As business owners, we hear the words “bankruptcy” and liquidation all the time. In fact, I’ve had plenty of people inquire about it. And it’s often misunderstood as to how it works, and why it can happen. So what does bankruptcy really mean for you, your assets, and your business?
In this article, I break down the nitty-gritty of:
- What bankruptcy really means
- What are the signs that indicate you’re at risk of bankruptcy
- How to reduce any risk of this happening to your business in the future.
What Makes Me Qualified to Talk About Bankruptcy?
The reality is that I’ve gotten to a point where I’ve got multiple ideal businesses, some of which are worth multi-figures. And I’ve designed them to work even without my direct involvement. Meaning, they’re like machines that work and make a profit even if I’m not exactly present.
But before all that happened, having been in business for over 30 years, I’ve actually been bankrupt twice. It was obviously not a good thing to happen to you or someone you know. But, it is something worth understanding and worth getting information about, so you can understand how to avoid it.
Because the truth is, this is something that often no one thinks about. No one says, “Oh, I’m going into business so I could potentially end up bankrupt.” But it’s one of the major risk areas that you could face when you kick off your business.
I talk more about this in 1:23 of this podcast episode on avoiding being bankrupt.
What Is Bankruptcy?
In the past when I went bankrupt, it wasn’t pleasant. Typically, you lose control over your assets. It can be quite demoralizing and can have a negative impact on your self-esteem. But as I reflect back on it, it was something that I probably needed to go through. I learned some really important lessons that helped me:
- Adapt my approach to the way I deal with business.
- Set up systems to reduce the risk from taking place again.
My wish is that you can also set up systems for identifying and protecting yourself from these risks. So that you don’t have to go through the same thing I went through when I was still starting out in business.
What Does Bankruptcy Mean?
In essence, bankruptcy is when a person or a company owes money to a third party, but they are unable to fulfill that debt.
It presents a choice:
Option 1: You can commit to diligently repaying your debts over time, if that’s a viable route for you.
Option 2: Opting for a “clean slate” by choosing the bankruptcy path.
Option 2 can be influenced by the realization that the burden of repayment is insurmountable and could hinder future progress. In simpler terms, bankruptcy is a way to clear existing debts, even though it involves surrendering certain assets.
I talk more about this in 2:10 of this podcast episode on avoiding being bankrupt.
What are the Downsides Relating to Bankruptcy?
When you opt for bankruptcy, any assets you’ve accumulated or built up will be used to repay your owed debts. Consequently, you’ll lose control over these assets, and specific limitations will apply throughout your bankruptcy period.
For instance, if you’re in Australia, you won’t have the freedom to travel overseas without seeking permission. Additionally, you won’t be able to serve as a company director or obtain credit during your bankruptcy, as it directly impacts your credit rating.
But in essence, bankruptcy acts as a way to hit the reset button, offering a chance to address past financial challenges, whether they originated from business ventures or personal endeavors.
Why You Need to Research Laws About Bankruptcy Specific to Your Country
The thing with bankruptcy, the laws relating to it vary from country to country. For example, I’m from Australia. Australia has specific laws around bankruptcy such as on how it works and how long you’re bankrupt for.
So depending on where you’ve established your business, find out what bankruptcy means in your location.
You may know someone who’s been bankrupt before, a colleague, a friend or a family member. It is worthwhile to have a discussion with them because both of you can learn more about their perspective and what their experience is like.
How to Set Up Structured Calculated Business Risk
To protect yourself from potential bankruptcy, you only need to do two things:
- Have awareness of potential pitfalls that could impact your financial stability.
- Only take structured calculated business risks.
To do this, here are some of the things you can do:
1. When Obtaining Credit From Suppliers, Look At Forms Carefully.
One of the things that they normally do is they’ll give you a credit application form. Before signing it, take the time to go through it. If there’s any indication of a director’s guarantee or a personal guarantee to obtain credit, you can still sign the form but cross those sections out.
Do not provide personal guarantees or director’s guarantees to any suppliers’ accounts. It’ll never become an issue. But if something goes wrong and for some reason your business is in a situation where you can’t pay those debts, then they have the right to come back to you to recover those debts and ask you to pay them out.
I talk more about this at 2:04 of the podcast “Structured Calculated Business Risk.”
2. Be Conscious of the Requirement for Personal Guarantees.
When it comes to personal guarantees, let’s dive into the second critical area – obtaining credit facilities. Picture this: you’re setting up shop, and you need credit from banks, credit cards, overdrafts, or even financing a vehicle. The deal sweetener? You’re likely to encounter personal guarantees, not just from yourself but potentially from fellow directors or other owners of the business.
I talk more about this at 2:36 of the podcast “Structured Calculated Business Risk.”
