Question 1

When is a startup considered to be distressed?

Accepted Answer

A startup can be considered distressed when cash flow forecasts indicate that it will not be possible to meet payment obligations in the coming months and there is no guarantee of new funding. Unlike traditional enterprises, startups can operate for prolonged periods with planned losses, which makes it difficult to pinpoint the exact moment when the situation shifts from a growth issue to a solvency crisis.

The clearest warning sign is the exhaustion of runway without a closed financing round or one that is well advanced. When that happens, the clock starts ticking for the directors, even though many founders do not realise it. At that point, it is essential to obtain legal advice to assess the available options before they narrow.

At AGM Abogados, we work with founders from the first hint of uncertainty, before the situation deteriorates into a crisis with no solution.

Question 2

What options are available to distressed startups other than filing for insolvency?

Accepted Answer

For startups in distress, there are several alternatives that can usually be explored before filing for insolvency: negotiating a restructuring plan with creditors and investors, raising emergency liquidity through a down round or a debt-to-equity conversion, selling some or all the distressed business in an M&A transaction, or transferring key assets or business units.

There are also preventive instruments available under Spanish insolvency law – such as informing the court of negotiations – which allow the startup to gain time and protect against enforcement orders while an out-of-court solution is negotiated. This is an extremely useful tool that many founders do not know about and that can completely change the course of negotiations with creditors.

Question 3

What happens with investors (venture capital, business angels) when a startup enters insolvency proceedings?

Accepted Answer

In insolvency proceedings, investors holding equity stakes in the startup – venture capital funds, business angels, and family offices – are treated as shareholders rather than creditors. This means they rank behind virtually all of the company’s creditors in the repayment order of priority, and in most startup insolvencies recovery is minimal or non-existent.

The situation gets more complicated when there are outstanding convertible notes, SAFEs, or unconverted participating loans, since these instruments can be considered debt until the conversion takes place, thus changing the holder’s position in the insolvency ranking. Liquidation preference clauses in shareholder agreements can affect the order of recovery in the event of a sale or liquidation.

The good news is that structuring these discussions properly before entering a formal process can protect both founders and investors. The time to do so is before the court takes over.

Question 4

What liability do the directors of a startup have in an insolvency situation?

Accepted Answer

The directors of a startup have a legal obligation to file for insolvency proceedings within two months of the date on which they became aware, or should reasonably have become aware, of the insolvency situation. Failure to do so may result in personal liability for debts incurred from that point onwards, meaning that, in practice, the founder’s personal assets could become exposed.

In addition, if insolvency is classified as culpable due to the situation having been aggravated through negligence or wilful misconduct, or as a result of breaches of certain accounting or disclosure obligations, the directors may be disqualified from acting as such for several years and ordered to cover some or all of the insolvency shortfall with their personal assets.

In the startup ecosystem, where founders are usually also directors, this can have tangible consequences that should be understood and managed from the start. If the startup also has directors’ and officers’ (D&O) liability insurance in place, it is advisable to verify whether it covers defence costs in this scenario – in many cases it does – and to implement the policy properly from the beginning of the process, as this can make a considerable difference in terms of both costs and outcomes.

Question 5

What is a distressed M&A process, and when is it the best option for a distressed startup?

Accepted Answer

A distressed M&A process refers to the sale of a financially troubled enterprise or its assets. In the context of startups, this can involve the sale of the entire company, the sale of a business line or product, or the transfer of key assets such as technology, intellectual property, or customer portfolios, either as part of or separate from formal insolvency proceedings.

It is often the most appropriate option when the business itself retains real value, but its debt structure or lack of liquidity makes continued independent operation unsustainable. When properly executed, a distressed M&A transaction can maximise recoveries for investors and creditors, while in many cases preserving jobs and ensuring the continuity of the product or business under a new structure.

The key lies in timing and legal execution. At AGM Abogados, our insolvency expertise combined with extensive experience in corporate transactions enables us to execute these deals with the speed and legal certainty that crisis situations demand.

Question 6

When is the right time to talk to a specialised lawyer?

Accepted Answer

Earlier than most founders think. One of the most common mistakes we see at AGM Abogados is founders who contact us when there is already limited room for action: the runway is exhausted; investors are not interested in another round; and creditors are starting to apply pressure. At that point, we can still help, but the options are much more limited than they would have been two or three months before.

The right time is when there are fewer than six months of runway left and there’s no advanced funding round, or when it becomes evident that the enterprise will not be able to meet its relevant payment commitments in the coming months. At that point, it is still possible to negotiate with creditors from an orderly position, have enough time to explore sale options, use the preventive mechanisms afforded under insolvency law, and shield directors from personal liability.

An initial conversation with a specialist does not imply any commitment or the need for an immediate decision. Instead, it provides a realistic picture of the available options, together with timelines and consequences. And that, in and of itself, is well worth it.

Question 7

What happens to the team when a startup becomes distressed?

Accepted Answer

This is the question that weighs most heavily on founders, and one of the least openly discussed. The honest answer is that much depends on how the process is managed: good management makes a real difference for teams.

In an insolvency situation, employees are preferential creditors. Subject to certain limitations, outstanding salaries, severance payments, and social security contributions take priority over most ordinary unsecured debt. Moreover, FOGASA (the Spanish Wage Guarantee Fund) acts as a safety net for certain amounts in cases of corporate insolvency. This does not remove the human impact, but it does provide a degree of legal protection that should be understood and communicated to the team at the appropriate time.

If there is a business unit with genuine value, it can be transferred as a going concern to a new owner, either as part of or separate from formal insolvency proceedings, preserving employment contracts and operational continuity. This mechanism, increasingly used in distressed M&A transactions within the startup ecosystem, allows the business to survive under a new structure even if the original company ultimately enters liquidation.

Transparency with the team, compliance with employment obligations and orderly management of the process also help protect founders against potential future claims. Managing the situation properly from the start is not only the right thing to do, but also the smartest approach.

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Frequently Asked Questions about distressed startups

Corporate debt refinancing processes

Distressed M&A

Buying and selling production units in insolvency proceedings

Tax

Employment and Labour Law

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