As we all know, most early stage tech and other high growth businesses are often reliant on equity funding, typically from institutions (such as VCs), or family offices, high net worth investors and crowd-funding platforms.

These rapidly-developing businesses are generally in a perpetual state of fund-raising, as they grow towards gaining sufficient traction in the market to make them profitable and cash-generative. Until that point, they rely on their existing and new equity investors to provide them with financial runway.

So, what happens when a catastrophic event, such as we’re seeing with COVID, causes these fledgling businesses to miss their financial targets or, possibly worse, causes their investors to stop being able to invest? Could this even lead to some of the investors’ previous “star performers” facing a cash shortfall or needing to make drastic cut-backs?

How do Investor-Directors deal with potential tension?

Very often, the investors themselves (particularly PE/VC/Family Offices), will have taken one or more seats on the Board of Directors of their investment companies. When funding is in short supply, how do these Investor-Directors deal with any potential tension that may arise between their role as employees of the investor and their fiduciary duties as a director of the investee company?

Worse still, what happens if funding becomes so critical that there is a real risk that the underlying investee company is unable to pay its ongoing liabilities, as and when they fall due – a prima facie test for insolvency?

In such a situation, the position of the directors changes: their primary fiduciary duty shifts from being owed to the company and its shareholders (ie the VC, family office and other equity investors), to being owed to the company and its creditors.

Identifying Conflicts of Interest

For the Investor-Directors, this may cause a significant problem: they now no longer owe a primary fiduciary duty to their main employers, as shareholders, and they need to consider other parties, first (ie creditors). It isn’t hard to see how a potential conflict of interest could arise.

Personal Liability for Directors

Not only that, but should the investee company continue trading and breach any of the detailed provisions of the insolvency legislation, the directors may face personal liability for any losses incurred.

Helpfully, the government recently announced an amnesty from the offence of wrongful trading (aka trading whilst insolvent), but this won’t protect directors from other claims that are commonly brought, such as misfeasance, preferring certain creditors over others or disposing of assets at less than fair value.

To make matters worse, the directors will be jointly and severally liable, and the investor-director may face personal liability, despite only having a relatively minor role in the management of the investee company. In fact, there are numerous precedents in which the investor-director faced the highest potential financial burden, when subsequent legal claims arose, as they were seen as having the “deepest pockets”.

Entering the “Zone of Insolvency”

In order to avoid these kinds of disaster scenarios, should the company be in danger of trading in the “zone of insolvency”, it is absolutely critical that the Investor-Directors ask themselves the question:

Is my role/connection with another company likely to prevent me, when acting as a director of the company, from giving sole consideration to the interests of the company?

Protective Measures for All Directors

Moreover, if taking the decision to continue trading is taken, all the directors must ensure that they:

• Develop a revised business plan, incorporating a short-term cashflow forecast, relevant to the current situation
• Meet regularly to review the ongoing financial position
• Review carefully any relevant transactions for which particular consideration should be given
• Keep and maintain regular minutes of all meetings and decisions taken (including the rationale for such decisions and the justification for continuing to trade)
• Take and follow professional advice from insolvency professionals

Protective Measures for Companies

There are a range of protections available to companies during the current crisis and beyond. These include the current government initiatives that we’ve seen (eg furloughing employees and protection from landlord action), but also include different restructuring options that can protect companies (and their shareholders) and guide them out of a potential crisis.


Author: Allister Manson, Partner at Opus
Call: +44 (0) 7775 750 017
Email: allister.manson@opusllp.com