As young companies, startups often have only minimal liquidity reserves. This lack of equity becomes particularly significant when a financing round doesn’t go as planned and no further funds flow in. This can quickly lead to a startup facing financial difficulties because it can no longer service its liabilities. If insolvency maturity already exists in such a case – meaning one of the two insolvency grounds defined in German insolvency law, namely over-indebtedness or inability to pay – you as the managing director of a startup are obligated to file for insolvency within the statutory deadlines. The most important message in this context: Your company’s story doesn’t automatically end in liquidation even in the event of insolvency.
Obligation to file for insolvency is back in full effect
In the event of financial difficulties for your startup, you should definitely keep in mind as managing director that the obligation to file for insolvency has been in full effect again since January 1, 2024. If inability to pay has already occurred, you as managing director have three weeks to remedy this or file for insolvency. In the case of over-indebtedness, the legislator allows you six weeks for this. What is not explicitly stated in law, but nonetheless applies: These deadlines can only be used by those who can demonstrate a restructuring concept that has prospects for successful implementation.
If restructuring is no longer possible, only one option remains: immediate insolvency filing.
To be able to assess the company’s situation at all times, careful business planning is necessary. If this reveals that inability to pay threatens within the next 24 months, planned restructuring using the tools of insolvency and restructuring law is also an option. In this way, the crisis identified early can be managed through, for example, shortened notice periods for rental contracts and employees or an insolvency plan that enables an agreement with all creditors on (partial) waiver of claims even against the will of individual parties.
To avoid wasting time if needed and to be able to act quickly but thoughtfully, it makes sense to familiarize yourself early with the possible consequences and procedures of insolvency, as well as the different types of proceedings [see information box Overview of restructuring and reorganization proceedings] while keeping an eye on the legal deadlines. The latter is particularly important so that you as managing director can protect yourself from potential personal liability for insolvent delay.
Restructuring and reorganization of a company always represents a special situation. Therefore, it is important to know the individual instruments and procedures and their special features in order to subsequently decide on the right approach:
· On the one hand, there is the so-called standard insolvency procedure under insolvency law.
· However, self-administration, i.e., restructuring under your own management, and the protective shield procedure, a special form of self-administration, also offer the opportunity to reposition a company.
· Since January 1, 2021, there has also been the possibility of so-called StaRUG restructuring. This procedure makes it easier for companies to restructure financially more simply than before – even before they become unable to pay. If the restructuring is successful, this can avoid insolvency proceedings.
Both standard and self-administration procedures can be concluded with an insolvency plan, a kind of court settlement with creditors. With the protective shield procedure, the insolvency plan is even provided as the primary restructuring instrument and must be submitted within a timeframe determined by the court. StaRUG restructuring is concluded with a restructuring plan, which is very similar to an insolvency plan.
The advantage: Through the restructuring or insolvency plan, the company remains intact and with it the equity stakes potentially remain valuable. The fact that shareholders also benefit from such restructuring is in turn a basic incentive for shareholders to pursue and support such a procedure.
When professionally prepared and carried out, the insolvency and restructuring procedures mentioned provide a reliable framework for implementing necessary change processes in a company in a short time. (Photo: Claudio Schwarz on Unsplash)
The transferring restructuring
There are several ways to restructure a startup within insolvency proceedings. One is the so-called transferring restructuring. In this case, the essential tangible and intangible assets of the insolvent startup are transferred to a new, debt-free successor entity – a new company. The successor entity acquires all assets from the insolvency administrator of the startup, while liabilities remain with the old company and are handled in insolvency proceedings. The proceeds from the sale of assets are used to satisfy the startup’s creditors.
The great advantage of transferring restructuring is that the startup, its business idea, and its venture can continue in a new company that can make a fresh financial start. Employees automatically transfer to the new company. The startup lives on.
