Investment in Progress

Negative Equity In The Annual Statements – To Do’s for the Managing Director

If the debts and reserves in the balance sheet exceed the assets of the company, the management has to react. Startups with high burn rates (before getting the next equity injection) often face this problem.

Regulated in section 225 (1) Austrian Commercial Code (Unternehmensgesetzbuch – UGB) the managing director has to explain in the notes, whether an over-indebtedness according to insolvency law right is present or not.

Insolvency or not?

If the managing director has to confirm an over-indebtedness (according to insolvency law), he should immediately file an insolvency report to the commercial register to avoid his prosecution for delaying the filing for insolvency.

In practice the managing director tries to explain that even in case of over-indebtedness in the accounts there is no insolvency case according to insolvency law.

One possible explanation could be that there are hidden reserves in the company’s assets – mostly in case of properties, shares or other investments which were acquired years ago and are booked with their acquisition costs, even though there was an increase in value due to positive market developments.

If such hidden reserves do not exist, the managing director must ask the parent company or the shareholders for a subordination of existing debts to the parent company or shareholders (or even to other understanding creditors). A so-called subordination of the creditors means that the satisfaction of this creditor in case of liquidation only takes place after all other creditors and/or the satisfaction of the subordinated creditor can only happen after removal of the negative equity in case of continuation of the company.

Another possibility for a sufficient explanation would be a letter of comfort: In this case, a (parent) company or shareholder gives a binding assurance in form of a written letter of comfort to ensure that the (subsidiary) company can meet its financial obligations at all times.

Last resort: Using the crystal ball 

If neither the shareholders nor the creditors show any willingness to support the (start-up) company, the managing director must use the crystal ball and predict the future in form of a positive forecast for the continued existence of the company.

This forecast has to show a well-founded statement that the company will predominantly be able to continue its business activities in the future in compliance with its payment obligations.

Short- and long-term forecast

A primary forecast and a secondary forecast must be created for this purpose. The primary forecast should document the solvency of the company for the next six to twelve months using a short-term finance plan. The secondary forecast must be prepared for a longer period (three years) and includes planned profit and loss statements, planned balance sheets and a planned cash flow statement. These calculations plus a detailed verbal justification should result in a sustainable turnaround of the company.

Only if the continued existence of the company can be expected with a predominant probability, it is recommended to a careful managing director to deny an over-indebtedness under insolvency law in the context of the notes according to § 225 Abs 1 UGB. 

Authors

Barbara Hölzl, Managing Director and Tax Advisor ECOVIS AustriaDavid Gloser, Partner, Chartered Accountant and Tax Advisor