It’s no secret that the business environment is tough, particularly for small enterprises where the margins are always a little thin. One late payment from a client can cause consternation, but what happens when that client fails? The chances of one of your major clients collapsing before paying you is very real and sometimes there may not be any warning whatsoever.
This situation can be a death knell for a company that has already spent the expected money. So, when a client goes bankrupt, how do you avoid slipping under with them?
“Generosity is a virtue, but unlimited generosity is a fast route to bankruptcy.” (Bret Stephens)
Healthy cash flow is what keeps a company afloat. The ability to pay suppliers and staff, without risking the future of the business, entirely independently of expected new payments, is vital for any enterprise to keep going.
In this era of regular redundancies and corporate collapses, managing your cash flow is the most important aspect of managing your business. Key clients and customers getting into difficulties and potentially failing puts serious strain on your own company’s ability to stay afloat. The six tips below should help you stay solvent even if your biggest clients bow out.
- Secure the debt upfront
Firstly, to talk “prevention rather than cure” for a moment, seek advice on taking some form of security for your debt (a cession of the client’s debtors perhaps) upfront. As we shall see below, being a “secured creditor” gives you a much better chance of at least partial recovery in the event of liquidation than being a “concurrent creditor”.
- Request upfront payments as standard
Still talking prevention, requesting payment up front can often feel like a rude or difficult thing to do. You may fear offending clients by implying they will not pay, or you don’t want to scare new business away by asking them to trust you to deliver. At the end of the day upfront payment is about trust; and asking for someone to pay you before you deliver may feel wrong. It does, however, have many advantages.
Apart from ensuring you will not be taken for a ride by fraudulent clients, asking for payment up front also protects against failure of those clients. The worst situation you can find yourself in is one in which you have done work, and now owe your own suppliers, only for the payment not to come through. Asking for money up front means this will never happen and questions around scaring off clients are generally unfounded. Of course, your own suppliers may already be asking you for upfront payment, especially in the current environment.
If a client has decided to work with you, they have likely done their research and are already trusting you to deliver within certain time frames and deadlines that they themselves need to meet. Generally, there is also an understanding that costs will be incurred by you to meet their requirements. Asking for upfront payment is therefore a relatively small pain point in this transaction and upfront payments are therefore common in trade businesses, or creative enterprises where payments may need to be made in order to start a job.
If you still feel uncomfortable asking for the money up front, at least ask for a deposit and progress payments. Be prepared to pause work on projects if payments are late before you incur additional expenses.
Particularly if it is your standard policy, you need not feel you are discriminating against any one client. In the long run your cash flow will be healthier for it.
The first, and most important thing to do to protect your company from going under when a client fails, is to have as many clients as possible. Diversifying your client base means you are not as dependent on that one client who may be struggling. It sounds like obvious advice, but there are business owners who, once that one big client is secured, sit back on their haunches, and live the easy life servicing that goose that lays the golden eggs.
It is important then to never stop marketing, or hustling for new business, and this is particularly important when that one big client goes under. One person’s misfortune is another’s gain, and your client’s failure is going to have a ripple effect through their industry. Somewhere, one of their competitors may find some space to grow. By marketing yourself and your products/services you may find your business in the perfect position to pick up that work when they start expanding.
So, while it’s important to focus on the clients you have now, it’s also important to start planning as early as possible for a future without one or more of them. If you landed one big client, the chances are you can land another.
- It’s time to become strict
No matter how long you have been dealing with a client, the second you suspect they may be struggling financially it’s time to alter the terms of your arrangement. Protecting your business needs to be your number one priority. If you had the client on a 90-day payment plan, move that to 30. Stop paying for things on their behalf and secure payments wherever possible up front. Suspend projects until payments are received. If your product or service is key to their operations, they will find a way to pay in advance, and if it’s not, well your payments would have been first on the chopping block anyway. There is absolutely no sense continuing work and spending good money chasing bad.
- Negotiate early and be willing to sacrifice
As soon as a client indicates that they are in financial distress, it’s time to look at your books and decide just how much of what they owe you is essential and how much you could reasonably lose. Then negotiate as below, because when a company goes into liquidation, there are three types of creditors, which will determine just how likely you are to get all or a portion of your money back during the winding-up process.
- Preferent creditors include employees of the company, who are owed wages, and of course the tax authorities.
- Secured creditors are those that have liens/security on the debtor’s property (such as the bank that loaned the company money to buy a factory taking a cession of debtors).
- Unsecured (“concurrent”) creditors include those that provided the company goods or services, such as suppliers and contractors, without taking any security. Unsecured creditors will be the last to get paid in any bankruptcy process and are therefore most likely to lose everything. Getting at least some of that back before the process begins is therefore the best you can hope for.
Once you become aware of a client’s financial difficulties, making them an attractive offer may help get something into your accounts. A good offer would be to ask for a 30% payment now with an offer to extend payment on the rest to a later date. An alternative would be to ask for 50% payment now in return for wiping out the remainder of the debt. The earlier in the process you do this, the more likely you are to get something back and don’t be afraid to be pushy. Keep lines of communication open and send frequent reminders. Most people feel bad about letting down their vendors and making sure you are front of mind will also encourage them to pay you out first.
A client’s financial difficulties could also result in their going into business rescue. This will mean that no payments may be demanded by creditors until (if) they trade out of business rescue back into health. So being aware of how your customers are doing is essential. This also applies to your suppliers as the failure of a key supplier may be a real problem for your business.
- Do a Cost-Benefit analysis
When your client has actually gone into business rescue or liquidation, it’s time for you to decide whether you are going to pursue your claim. This can be an expensive and time-consuming process and the amount of debt involved will need to be measured against the costs and time chasing it.
In a practical sense, you need to look at the value of the client company, how many assets they have and what chance there is that there may actually be any money to recover. Then look at how much time and money you can spend chasing that money. Again, beware of spending good money chasing after bad.
To be in line for some payment in a liquidation, you will need to submit your claims with proof at the first meeting of creditors which will be scheduled by the liquidator, which sounds like an easy decision to make. You must be careful, however, because if there are not enough assets in the company to satisfy the cost of liquidation, anybody who proves a claim at a meeting of the creditors may be called upon to contribute to the costs of liquidation. Check first with the liquidator and find out if there is a danger of a contribution being levied on concurrent creditors.
Only go as far along in the process as you are willing to, based on costs, efforts and the money you reasonably expect to recover. Often your time will be better spent looking for a new client.
For additional reading:
- Read the Global Restructuring & Insolvency Guide for South Africa for an explanation on the laws of insolvency, here.
The article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.