My company can't afford to pay a director's salary

My company can’t afford to pay the directors - what should I do?

As the director of a limited company, you cannot simply treat the business’s profits as your personal income, as you might in a sole proprietorship or ordinary partnership. Instead, you must pay yourself formally through the company, which, for tax reasons, most directors do by taking a small salary and topping it up with dividend payments. 

As a director’s salary is typically small, going without it for a few months may not ordinarily be a problem. It’s actually quite common for the directors of small and early-stage companies to forgo their salary and reinvest it in the business. 

However, doing so for a prolonged period can put you under financial strain. If you find yourself in that position and there’s no end in sight, these are the steps to take. 

Document the decision formally

The first step is to make sure you stop the payments legally and transparently. Don’t just cease taking a salary. Instead, make a board resolution and document the decision. 

You should also decide whether to waive the payments permanently or defer them for a future time when the company has more liquidity. If you choose to defer them, document whether you’ll receive interest on the delayed payments or if you might take them in another form, such as equity. 

Assess the business’s finances

Next, you need to identify the root cause of the problem.

• Firstly, is the business profitable? - Reviewing the company’s profit and loss statement will give you a breakdown of its performance, usually over 12 months. If the company is not profitable, you should consider pricing, revenue generation and cost reductions to turn the situation around.
• Or are you suffering from a cash flow shortfall? - If the company is making a profit, its inability to pay a salary will be due to short-term cash flow issues. Insufficient cash flow is a leading cause of company insolvency, even for profitable businesses, and is something you should resolve quickly. 

Improve your cash flow position

If the company is profitable and its business model is viable, there may be several ways to improve your cash flow position so you can take a salary. You can:

• Negotiate better payment terms with your suppliers
• Improve your credit control processes and collect late payments more quickly
• Explore your short-term funding options - invoice financing and merchant cash advances can help you free up cash without taking on additional debt
• Sell non-essential assets or use asset-based lending to borrow money against them

Be transparent about your situation

When applying for credit or seeking funding, you must be transparent about your financial situation. Not taking a salary can be seen as a sign of commitment to the company. However, prospective lenders or investors will want to see that you have a plan to boost the company’s long-term sustainability. 

You must also be cautious when seeking external funding. If the company is unable to pay its debts as they fall due, it is considered insolvent. At that point, directors have a legal duty to act in the best interests of creditors. If you borrow money or use company funds to pay yourself a salary during insolvency, particularly if the business has no realistic prospect of a recovery, you could become personally liable for those payments if the company later fails.

Monitor your company’s financial position closely

If your company cannot afford to pay a director’s salary for a prolonged period, it suggests all is not well with its finances. Failing to pay director salaries is a warning sign of insolvency, and when a company is insolvent, your legal duties as a director change. 

Your primary duty shifts from acting in the interests of shareholders to protecting the interests of its creditors (the parties it owes money to). Continuing to trade and accumulating debts when you know or ought to know the company is insolvent can lead to severe penalties.

That’s why it’s essential to regularly monitor your company’s financial health, seek professional advice if you're unsure and act quickly if you suspect the company is insolvent.

What should I do if my company is insolvent?

If you can’t afford to pay a director's salary and the business has other liabilities it cannot meet, it may well be insolvent. A company is technically insolvent when:

• It cannot pay its debts when they’re due (such as rent, supplier payments and tax bills); and/or
• The total value of its liabilities - including its liabilities that are likely to become due in the future - exceeds the value of its assets.

If either of these is true of your business, you should contact an Insolvency Practitioner immediately. They will assess your company’s finances and explain your options. Seeking professional advice early on will help you avoid breaching your duties as a director and increase the company rescue options that are available.

“Spoke with Chris who put me at ease straight away. He was very knowledgeable and listened intently to all my worries and concerns. Will definitely be using Real Business Rescue and advise anyone with business issues to give them a call.”

Diana

 

Contact the Real Business Rescue Team today

Chris Bristow
Business Debt Expert

What are my options if my company is insolvent?

If you’re not taking a salary from your company and it is insolvent, there are likely to be several routes available to you. The most appropriate option will depend on the financial position of your company, its future viability and your appetite for continuing to run it. 

Informal creditor arrangements

If your business model is viable but you have an underlying cash flow problem, an informal repayment arrangement with your creditors could give you the breathing space you need to get back on track. For example, you may be able to negotiate a payment plan with a supplier or make a Time to Pay Arrangement with HMRC. 

One issue, however, is that this type of agreement is not legally binding, so creditors can change their minds at any time. Unlike formal insolvency procedures, it also provides no protection from creditor legal action, such as County Court Judgments (CCJs) or Winding Up Petitions. 

Company Voluntary Arrangements (CVAs)

If your financial difficulties are more severe or you have debts with multiple creditors, a formal option such as a Company Voluntary Arrangement (CVA) may be a better fit. 

A CVA is a legally binding creditor agreement that allows you to repay your creditors in monthly instalments over a typical period of three to five years. And at the end of the CVA, any debts you haven’t repaid in full will usually be written off. 

Administration

If the company can’t afford to pay the directors and is under severe financial pressure, Company Administration could be an option. Acting as the administrator, an Insolvency Practitioner will create a plan to rescue the business, sell it as a going concern or work to achieve a better outcome for the creditors than if it were liquidated.

Creditors’ Voluntary Liquidation (CVL)

If the company is no longer financially viable and has no realistic prospect of a recovery, a Creditors’ Voluntary Liquidation is an efficient and legally responsible way to bring it to an end. An Insolvency Practitioner will wind up the company’s affairs and sell its assets to raise funds to repay the creditors as far as possible. Any debts they cannot pay will usually be written off.

Choosing to liquidate the company voluntarily helps directors fulfil their legal duties and minimise the risk of personal liability. You may also be eligible to claim director’s redundancy pay, which can provide some much-needed financial stability when you haven’t been taking a salary.

How can we help?

If your company can’t afford to pay a director’s salary and you’re worried it could be insolvent, our Insolvency Practitioners are here to help. We will assess your financial position, explain your options and recommend an appropriate route forward. 

We can also implement and manage a full range of formal insolvency procedures and guide you through the process from start to finish. Please get in touch for a free consultation or arrange a meeting at your nearest office.