There are several reasons a company might liquidate. It might be the case that the company is insolvent and no longer has a viable future, it cannot pay its debts, or perhaps it is sustainable but the director has chosen to retire.
Whatever the situation, it is important to understand the differences between compulsory and voluntary liquidation. After all, although both are formal insolvency processes that will wind-up and dissolve a business, they involve different processes that will impact a business in different ways.
To help you understand the key differences between voluntary liquidation and compulsory liquidation, Clarke Bell has put together this handy guide, to help keep you informed on the best route forward.
What is liquidation?
Liquidation is a formal insolvency process that officially winds up a company’s affairs and finances.
There are two main types of liquidation, compulsory liquidation and voluntary liquidation.
Although they both have the same outcome of liquidating and closing the company, the main differences between the two are around how the liquidation process is brought about.
First let’s look at compulsory liquidation, what it is and how it is initiated.
As the name suggests, compulsory liquidation is when a company is forced to liquidate. This is a process that is initiated by creditors who are owed money.
This occurs when a company can no longer afford to cover its debts, leading to a creditor taking legal action against it in order to get back what they are owed. A creditor can only issue a winding-up petition if the company owes them over £750 and has had their repayment demands gone unfulfilled for 21 days.
To begin the process of compulsory liquidation, the creditors will issue a winding-up petition to the court. If this is successful, the court will appoint a licensed Insolvency Practitioner to put the company into liquidation. Here, the company’s assets will be sold to raise the funds to repay outstanding debts.
Finally, the company will be dissolved after 2-3 months meaning it will be removed from the company register.
This is the most serious form of liquidation and can have a range of negative consequences on the business and director:
- Bodies and professionals such as banks, accountants and solicitors can share a dim view on directors who let their company go into compulsory liquidation
- The director’s own credit rating can be badly impacted
- Some may take the view that the director was complacent about their legal duties as a company director
Unlike compulsory liquidation, voluntary liquidation is a completely voluntary process that is initiated by the company directors.
There are two types of voluntary liquidation, Creditors’ Voluntary Liquidation (CVL) and Members’ Voluntary Liquidation (MVL.)
Creditors’ Voluntary Liquidation
First, let’s look at Creditors’ Voluntary Liquidation.
This is an option open to directors of insolvent companies. The company will no longer be able to cover its daily costs and pay their bills and will have liabilities that are greater than its assets.
Although this is a completely voluntary process, it is prompted by the fact that the company does not have a sustainable future. It is a way of closing an insolvent company and liquidating its remaining assets whilst paying back creditors what they are owed.
If your business is experiencing financial distress, it is always better to act quickly and take a route such as Creditors’ Voluntary Liquidation before things get worse. Otherwise, you could find yourself being forced into compulsory liquidation which can have negative impacts on you as a director.
A CVL is the better option as it protects your personal finances, will not harm your reputation as a director and will mean that should you wish to open another business in the future that you are free to do so. This is a clear indication that you have dealt with the problem and taken the necessary steps to pay back creditors.
Members’ Voluntary Liquidation
Unlike with Creditors’ Voluntary Liquidation, Members’ Voluntary Liquidation is an option available only to solvent companies.
There are many reasons a director might choose to close their company with an MVL. This could be because they no longer have a need for the business, they are retiring or they are moving abroad.
Whatever the reason, this is a hugely popular option for solvent companies with assets over £25,000 as it allows them to close the company in a tax-efficient way.
This is because through an MVL, any funds taken out of the business are subject to Capital Gains Tax rather than Income Tax.
What’s more, there are additional tax advantages for companies that qualify for Business Asset Disposal Relief which was otherwise known as Entrepreneur’s Relief prior to 6th April 2020.
With Business Asset Disposal Relief, eligible entrepreneurs that sell all or part of their business will pay just 10% in Capital Gains Tax on profits over the lifetime of the business up to a limit of £1 million.
This is significantly less than the level of income tax you would otherwise pay which stands at 18% for the basic level and 28% for the higher level.
As you can see, this is a great way of closing a business in a tax-efficient way that is completely approved by HMRC.
What’s more, this is totally voluntary, meaning it can be done at a time that is convenient and right for the director.