Now, that’s not an issue. It’s just important that you’re aware of what you’re getting yourself into.
Personal Guarantees are Widely Accepted Practice
Generally, these guarantees are the norm. Whether you’re applying for a credit card like an AMEX or a Mastercard, a small overdraft facility, or even setting up a corporate account, be prepared to be personally responsible.
Personal guarantees are just the rule of the game. Banks and lenders usually require them as a safeguard. While specifics vary by location and laws, it’s common practice across borders.
How to Think About Personal Guarantees
It’s tough to secure credit without putting your personal guarantee on the line. However, proceed with caution. Personal guarantees mean you’re on the hook. If things go awry and your business can’t settle the debt, creditors have the right to knock on your door.
So, when you’re out there, chasing opportunities and securing credit, remember: personal guarantees aren’t a mere formality. They’re a commitment. They’re a safety net. They’re a factor in the grand equation of your business’s financial health. Proceed with eyes open, consider your risk appetite, and find the equilibrium that lets you walk the entrepreneurial tightrope with confidence.
3. Be Conscious of Events That Take Place Outside Your Control.
In the realm of business, some threats come unannounced, beyond your control. The only way to have an element of control over these type of events is using insurance.
Unfortunately, when you have a go at insurance, you have to pay a ton of premiums. I don’t even know how much money across my businesses is used to pay insurance premiums. I just know it’s substantial every year. Despite this, insurance is still a very important part of the risk management process.
Why Get an Insurance
Depending on your chosen premiums, some of the issues it can protect you against include issues of:
- Embezzlement
- Fraud
- Getting hacked or scammed.
For example, we’ve had incidences where we’ve had people trying to pass invoices off as valid invoices even if they weren’t.
Some spam emails pretend to be from the CEO and ask the CFO or the accountant to transfer money. These emails look legitimate. I know some people who have fallen for this scam and lost money. However, there are insurance policies that can cover and prevent these kinds of incidents.
When to Get an Insurance Broker
If you’re not sure what your risk is in your business and where your exposure lies, I recommend getting an insurance broker.
They can actually:
- Do an overview of your business and have a look at what’s going on.
- Share with you some insights into some of the insurances that may be appropriate for you and for your business in relation to risk side of things.
4. Monitor the Numbers in Your Business.
Don’t forget to set up statistics as these numbers help you gauge how things are shaping up.
Why Monitor Your Statistics?
First off, picture this scenario: You’re cruising along, running your business, but suddenly you find yourself falling behind in some key areas. Take tax payments, for instance. Or, if you’re down under in Australia like us, it’s the GST or VAT. Then there’s the sales tax, and those creditor terms – they’re giving you a bit of a tough time.
Well, these signs right here are like red flags waving in the breeze, signaling that your business might be struggling with its cash flow. And you know what happens next? It could lead to some unwanted issues or even trigger an unexpected event. That’s why it’s absolutely crucial to keep a watchful eye on these indicators.
I talk more about this at 7:33 of the podcast “Structured Calculated Business Risk.”
What Do You Do When The Numbers Aren’t Doing Well?
Now, let me share a little nugget of wisdom from my own experience. When you’re caught up in these situations, one of the smartest things you can do is to truly understand your financial position. Know where you stand when it comes to your cash flow and your overall financial situation. And you know what’s the key ingredient here? Open and clear communication.
It’s like a secret sauce that works wonders. Reach out to the folks you owe money to. Those suppliers are part of your team, after all. And believe me, most of them get it. They’ve been around the business block. Sharing your situation openly and honestly can work like a charm.
Speaking from my own journey, there’ve been times when the cash flow was a bit tight, making things a tad tricky. But guess what? Treating your suppliers like partners and being upfront about your situation can really save the day. I’ve done it, and it’s been a game-changer. The key here is crystal-clear communication.
Final Words
So, keep this in mind – if there’s anything linked to financial risks, you’ve got to handle them with care. Why? Because these financial risks have a way of trickling down and affecting you personally.
One of the most important approaches is, when you have a surplus of cash and you’ve had a good month or a good quarter, you need to set aside some cash for unforeseen events. That’s another way to stay a little bit safeguarded against things that might take place a little bit outside your control.
Things often happen that we really hadn’t planned or we’ve got no clear understanding of. But they will happen. That’s just the way it is. Whether it’s market events that take place or legislative changes or things that take place in your particular national marketplace.
These events do take place and can put you in a position where you’re at risk of bankruptcy. So remember to stay prepared for them by having reserves. Doing so will reduce the stress and risk exposure in the event that things don’t quite go right.
If you want to follow along with the story of how I redesigned my previous business into an ideal one, sign up for our newsletter: https://idealbusiness.invizbiz.com/newsletter