What founders need to know about insolvencies

Not every idea works. Sometimes the only option for entrepreneurs is to go bankrupt. But this does not mean the end of your own company - if you do it right.

Few German politicians have mastered the art of controlled outrage as well as FDP leader Christian Lindner, and few scenes demonstrate this better than a discussion in the North Rhine-Westphalian state parliament. In 2015, it burst out of Lindner, then leader of the parliamentary group. A heckler had made fun of the insolvency of a company that Lindner had founded as a young man. This was followed by a minute-long attack on the German approach to corporate insolvencies, the difference to the USA and the question of the extent to which all of this was hindering the entrepreneurial spirit in this country.

At the time, Lindner struck a nerve with people who deal with this topic. Because being ashamed of insolvency is wrong, says Axel Bierbach, for example. The insolvency administrator and lawyer has been supporting companies in this difficult phase for 20 years, including many start-ups. "Insolvency generally offers opportunities, allowing companies to shed legacy burdens and make a fresh start," he says. Younger founders in particular are now ticking differently and, in case of doubt, are already prepared to take this tough but sometimes necessary step.

However, the requirements for insolvency proceedings are narrowly defined, the process is predetermined and the way out is not always easy. An overview of what founders need to know.

When is a company insolvent?

In principle, there are two reasons why a company must file for insolvency and one reason why it can file for insolvency. Filing for insolvency is unavoidable if the company is insolvent or overindebted.

Insolvency exists if a company is unable to pay 10 percent or more of its due obligations for more than three weeks. A company can also file for insolvency in the event of imminent insolvency, which is the third, optional option. In this case, the period in which a company can no longer service its liabilities is not quite as clearly defined.

Balance sheet over-indebtedness exists when the company's existing assets no longer cover its debts. However, there is a restriction under insolvency law that is particularly interesting for start-ups. "If the start-up is fully financed for the next twelve months, for example through commitments from investors, then over-indebtedness is irrelevant for the time being," says Axel Bierbach. Start-ups in particular often have a terrible balance sheet on paper, but this says little about the actual situation.

How does a company file for insolvency?

The insolvency application is submitted to the competent insolvency court. As a rule, this must be done no later than three weeks after those responsible have recognized the problem. Otherwise, the managing directors face proceedings for delaying insolvency and personal liability. "If you're not sure, you should bring a specialist consultant into the company," recommends Bierbach. They can determine with legal certainty whether or not it is necessary to go to court.

If there are grounds for insolvency, the management could ask the shareholders for financial assistance, pointing out that there is otherwise a risk of insolvency or over-indebtedness. If they refuse and no other solution can be found, the application must be filed.

How do insolvency proceedings work?

There are two types of insolvency proceedings. In standard insolvency proceedings, an insolvency administrator is appointed, while in self-administration proceedings, the management itself remains at the helm, albeit supervised by a trustee appointed by the court. In either case, however, the proceedings have two objectives: First and foremost, to serve the claims of the creditors and, if possible, to preserve the company.

The proceedings result in one of three possible outcomes. If an insolvency plan is in place, all parties involved can endeavor to ensure that the company continues to exist in its existing form. To this end, either the debtor or the insolvency administrator submits a plan to put the company back on a sound footing. If the creditors and the court agree, the plan can be implemented. Ideally, the company can then make a fresh start after a certain period of time.

Alternatively, insolvency proceedings can also lead to the legal entity being liquidated, i.e. the original company is dissolved but business operations are continued by others. In this case, another company buys parts of the company's content, such as patents, production tools or takes on employees.

In extreme cases, however, it can also lead to complete liquidation. This means that the company is completely wound up and the business is not continued at all.

How do most start-ups deal with insolvencies?

"Insolvency plans and full liquidations are rather rare in the start-up sector," explains insolvency administrator Bierbach. Young companies are often concerned with quickly maturing a product and achieving a certain level of market penetration. If something like this fails, it is often due to disputes among the shareholders. According to Bierbach, an asset deal is then often worthwhile. "The founders, possibly with some of the old or new investors, buy key assets from the insolvent company and continue the business," he explains.

Experience shows that such a deal often works very well, especially with investors. Creditors who are more difficult to satisfy are usually the employees, landlords or external service providers. "It only becomes difficult with the shareholders if they have the impression that the founders just want to shake things up and get rid of annoying old burdens," says Bierbach.