Startups in Crisis Mode – Avoiding Liability in the Event of (Impending) Insolvency
The transition from seeking investors to facing a crisis is usually gradual and poses a significant liability risk for managing directors. This is because the obligation to file for insolvency also applies to the managing directors of startups, provided they are organized as a corporation (e.g., a GmbH). If grounds for insolvency arise, the managing directors must file for insolvency in a timely manner to avoid personal liability. The deadlines for filing for insolvency—three weeks, or six weeks in cases of over-indebtedness—are maximum time limits. Managing directors are therefore required to do nothing less than constantly monitor the company’s financial situation. Compelling grounds for insolvency include the onset of insolvency and over-indebtedness.
What does “insolvency” mean?
Insolvency exists if the company is unable to meet 90% of its due payment obligations within the next three weeks. This must be verified by comparing liquid assets with (all!) due liabilities.
What does “excessive indebtedness” mean?
Over-indebtedness exists if the debtor’s assets no longer cover existing liabilities, unless the continuation of the business over the next twelve months is highly probable under the circumstances (so-called going concern prognosis). If there is a positive going concern forecast, over-indebtedness is ruled out.
Relevance of the going concern forecast for startups
In practical terms, the going concern forecast is nothing more than a preview of liquidity for the coming twelve months. For this period, there must be a high probability of solvency (>50% of liabilities) based on a coherent and feasible plan. It must be prepared by the managing director and, if necessary, subjected to review by an independent third-party expert. The question of whether, in addition to solvency, profitability is also a prerequisite for the going concern forecast has not yet been decided by the highest court. This would mean that the funds to finance the company must come from the company itself. However, this point is particularly crucial for startups, as they would be over-indebted and consequently insolvent under this requirement due to the high level of debt financing. In its ruling of August 16, 2023 (Case No. 12 U 59/22), the Higher Regional Court of Düsseldorf most recently confirmed its own case law, according to which, at least in the case of startups, profitability is not a prerequisite for a positive going concern prognosis. The liquidity required for this can also be provided by third parties, including both debt and equity investors. This is consistent, as business opportunities for startups usually only materialize at a later stage.
Essential components of the going concern prognosis
As is so often the case, good prevention and planning are the best ways to avoid liability. The most important component of the going concern forecast is a coherent and realistic financial plan for the entire forecast period, the implementation of which should be regularly monitored. (Expected) financing contributions must be documented along with their probability and the reasons for them. In addition, the going concern forecast should include a current presentation of the business concept and relevant milestones. Market opportunities and expected market developments must also be documented. In case of doubt, legal advice should be sought.