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When to Shut Down an Insolvent Business

One of the toughest challenges business owners face is determining whether and when it’s time to accept defeat and close down the business. Since most businesses experience unstable income and other setbacks during the early days, it can be difficult for owners to separate the normal start-up obstacles from signs of real trouble.

Determining that the business is insolvent is one piece of the puzzle, but isn’t necessarily the only factor to be considered.

Identifying an Insolvent Business

From an economic standpoint, there are two separate tests for business insolvency:

  • A business is deemed insolvent if its cash flow is insufficient to pay obligations as they come due
  • A business is considered insolvent if its liabilities exceed its assets

Occasionally, one or both of these conditions may be short-term, and you may have a clear plan for moving the business forward. Few entrepreneurs or experts would suggest that any business that has a shortfall one month should close its doors. Giving up too easily can be as costly as holding on for too long.

However, the financial instability of your business shouldn’t be ignored or treated lightly. If you are operating an insolvent business, it’s time to take a hard, realistic look at your circumstances and prospects and determine whether it’s wise to continue operations.

The “Sunk Costs” Trap

One reason many business owners struggle with closing down a business is sunk costs—the money, time, effort, and other resources already invested in getting the business off the ground.

Many business owners look at the investment already made and are reluctant to let go, feeling that all of that time and money will be lost if they shut down the business.

The impulse is understandable, but if you’re not careful and realistic a struggling business can become like an old car you keep repairing because you’ve already put so much money into it.

The truth is that if the business is failing, then those previous investments are already lost. Continuing operations beyond the point of viability aren’t likely to be beneficial and may result in the loss of any remaining assets or value in the business.

Unfortunately, the consciousness of those sunk costs often taints the decision-making process.

The Danger of Personal Guarantees

One of the most significant risks owners of struggling businesses take is to personally guarantee loans to or other obligations of the business. While an owner or member of a small LLC or corporation may see little difference between business and personal obligations, the legal ramifications of a personal guarantee are significant.

The decision to close down a business is rarely easy but becomes even more complicated when owners or members are aware that dissolving the business could result in legal action against them personally and the attachment of personal assets. Concerns about personal liability can also influence decisions about the business, often in counter-productive ways.

Get Professional Advice about Your Insolvent Business

The business attorneys at Dworken & Bernstein have assisted many businesses at various stages, and have the experience necessary to help you determine the best next steps for your business. As both knowledgeable advocates and neutral assessors, we will examine the current state of your business, your options for moving forward, and the ramifications of each for the business and its principals.

Don’t delay getting the advice you need. Contact us today to schedule a consultation.

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