Managing a startup’s board of directors becomes particularly demanding during financial difficulties. These challenges are more pronounced in startups, where companies often burn cash without generating significant revenues in the early stages. This article outlines the duties of the board of directors in financially challenging periods and provides recommendations, taking into account the amendments introduced by the corporate law revision effective January 1, 2022.
General Supervisory Duties of the Board
Under Article 716a(1) CO (Swiss Code of Obligations), the board has non-transferable and irrevocable duties, including the design of accounting, financial control, and financial planning. In cases of over-indebtedness, the board is also obligated to notify the court. Therefore, monitoring the company’s finances is a central responsibility, both in good and bad times. During financial hardship, the rules outlined in Articles 725 et seq. CO must be observed.
There are three key stages that require different actions:
- Imminent insolvency
- Capital loss
- Over-indebtedness
1. Imminent Insolvency
Under current law, the board is formally required to take restructuring measures only in cases of capital loss. However, the revised Article 725 CO also imposes obligations in the event of imminent insolvency.
Definition of Imminent Insolvency
A company is considered to be on the brink of insolvency when it can no longer meet its due obligations and lacks the necessary liquid assets or access to credit to obtain the funds.
Board’s Obligations
The revised Article 725 CO requires the board to:
- Monitor the company’s liquidity regularly to detect potential insolvency.
- Take immediate actions to ensure liquidity if insolvency becomes imminent.
- Implement additional restructuring measures, if necessary, to restore the company’s financial stability.
This new focus on liquidity monitoring introduces an early warning mechanism that must be taken seriously, particularly for startups. While this obligation emphasizes the importance of monitoring, it does not impose new duties beyond the board’s existing obligation to continuously oversee the financial condition and take corrective actions when needed.
2. Capital Loss
Capital loss is defined in Article 725a CO. It occurs when the company’s net assets, as shown in the most recent financial statements, fall below 50% of the share capital and legal reserves. The legal reserves include statutory capital reserves and statutory retained earnings and are considered only up to 50% of the share capital (per Article 671(2) CO).
Board’s Obligations in Case of Capital Loss
- Mitigate the capital loss by taking corrective measures.
- If restructuring measures require shareholder approval, a general meeting must be convened.
- Before the general meeting approves the annual financial statements, they must undergo a limited audit by a certified auditor.
Failure to conduct this audit renders shareholder resolutions approving the annual and consolidated financial statements and the appropriation of profits void (per Article 731(3) CO).
3. Over-Indebtedness (Article 725b CO)
If there is a reasonable concern that the company’s liabilities exceed its assets (over-indebtedness), the board must immediately prepare interim financial statements (including a balance sheet, income statement, and notes) at both going-concern and liquidation values.
- If going-concern assumptions hold and the interim financial statements prepared on this basis show no over-indebtedness, the preparation of liquidation-value statements can be waived.
- If the going-concern assumption is no longer valid, only the liquidation-value financial statements are needed.
The interim financial statements must be reviewed by the auditor or a certified auditor if no formal auditor exists. If over-indebtedness is confirmed in both statements, the board must notify the court immediately.
The board can avoid notifying the court if creditors agree to subordinate their claims (including interest) to all other liabilities through a debt subordination agreement. Additionally, the notification can be delayed if promising restructuring measures are implemented (so-called silent restructuring). From the moment the interim financial statements are approved, the board has 90 days to execute the restructuring.
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What Should a Startup’s Board Consider During Financially Challenging Times?
1. Liquidity Planning and Payment Control
The board is strongly advised to review and adjust liquidity planning continuously. This involves not only monitoring liquidity but also developing a strategic plan to ensure long-term solvency. In difficult times, the board should also closely monitor all payments to creditors. It must carefully follow the rules governing preferential treatment of creditors or creditor detriment under Articles 287 et seq. DEBA (Debt Enforcement and Bankruptcy Act).
This oversight will help the board demonstrate to auditors, if needed, that the company can continue to prepare financial statements on a going-concern basis and avoid liquidation accounting.
2. Investor Communication
Since restructuring for startups often involves new financing rounds, the board should maintain close communication with investors. Typically, a general meeting is required to approve such financing measures. Timely communication ensures that the board can quickly convene a general meeting to obtain the necessary approvals.
3. Additional Board Meetings and Documentation of Decision-Making
The board should meet more frequently during challenging times to assess the financial situation and discuss restructuring measures. It is important to document the deliberation process in detail, including an analysis of the risks and opportunities associated with different options.
A mere resolution protocol is not recommended. To prepare for any potential liability claims, the board should document the reasoning behind each decision. This will make it easier to prove in court that decisions were made with due care and diligence.
4. Personal Liability for Tax and Social Security Obligations
While the liability risks for startup board members are generally limited, there are some critical areas of concern. Startups typically have few employees with short notice periods, and large liabilities are rare (aside from subordinated loans from investors).
However, board members can be held personally liable for unpaid taxes and social security contributions. According to Article 52 AHVG, the board is liable for unpaid AHV contributions. Similarly, Article 55(1) DBG and Article 15 VStG impose liability for withholding tax obligations. Additionally, Article 15 VAT Act introduces potential liability for outstanding VAT in the event of liquidation.
In summary, managing a startup’s board during financially challenging times requires proactive liquidity monitoring, frequent communication with investors, rigorous decision documentation, and a keen awareness of personal liability risks. Adhering to these principles will help the board navigate the complexities of financial distress while minimizing legal risks.
