ALL new businesses begin full of belief in the strength of their product or service but, unfortunately, it is simply a fact of business life that some businesses will fail. Figures suggest that more than half of all start-ups will no longer be in existence in five years’ time.

There will be a wide variety of reasons for this and indeed some people take a Darwinian approach and view this simply as a species of “survival of the fittest”. However, running out of cash is the second biggest cause of business failure (beyond the more fundamental problem of having a product but no market!).

In a later article in this series, I will write on bouncing back from business failures but, as always, prevention is better than cure and that is the focus of this article. The business leaders who are the most effective are the ones who keep a focus on any looming obstacles and are prepared to deal with difficult questions at an early stage. However, by clearly identifying any issues, whether in relation to cash flow, management style or skill set, you can expect to achieve future success rather than simply postponing failure.

The ultimate form of business failure is where a company is put into liquidation. The specifics of the liquidation process and the different forms of liquidation are outwith the scope of this article and I will focus on insolvent liquidation in Scotland rather than any other form. This is by far the most common form of liquidation and occurs where a creditor who is owed more than £750 seeks to have the debtor company brought to an end. The company’s assets (such as they are) are sold where possible, turned into cash and then distributed amongst the creditors. Most creditors’ debts rank equally with one another, meaning that, in normal circumstances, each would only get a percentage recovery of their debt.

However, any creditor who wished to put a company into liquidation must first be able to establish that sums are due and that the company is insolvent. The most common way of doing so is by obtaining a decree following a court action.

Against that background, and while this may sound obvious, the best way to avoid the possibility of liquidation would be to avoid decree being granted in the first place by reaching a negotiated settlement. Often, it is the fact that a debtor has buried their head in the sand and refused to engage sensibly which has led a creditor to take the ultimate step of seeking to appoint a liquidator. Indeed studies have shown that being in debt can be considered to be akin to an illness where the sooner that help is sought the greater the chances of survival.

It should be stressed that liquidation does not provide a guaranteed recovery of money for a creditor and it’s not a magic bullet. In fact, in my view, the most common misconception is that a creditor who petitions for the liquidation of a company puts himself in a better position than the body of the creditors generally. This is simply not correct, because once a liquidator has been appointed, they are under an obligation to act in the interests of all creditors. It is also important to note that the liquidator will require to be paid his or her fees first from any funds obtained.

One of the duties of a liquidator by virtue of their appointment is to consider the actions of directors of the company prior to liquidation. Directors are required to act both in good faith and in the interests of the company. If they don’t do so, and if the misconduct is particularly bad, (for example, by continuing to trade when it is apparent that debts cannot be paid), then there can be a prohibition on acting as a director in the future.

Accordingly, a realistic assessment of the ongoing and future financial position of the company should always be in the back of the mind of anyone running a business. While failure is a fact of life to which there should not be a stigma, dishonesty or negligence will be viewed differently.

John Grant is a senior associate at law firm Wright, Johnston & Mackenzie LLP.