I’ve had no luck searching here or elsewhere. My wife recently quit her job working for a small company that is essentially a slowly sinking ship. The problem is that the ship has been sinking for a long, long time and never quite seems to actually sink.
According to my perception of The Way The World Works, this company should have died quietly years ago. I hear all the time about the typical struggling small business owner. It’s always seemed to me that the very nature of small business ownership leads to this struggling (thus the “small,” from output to employee base to market share and revenue). This company has an owner that seems uninterested in making smart financial decisions, is equally uninterested in exploring areas that cost money and ways to limit the damage, and has no problem treating his employees to virtually no benefits (and no incentive to work efficiently or well). The company has been operating at a loss for at least a year, probably two or three. The owner has taken out a business loan or two that (along with a credit card or three) floats them along so that they typically barely make payroll each month. Owner makes around $100k per year.
I believe the company is an s-corp. This seems to somewhat shield the owner from financial liability. Is that seriously the key for a generic SBO–just start up a business that runs well enough for a while to secure a loan or two, then float along losing money every year, raking in a nice salary until your loan wells run dry, then declare bankruptcy and slime out of any personal repercussions or liability? I know next to nothing about economics and business ownership. But what I see with this company is amazing. The stories I heard–almost daily–about incredibly unsound leadership and money-costing decisions/job bidding/employee hiring, seemingly willful financial negligence… I just don’t understand how the company is still in business, and how the owner will fare once (if) the company finally folds. Is he protected, and if so, how? For those SBO’s on here, how long can you last running at a chronic loss, and how motivated are you to correct practices that very clearly cost you substantial money (i.e., thousands) each month?
Just because the company appears to be in financial straits, it doesn’t mean it actually is. Lots of companies borrow money to make payroll. In fact, most do it regularly.
How is it not? Wife did the payroll, paid bills, worked with the accountant, managed the accounts, determined where the company was losing money and analyzed how much profit/loss occurred each month/year. If a company is truly losing money month after month and is already having a hard time making payroll, is that not considered “financial straits?” Is that the state of the typical small business? If you borrow money a few times over the course of a year in order to make payroll, but overall you net enough over the year to pay back the loan, then I can understand that practice. But that’s not what’s going on with this company.
My theory is that the owner has the system (and his protection) figured out and is biding his time until the company goes under. Either that, or he’s incredibly dumb.
Fair enough. I guess it depends on what you consider “a long time”, though. The economy has been doing poorly since 2008; maybe the company was profitable during the boom years.
In all probability, he was a guarantor for the company’s first loans. If he’s letting this company die and moving on, it’ll still be his credit on the line.
Many businesses operate on a line of credit, especially if they have an erratic cash flow.
Generally, for a small business with one or two owners, the banks fronting any money probably want personal guarantees from the owners as well. The guy may be able to stiff his employees when the end comes, but the banks are usually smart enough to get their pound of flesh.
I remember one small business owner complaining that when his wife left him, times were very difficult for his business - because the bank was afraid she was going to take half of everything and he would not have the assets to cover his loans, or they would be frozen for months and liened and that much less liquid.
“Never ascribe to malice what can as easily be explained by incompetence”. This may not be a plan on the owner’s part; just because he’s a good plumber or mechanic or engineer or builder or chef does not mean he’s a good business manager, accountant and job estimator. He’s just going down the drain in slow motion, meanwhile enjoying the $100K lifestyle and unwilling to make the needed sacrifices.
He’s borrowing against the remaining assets of the company. So, he’s in a slow downward spiral. He still pays his bills, still draws a nice salary, and will keep going until the bank decides not to lend him money anymore. He goes out of business, sells of the assets to pay back the bank, and gets a new job.
It’s really on the bank to cut him off if his business performance is unable to meet the debt service.
Depending on their fixed costs, they may also lose less money by staying in business than by shutting down, at least in the short run. If you have to pay out the leases on the building and any capital equipment regardless, it can make sense to stay open and try to recoup as much of those costs as possible.
This is what I figure, but it seems so easy. And I don’t have a good understanding of what protection is afforded to him under the S-corp structure. Chances are that this is his last gig before retirement. I’m trying to get an understanding of how at risk that retirement (and the hundreds of thousands he’s “earned” over the last ten years) is once he folds. If he’s unable to pay back the loans by selling assets, then what? Can he still retire comfortably if he’s assumed responsibility for the debts? And if it’s that easy (albeit unethical), why isn’t everyone doing it?
A corporation or LLC only provides protection from liability in theory. In practice, most loans and leases require a personal guarantee from the owners so that their personal assets can still be used for repayment. This isn’t a question we can really answer without seeing all of the contracts, though.
