person carrying out the same functions, but also the general knowledge, skill and experience that the director actually possesses.
  • avoid conflicts of interest and avoid placing him/herself in a position where there is a conflict or possible conflict, between the duties owed to the company and the director’s personal interest or other duties owed to a third party. This is crucial where the director has different business interests.
  • not accept benefits from third parties. In addition to falling short of the director’s dirties under the Company Act, this could also constitute a criminal offence under the Bribery Act.
  • declare interest in proposed transactions or arrangements before proceeding in the company’s name.

Directors’ actions and decisions complying with these duties is increasingly important  where a business is deteriorating and there when its solvency is questionable. At this stage, directors’ duties change in order to protect the interests of creditors. Directors must protect the value of the company assets and minimise losses to creditors as far as possible. Directors must therefore be alert to the warning signs that indicate the company is struggling to pay its debts and liabilities and change their conduct of the business accordingly.

Even if they work in a limited company, directors can be sued personally for:

  • fraudulent trading, which involves a degree of dishonesty, and, if found guilty, the director may be required to contribute towards the company’s assets personally and could face criminal charges;
  • wrongful trading, which may require a director to contribute towards the pool of assets if the director knew or ought to have known that insolvent liquidation is inevitable and allows the company to continue trading.

In addition, a director can be disqualified to act as a director of any company for a period of between two and fifteen years.

Conclusion

The priorities of entrepreneurs who start a new business are varied and numerous. Whilst the initial priorities which occupy most directors at night are important, directors should not lose sight of their duties and obligations under the Companies Act.

In economically difficult times it is particularly important that directors recognise financial difficulties at an early stage and to take the right measures instead of ignoring the problem. It is important to take action and seek professional advice on how to proceed in the best interest of the company, and to take into account the company’s creditors. This is not only important for the company’s survival, but also for the director’s personal liability and future directorships.

 

This guest article was written by Melanie Stancliffe, a partner in the Employment Team at Irwin Mitchell

 

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