Why have a Dissolution Event?
A CARE investment will not guarantee the path to a successful Equity Financing or Liquidity Event. It’s a tough world out there and a significant number of start-ups will fall on hard times, forcing them to shutter their doors. The CARE does, however, envisage such an unfortunate outcome.
A ‘Dissolution Event‘ under the CARE includes a number of events that negatively impact the company, both voluntary events (e.g. termination of business operations; voluntary winding up) and involuntary events (e.g. liquidation; dissolution; compulsory winding up).
What happens on a Dissolution Event?
If a Dissolution Event occurs, a CARE investor is entitled to repayment of their initial investment.
They may be entitled to that repayment, but there’s certainly no guarantee they’ll actually receive it. Firstly, the company may have a limited pool of cash or other assets for distribution. It is, after all, uncommon for companies to close down if they’re wildly successful. Secondly, there may be a number of people with a claim to that limited pool of cash. Some of those people may be more entitled to it than others. This is why investors must familiarise themselves with the risks posed by the Liquidation Priority waterfall.
What should a Founder be aware of?
From the founder’s perspective, it’s worth a reminder of their important duties if a precursor to a Dissolution Event happens, i.e. if their company becomes insolvent. What constitutes ‘insolvency’, and what happens when a company becomes insolvent, varies from country to country. It’s important that you understand your local insolvency rules.
To generalise, a company will often become insolvent if:
- it is unable to pay its debts, and/or
- its liabilities are greater than its assets.
If their company is or may become insolvent, founders will need to consider the (sometimes conflicting) interests of various groups, including their employees, business partners, investors and creditors, to name a few. If they fail to manage this correctly, they could become personally liable, e.g. for wrongful trading, fraudulent trading or a breach of their duties as directors.
Needless to say, if a founder believes their company is or may become insolvent, it is recommended to seek professional advice immediately.
Is there anything a Founder can do?
The most important point about a Dissolution Event may, however, be trying to catch it before it happens. CARE investors have the right to receive information about the company’s business and financial condition. Technically investors need to request this first. However, it can often be better to disclose and discuss financial concerns with investors at the earliest opportunity. It’s best to tackle a crisis before it arrives – and investors may be able to help with this.