What happens when a company you have invested in goes bust ? 2

Ever wonder what happens to your equity once a company you have invested in (whether a private company or one listed on the stock exchange) goes into administration. The first question that will come to most peoples minds is whether or not I will get the money I have invested back?

In order to answer this question we first need to see why a company becomes insolvent. A company becomes insolvent when it can no longer meet its finical obligations. There are 2 main tests for insolvency which are:

  • Solvency Test – when the company’s assets are less than its liabilities.
  • Liquidity Test – when a company’s liabilities cannot be paid as they fall due.

Once a company is deemed as insolvent, there are 5 options a company has. These are Administrations, Administrative receiverships, Company Voluntary Arrangements (CVAs), Creditors’ Voluntary Liquidations(CVLs) and Compulsory Liquidations. The first three have the potential to rescue the company whilst the latter two do not. These types of insolvencies mentioned are topics on their own and are not the focus of this post. What you want to know is at what stage do you receive the money you invested?

Basically, when a company becomes insolvent, it sells its assets and has an order of payment as follows:

1) Fixed- Charge Holders – Anyone holding a fixed charge is the first to be paid by the company. A fixed charge is a charge secured against a specific asset. Thus, although holders of the fixed charge are paid first, they can only be paid from the sale of the asset they hold the specific fixed charge on. If the asset is sold for less than the amount owed to the charge-holder, the balance of the debts is placed together with unsecured debts. An example of a fixed charge is a debenture.

2) Liquidation expenses – Next, the company needs to pay for the liquidator’s expenses which consists of all expenses the liquidator could incur in managing the liquidator.

3) Preferential Debts – With any money left over, the company needs to pay preferential debt holders. These include all contributions to pension schemes, any outstanding wages and salaries for 4 months that need to be paid to employees and outstanding holiday pay.

4) Floating Charge Debts – Floating charge debts are paid next to the parties that hold the floating charge. A floating charge is secured on a group of assets instead of just one asset as above.

5) Unsecured Debts – Yes, like every other thing in the world, the government has to have a share. All taxes due to HMRC are paid at this stage. Also, any payments to trade creditors are made at this stage.

6) Statutory Interest – This is interest on late payment of tax once a company goes into liquidation

Only after the above have been paid can the company make a repayment of share capital to the shareholders. Dividends paid after a company has been would up is called Capital Dividends as they represent the disposal of the shares. Shareholders do not need to pay income tax on Capital Dividends but capital gains tax may be due. The capital gain is the difference between the price the shares were originally acquired and the amount paid to the shareholder when the company is wound up.

So you can see, when a company is winding up, the money it raises from asset sales will be paid to the required creditors numbered 1 – 6 above in chronological order. Only after these creditors have been paid, will shareholders receive their share of any money remaining!