The business and the person can declare bankruptcy separately or together. The bankruptcy courts have various requirements about how much money you can make or keep after bankruptcy. While this can be a real boost to the owners of a failed business and it can help them get back into a productive situation, the reality is that the owners would always have been better off with a successful company.
Even if we ignore the financial costs, there are huge emotional costs for most owners. I would say that most people don’t do it because it is the worst experience of their lives - I think you can only compare it to the slow death of a loved one over years. Most small business owners really are that attached to their companies, and this is often the reason that they let it languish in a long, multi-year failure rather than closing up the doors when it’s obvious to everyone else that the thing is doomed.
So when you ask if the owner is stupid, I would say almost certainly no. The owner may not be cut out to run a company and may lack the skills and knowledge to do so. There are uncountable numbers of people who are totally unsuited to own their own business for reasons other than intelligence. The most likely explanation for this situation, though, is that the owner is simply making decisions from an emotional position rather than a logical/financial position.
As I said, he can stiff the emloyees, and possibly suppliers. After all, the corp owes them, not him.
The banks, to finance the operation, probably have required him to personally guarantee the loans. Therefore, his only exit is:
the company goes bankrupt.
-If possible, the last few months stall on any bills or payroll and use the cash flow to pay the bank as much as he can rather than the corporation bills.
-he will talk to his lawyer if he’s smart. If he fails to pay the employees’ health care premiums, for example, can they come after him personally? The lucky ex-employees will probably be out one or two paycheques and then discover they have not been covered by the insurance for a few months. And no vacation pay left. The end is near when he starts giving excuses why they can’t take vacation right now…
-once the company is bankrupt, all he has to worry about is the money he has personally guaranteed - i.e. the main bank loan. If he has stashed away enough of his $100K/yr salary he can pay that down and hav a tidy nest egg.
-if he was completely stupid and blind, he ends up losing his house, savings, etc. and goes pesonally bankrupt too.
-odds are his car was bought by the business, so he’ll drive that fo free until it is repossessed (speaking of loans to skip payments on) then have to buy one out of his own pocket.
He can only get ut of personally guaranted loans through personal bankruptcy.
Oh, and don’t forget skipping paying tax remittances to the IRS. Local sales taxes? Not sure how much liability there is for him personally on those, but the corporation can avoid those by going bankrupt. More cash to pay down the bank.
An S corporation is a tax concept; legally it’s just a corporation. For tax purposes, the corporation is treated essentially as if it did not exist, and the business is just the owner. Legally, the corporation provides a measure of protection against liability, since plaintiffs may be able to proceed only against the corporation and its assets. That gives the owner no help if he has guaranteed the debt (or if it’s his personal debt, as I assume is the case with the credit card debt). It also doesn’t help if the plaintiff has a personal claim against the owner (e.g., if he’s a physician, his patients could still bring a malpractice claim against him personally).
Keeping the business going may be a good decision for the owner. Suppose he’s paying himself $100K per year and the business is losing $20K per year. Also assume that he could make only $50K/year if he worked somewhere else and that his return on what he would get if he sold the business would be $20K/year. If that’s the case, then he’s clearing $10K/year more than he would if he sold the business and got another job.
It may also be that the numbers are different and selling the business would be a better choice. Not everybody is a financial whiz. He could be doing what he’s doing out of habit or stupidity, or because he loves having his own business even if it costs him money, or because there are other benefits to owning the business (jobs for family members is a classic example).
If he can’t sell the business (or its assets), perhaps he will declare bankruptcy at the end. He likely has retirement savings (e.g., in a Keogh plan) that are protected against creditors. The banks or other professional lenders to the business are undoubtedly aware of these issues and have taken steps to reduce their losses if things turn out badly. Others, such as employees and perhaps customers, may be less sophisticated.
In Washington state, the owner* is not only liable for sales (and payroll) tax, but can be charged with a felony theft if he doesn’t pay it (since the company never owned the sales taxes, they just collected sales tax as an agent for the state). Bankruptcy will make no difference at all.
*Not just the owner, actually. It’s the person who is aware of the obligation and able to authorize payment, but who fails to do so. This could be an employee, but is usually an owner.
The IRS is particularly unforgiving about payroll taxes.
Income taxes are generally not avoided by going bankrupt, but there are whole books written on the finer points of what can and can’t be done.
I would classify willful blindness, or unwillingness to face the facts, as a form of stupidity. True, it’s not in the same class as 2+2=5; but letting emotions cause financial mismanagement is never good.
OTOH, that’s very true. I am very poor at meeting new people, I hate calling people, I would never make a good salesman. Perhaps this guy was really good at the initial business, but totally incapable of running it effectively once it got past 2 employees. Then he’s letting it fail by default instead of by design. Either way, he’s eventually screwing a bunch of employees and suppliers by his own inadequacies. The only hope is that it’s poetic justice if he screws himself too.