Continuation solution within four months
A good example of such a fresh start is the Munich HealthTech startup Smart4Diagnostics, in which I served as insolvency administrator. Through transferring restructuring, we were able to achieve a continuation solution for Smart4Diagnostics within four months. A renowned venture capital provider acquired the business operations of the company founded in 2018 through the newly established successor entity S4DX and also took over the entire workforce. This now provides a future perspective for the employees and the company’s product – the world’s first digital and automated tool for quality assurance in human blood samples.
The crisis had occurred because Smart4Diagnostics, together with renowned partners from the medical field, was involved in several international tenders with a volume of several million euros, but these were postponed in time. The startup could not generate the ongoing costs and investments in software development from ongoing business operations until these decisions were made. The previous shareholders were not willing to invest additional funds in the company. Subsequently, management filed for insolvency early, so that within insolvency proceedings a new investor could be sought and found.
An investigation by Schultze & Braun, which focuses on so-called second insolvencies and the sustainability of company restructurings, shows that standard insolvency procedures, self-administration, and protective shield procedures stand for successful and sustainable restructuring of companies. In a second insolvency, the company’s first restructuring was not sustainable enough to avoid a second trip to insolvency court.
High sustainability rate
In the study (findings, database, and study design at www.nachhaltige-unternehmenssanierung.de), on the occasion of the tenth anniversary of the insolvency law reform coming into effect on March 1, 2012 (ESUG), the years since 2012 were examined: In the period from March 1, 2012 to September 1, 2021, based on data from data analysis provider STP Business Information, a total of 114 second insolvencies were identified – in 44 of these, the first restructuring took place in self-administration or protective shield proceedings. With around 2,200 ESUG procedures since March 2012, the sustainability rate is definitely impressive – even though there is no data on how many of these procedures led to a restructuring solution on the first attempt. This also applies to standard insolvency procedures – i.e., restructurings with an insolvency administrator – which nonetheless have nothing to hide. 70 second insolvencies among around 54,400 standard insolvencies also speak to a high sustainability rate.
Another important finding of the study is that the vast majority of identified second insolvencies occurred within the first five years after the first insolvency. This means that for a restructured company, the causes that led to the first insolvency have typically been overcome if more than five years have passed since restructuring.
Using the second chance the first time
One goal of the legislator is for companies to view necessary restructuring – especially with the help of insolvency law – as a second chance. Another finding of the study shows that it is important to use this second chance the first time. Furthermore, it underscores the importance of sustainable company restructuring: Companies that must file for insolvency again within five years of the first insolvency are liquidated almost 1.5 times more frequently than restructured. This underscores how essential it is to address the operational causes that led to insolvency in any restructuring, not just reduce liabilities. (Photo: Freepik)
The insolvency plan
The alternative to transferring restructuring is the insolvency plan. With this instrument, a startup can essentially restructure itself from within. During ongoing insolvency proceedings, you as managing director negotiate a settlement with creditors with the participation of the insolvency administrator, which usually involves partial waiver of claims. This can be financed either from proceeds generated by continuing operations or through third-party funds. The advantage: With the insolvency plan, the company as such remains intact and the equity stakes of the startup also remain potentially valuable. The fact that shareholders therefore benefit from restructuring with an insolvency plan is in turn a basic incentive for shareholders to pursue and support this procedure. However, since it requires extensive negotiations with the parties involved and a court voting procedure, you typically need to allow a timeframe of three to six months for an insolvency plan procedure.
Evaluate the appropriate restructuring instrument individually
Even though this may read as if the insolvency plan would always be the better alternative, the rule of thumb is: The appropriate restructuring instrument should be individually evaluated for each startup. When looking at the insolvency plan, the reality is that most startups – and this must also be stated truthfully – do not have the liquidity reserves to maintain normal business operations until the plan is negotiated, and frequently also lack sufficient surpluses to (partially) satisfy creditors. Therefore, for most startups in practice, transferring restructuring is rather the first-choice restructuring instrument, as it can usually be implemented more quickly. In any case, however, one thing is certain: A crisis or financial difficulties following company formation need not be the end of a startup.
