The term “Zone of Insolvency” often floats around in financial and legal circles, but pinning down its meaning is like trying to catch smoke with your hands. No mathematical formula or financial algorithm can reliably signal when a business enters this nebulous zone. The irony is that you usually only realize you’ve been in this zone once it’s confirmed that the business is, indeed, insolvent.
If you’re a startup, you’re nearly always flirting with the “Zone of Insolvency.” One day, you’ve got two weeks of runway, and then that bank transfer from one of your investors bridging you saves the day. Six months later, you’re waiting on a payment from a customer, and you’re not sure if you’re Gusto payroll will clear. In both cases, you’re in the zone, but as with all startups, cash flow is like a roller coaster.
Can’t meet your liabilities? Some insolvency professionals will argue you’re officially in the zone! If a startup uses that litmus test, get comfortable in the zone. If we equate the “Zone of Insolvency” with a “zone of possible failure”—a point in the future where a business may not meet its liabilities—then almost every pre-revenue startup finds itself in this zone. Given that most startups operate in constant uncertainty and financial risk, this would mean that virtually 100% of pre-revenue companies are perpetually in the “Zone of Insolvency.”
The Zone of Insolvency implies that a startup’s fiduciary obligations officially switch to secured creditors being the first paid back. So, entering the zone has real implications for how a startup distributes its cash. Suppose a startup chooses to enter the zone. In that case, we highly recommend one of our experts in managed wind-downs to manage increasing the value of your debts and reducing liabilities to ensure a maximum payment to your secured and possibly your unsecured creditors.
At Ravix Group, we help you determine if it’s the right time and, more importantly, how to wind down. Entering the Zone of Insolvency typically starts with an ABC – Assignment to the Benefit of Creditors. That’s when you transfer your company to a person, Chief Restructuring Officer, who will operate the company while the assets are liquidated and sold at the highest value possible and
Wondering if your startup is ready to officially enter the Zone of Insolvency? Meet with one of Ravix Group‘s Chief Restructuring Officers today by completing the form.