Most owners who end up here have been telling themselves the same story for a long time. Sure, sure, they’ll bring in enough sales next week to pay these bills off. And for months, it’s been those “next weeks”. Then one day you add up what the company owns and what it owes, and the second number is bigger.
What does it mean when a company has “more debt than assets”? Well, it means there’s a big problem. If your business owes more than it owns, that’s a sign of negative net worth or - you guessed it - an insolvent company. Everything the business owns would fall short of the amount owed. How you proceed depends on your situation, how your company is set up, what you signed, and what you intend to do.
Limited Liability Company
If the business is a limited liability company (LLC) and you are a member in the LLC, then you are not liable for the debts of the LLC. The most you stand to lose is what you invested in the company. The exception is a personal guarantee. A personal guarantee is an agreement to pay a debt if the company cannot. If you signed a personal guarantee to back up one of the LLC’s loans, then you’re on the hook for that debt.
Winding Up
When an LLC closes, it dissolves and goes through a process called winding up, in which the company’s affairs are liquidated, debts are paid, and remaining assets are distributed to the owners. In practice, that means gathering up the company’s real estate, inventory, equipment and supplies and selling them off, and paying the proceeds to people the company owes.
Before any of that money goes out, the company usually has to tell its creditors it is closing. For the ones you know about, such as a bank or lender, you just reach out and give them the news personally. However, you may have other people who might be creditors that you do not know about. So you will want to publish a notice in a local or regional newspaper, giving these people time to present their claims against the company before you dissolve it and shut down for good. In the notice, tell them that the company is winding up, you will be closing down, and if they have a claim against the company, they must notify you.
Then comes the question of who gets what. Secured creditors take their cut from the asset they secured, and unsecured creditors get paid next. If the company borrowed to buy a delivery truck and the lender holds a lien on it, the lender should get paid first out of the proceeds of the sale. Secured lenders don’t always wait for a sale, either. The creditor may have the right to remove the truck or take back the leased equipment. It gets more complicated when more than one lender has a lien on one of the company’s assets. A lender with the first lien on a piece of property gets paid first out of the sale of that property. A second lender with a lien on the same asset gets paid second. So on and so forth. With each successive lien, there is less money to go around.
Unsecured debts, like a credit card, are paid with leftover money after the secured debt is paid. That’s if there is any money left to pay that debt. The same goes for a line of credit or the fee a landlord charges for breaking a lease. Don’t forget that you might be one of the creditors yourself. Sometimes an owner writes a check to their business and it’s unclear whether it’s a loan or a contribution to equity. If you lent the business money instead of investing it, then it owes you repayment. The same is true if you lease the company a building or equipment you own.
In a company that can cover everything it owes, the members usually get their capital contributions back first. After that, the money is distributed among the members of the LLC in proportion to their ownership interests, unless the company’s operating agreement says otherwise. Some owners hold part of that money back in reserve for a few months or even years. If someone turns up after the close, they still have a right to be paid. If the company has already handed everything out and a creditor later shows up claiming an unpaid debt, the owners will have to find that money somewhere. If that creditor sues and wins a judgment, each member can be personally liable for it up to the amount they received in the distribution. A reserve keeps the members from carrying that risk, or from having to sit on their share in case it is needed.
When the Business Owes More than It Owns
None of that applies, of course, when the business owes more than it owns. In that case, the money from selling the business’s assets goes first to pay secured debt, and then to unsecured debt. There isn’t enough money to cover everyone. Unsecured creditors might have to write off some of what they are owed and settle for a partial payment. There is nothing left for the owners. Your capital contributions do not come back to you. If a member gave a personal guarantee for one of the company’s debts, the creditor can sue that owner for the amount owed. A guarantor’s personal debt is not discharged or erased by the company’s inability to pay it.
There is one more thing to know. Creditors don’t have to accept a quiet dissolution. If they think it hurts them, they can go to court and put the company in involuntary bankruptcy. Once that happens, what becomes of the company’s assets is decided under bankruptcy law and procedure rather than by you and your partners.
If you are looking at a balance sheet like this one right now, think carefully about the next steps you take. If you are a member of an LLC, most of your risk will be limited to the assets you invested in the business. But if you have personally guaranteed any of its debts, you are on the hook for those. Look at your corporate documents and determine how the business is set up. If it is a limited liability company, then look at your operating agreement. Determine whether any of the members signed personal guarantees. Review what the LLC’s assets are and what it owes. Talking about it sooner rather than later with your partners may help you work out a solution before the door to the parking lot locks behind you. And if you want to talk through the debts themselves, we can help you figure out what happens to them next.
