16th February 2024

Ethics or Bust: Tech’s Insolvency Spike Reveals a Costly Moral Dilemma

In today’s software development industry, small businesses often operate on a foundation of trust, collaboration, and mutual respect. These principles are not just niceties; they are essential for survival in today’s market. Yet recent events have forced us to confront a troubling reality: the façade of virtue that sometimes masks unethical behaviour in our sector.

Free money

Data reveals a worrying trend: corporate failures are on the rise, with digital agencies particularly vulnerable. According to the Insolvency Service, in the first quarter of 2023 alone, there was a 17% increase in the number of digital agencies entering insolvency procedures compared to the previous year. This upswing reflects the demise of the quintessential agencies of the 2000s and 2010s, agencies that could have been the real-world counterparts to the satirical ‘Perfect Curve’ from the BBC series W1A.

Those were the days of Instagram-able central-London offices with beanbags, table tennis brainstorming sessions and fish-tank meeting pods.

Yet, in these monuments to excess, the writing has been on the wall for some time. The era of ‘free money’ — fuelled by the days of venture capital largesse and rock-bottom interest rates, and the ‘growth at all costs’ mantra — is undeniably over. In this new economic reality, it is the lean, mean, hyper-automated, ultra-efficient enterprises who will survive and thrive.

Wrongful or fraudulent?

Economic hardship can befall any business without necessarily being the fault of its directors. However, when a company’s insolvency is cloaked in deception, through negligence or deliberate misrepresentation, it crosses into the realm of wrongful trading. This can leave directors personally liable for the company’s debts. Worse yet, if it’s found that there was deliberate dishonesty, directors could face charges of fraudulent trading, a criminal offence.

Not all sectors operate under the same level of financial scrutiny. As suppliers to the UK public sector, we are required to maintain a positive asset position, ensuring our eligibility to bid for contracts. This process involves submitting an up-to-date balance sheet along with most bids, which provides a transparent view of our financial health to potential clients at any given time.

Conversely, companies that supply solely to the private sector are not subject to the same scrutiny – submitting accounts to Companies House just once annually. These filings can be as much as nine months out of date (or sometimes more), even at the time of submission, which can make the true financial state of a business fairly opaque or even downright misleading.

Our story

Our cautionary tale began with an agency with whom we had a subcontracting relationship. The company’s website and social media posts made them seem like a paragon of integrity. Unfortunately, in this case, looks (and LinkedIn) were deceiving.

From the start of the engagement, the true reality of the situation started to become clear: poorly trained staff, projects languishing well past deadlines, and a general sense of disarray.

It became rapidly apparent that our role was not just to supplement their workforce but to rescue projects from the brink of total collapse. We were tasked with salvaging at least three critical projects that were essential to their portfolio. Within a matter of weeks, we were able to bring things back on track, and received glowing feedback from the client.

We had, to use their words, “saved their bacon”.

The client had insisted on monthly invoices with 30-day payment terms, and only after completion of the project did the first invoice go overdue. This isn’t unusual – late payment is an unfortunate reality in all service sectors, but after repeated assurances that they were “working on the problem” and that our invoices would “go into the next payment run”, the alarm bells started to ring.

After engaging debt recovery specialists with no success, we were approached by a new company—suspiciously similar in shareholding to our debtor—informing us that the original agency had gone into liquidation, that they had taken over all of their end-client contracts and suggesting we liaise with liquidators for our dues.

The tone was somewhat sympathetic, and it included a promise to make a percentage payment at some unknown future date, along with an offer of personal support in recommending our services to other potential clients.

Alas, so far no such payment or support has been forthcoming.

The liquidators shortly published the old company’s statement of affairs, which exposed the entire group’s debts of nearly £2 million, on an asset base of only a few thousand.

Lesson learned

We learned a harsh lesson: due diligence is a continuous, critical practice, not just an item on a checklist. It has strengthened our resolve to look deeper than surface-level assurances and ensure that the values expressed by our partners are genuine.

In the end we were fortunate to be in a position where we had the reserves to absorb the loss, but we know of other creditors of the same company who were not so lucky – individual contractors who were left out of pocket, unable to pay living expenses, while the company in question was able simply to write off the debt, take credit from their clients for the work done by the subcontractors they never paid, and continue trading under the same name as if nothing had happened.

Today, the only visible difference is a one-word change to the company name in the copyright notice on their website, reflecting the new “phoenix” company that has taken over the business.

In light of this, we (humbly) offer some advice:

To suppliers and subcontractors:

• Trust actions over words: Past behaviour is the best predictor of future actions.
• Insist on payment in advance, especially for new clients, to mitigate the risk of non-payment.
• Perform thorough credit checks on potential clients and tailor your payment terms accordingly to their financial stability. (Lloyds Finance Manager offers a free company credit checking service).
• Maintain a diversified client portfolio to reduce the risk associated with any single client’s potential default.
• Continually monitor the financial health of your clients, not just at the start of a business relationship but as an ongoing process.
• Implement a strict follow-up process for late payments, including a structured sequence of reminders, calls, and formal notices.
• Check companies house – look for warning signs: delayed filing of accounts, multiple director resignations, multiple floating charges registered against the company’s assets.
• Don’t just check the entity you are dealing with currently, but any previous companies managed by the same directors – has the management got a track record of liquidating companies and moving on?
• LinkedIn can be your friend in joining the dots here – Companies House sometimes registers the same person twice as a director for different companies, and doesn’t always automatically connect them.

To buyers:

• Check your contract carefully – ensure it doesn’t give the supplier the right to simply transfer (“novate”) your contract to another company without your consent.
• Understand the financial health of your suppliers to safeguard your supply chain from any potential disruptions due to their financial instability.
• Require transparency from your suppliers about their own subcontractors to ensure they uphold the same standards you expect.
• Seek references or case studies from potential suppliers to assess their track record.
• Negotiate the right to audit the supplier’s work periodically to ensure that contractual obligations are being met.

To our peers in the industry, we hope this serves as a useful warning: in times where online and social media appearances can deceive, govern your partnerships with scrutiny. Investigate, validate, and protect your business.

PS: In an ironic twist that seems almost too bizarre to be true, the director of the original agency that failed to manage their own affairs is now running a consultancy service for other agencies! They can be found at various speaking engagements, offering advice on how to run a digital agency. It seems there’s no shortage of lessons they’re willing to share (learned at the expense of their suppliers and clients). One can only hope that these new teachings are taken with a healthy dose of scepticism and a few minutes of research on Companies House.