What happens when a start-up fails?


5

It seems like there isn't very much information on the web about wind-down processes in a start-up, largely because probably don't want to admit publicly when their company didn't pan out. However, it seems like handling this process well is as much a part of entrepreneurship as anything else. To that extent, I have a few questions:

1 - If a start-up can't cover it's liabilities and needs to wind down what happens to the assets? Specifically stuff like customer lists, IP, etc. that might not be worth very much to other people?

2 - Can the founders buy back the assets of a company if they're legitimately the people who will pay the most for them? If so, does this create an agency problem whereby when a company is running out of money the founders don't do everything they can to save it because they know if it fails they can buy the assets.

3 - Are there any guidelines for knowing when the right time is to shut a company down? Nowadays considering how cheap web startups are to run it seems like many companies could be run indefinitely. Do the founders (assuming they have taken investment) have a fiduciary responsibility to keep running the company forever or are there legitimate reasons to wind down a company before absolutely necessary?

Failure

asked Jan 12 '10 at 08:19
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Tommy Maddox
156 points

2 Answers


3

Winding down a company is one of the most unpleasant things one can do. It almost rivals laying people off as the single worst job ever. Being around for a wind down feels awful. With that said, here are the answers to your questions:

  1. The assets are the property of the creditors and shareholders or whomever has a lien on the company. These assets, if any are left, are divided between creditors according to the deal worked out between the company and those creditors. IP, like patents, will most likely lapse or be sold with the other assets of the company.
  2. When the assets are up for sale, to usually pay creditors, anyone can bid on them. So the founders could buy back the assets if they had the money. Clearly, management has a fiduciary responsibility to the company but decisions about winding down a company are usually made by the board of directors. So, there could be issues but usually that's not the case.
  3. As for knowing when to shut something down, well, you just kind of know. Usually, it has to deal with no money in the bank, creditors banging at your door for payment and all your employees leaving. Those are usually the signs to shut down. The only people that have a fiduciary responsibility to the company are the board of directors and the executive staff. Investors or founders can walk away if they are not involved in either of those activities.

In the end, shutting down a company really depends on how the board, executive staff and investors feel about it's future. If the company fails to be an "on going concern", then it's best to shut it down and stop burning money and time.

answered Jan 12 '10 at 09:29
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Jarie Bolander
11,421 points
  • In the case that I'm familiar with (friend of a friend) two of the founders are on the board so it seems like the agency issue could be a real one (in terms of founders wanting to buy back the IP). I'm curious as to whether there's any sort of standard process for putting the assets up for sale or whether this is done on a case-by-case basis. – Tommy Maddox 9 years ago

1

Hopefully this is just a hypothetical question for you and you're right; wind-down is a part of the entrepreneurial experience. I agree with Jarie that it is a very unpleasant experience, even more so then laying people off because you get to do that and deal with angry creditors too!

I agree with all of Jarie's comments. I'd just like to add to point #3.

I recently had to put a company into Chapter 7 (liquidation) bankruptcy which can be messy, lingering, and to be avoided if possible. The way to do this is to close down BEFORE you are unable to meet your creditor debts. That way you might be able to do an orderly windup and mothball the assets without necessarily having to liquidate.

To do this, the strategy I would advise is the following:

  1. Make sure you can pay off all payroll taxes and wages due before shutting down. You should know that tax obligations are not discharged in a bankruptcy, so make sure you can pay these. This may also apply to wages due depending on the state you are in. (Note: I am not an attorney. Consult a good bankruptcy attorney if you need legal advice.)
  2. Self off as many assets you can to generate cash.
  3. With any remaining cash, try to settle with creditors. They may be willing to accept less than the total due if they know you are closing down. While they can take you to court this is expensive, time-consuming, and there is no guarantee that they will be able to collect. If you do cut a deal, make sure you get a release from them.
  4. Don't forget to settle with any ongoing customers as well, especially if you have any unfulfilled contracts.
  5. Optional: If you wish to formally close your legal entity, remember that there will be legal and filing costs associated.

Hope this is advice you won't ever need.

Answer to your comment (add comment feature isn't working for me):

This is a tough one as it becomes a business judgement issue. Again, I'm not a lawyer, but the company's board directors face potential liability if they continue to operate when it is "clear" that the company may no longer be a "going concern". What constitutes "clear" is subject to interpretation. It may be viewed as bad faith or even fraud if the company continues to wrack up debts that it has no ability to pay.

This is definitely a decision that your board needs to make. At very least, you might need to have a sit down with your largest creditors to see if they are willing to play ball with respect to a potential investment or acquisition or not. Note that if two or more creditors get together, they can actually force you into involuntary bankruptcy.

In any event, make sure all your tax obligations are cleared up first!

answered Jan 12 '10 at 14:39
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Edwinoh
696 points
  • Thanks for the comments. In the case of insolvency is it mandated to shut the company down? In the case I am familiar with there are potential investors and/or acquirers and so it seems to be a fine line between keeping the company going to try to get to an investment or acquisition (which would make the creditors whole) or winding down and paying the creditors pennies on the dollar. – Tommy Maddox 9 years ago

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