We receive calls every day from distressed companies that are running out of money and don't know what to do. It's a hard discussion if you've never been in this situation, but it is important to understand that not every situation is the same, and different options are available, depending on the goal. One thing that is always the same? Time is money, so you need to move fast.
When time is of the essence and limited funds are available, there are three basic choices for distressed companies. You can shut down, sell quickly or restructure.
Before you weigh your options, think about your goals for the future. Do you want to maximize your company's value? Create an opportunity for your employees to keep working? Build a transition/soft landing for your technology and intellectual property? Each strategy is better at achieving different goals, so you need to figure out your priorities first.
To execute on any of the three strategies, distressed companies with diminishing funds utilize four tools: (1) restructuring debt, (2) a managed wind-down/liquidation, (3) a general assignment for the benefit of creditors (ABC), or (4) a bankruptcy.
The right choice depends on your goals and current financial position. It's also important to consider all of the tools to make an informed decision. Keep in mind that advisors who specialize in one area tend to promote their specialty, so bankruptcy lawyers will encourage bankruptcy, ABC specialists will recommend ABC, etc. To get an unbiased recommendation, it helps to work with a firm that offers all four of the options:
Debt restructuring makes sense if you think your company could survive if you change the terms on your outstanding debts—like moving to interest-only payments for a period of time. You hire a professional to go over your current debts and renegotiate the terms with your creditors, so you can avoid going into a bankruptcy or an ABC, where they might end up receiving less. You also avoid the hassles and costs of a court process.
Restructuring debt gives you the flexibility to negotiate different types of terms with different creditors. For example, you can offer a key supplier terms that align with your go-forward plan (e.g. payment over time), while offering a different payout to another vendor you don't plan to work with again (e.g. lower payout now). In a bankruptcy or an ABC, you don't have this flexibility and need to treat creditors equally—for example, everyone gets 50 cents on the dollar today for the settlement.
For debt restructuring to be a viable option, you must have something positive to bring creditors to the table. For example, you will be getting new funding to make a lump settlement, but it is contingent on getting liabilities down, or you have a major project coming up, so you can start making debt payments again later. If you can't show creditors that they will be better off, they won't have an incentive to negotiate.
You can use a managed wind-down if you'd like to shut down your business and can pay off all your existing debts. Either you have enough cash on hand or you will after you sell some assets. With this approach, you don't go through a formal or court process. You just pay off your creditors. Once that's complete, you enter a formal dissolution to end the business.
A managed wind-down is not as simple as it seems. So it's still best to have a professional oversee the process, because they can handle everything more quickly and efficiently, including following up with state and federal authorities. Your advisor will know exactly what documents need to be filed for the dissolution, what final returns need to be put together, what licenses need to be cancelled, etc. They'll also watch out for the kinds of problems, like contingent liabilities, that could get you in trouble post-dissolution.
An ABC is a state-level process, similar to a federal bankruptcy: An insolvent company liquidates their remaining assets to pay off creditors. However, it has several key differences.
First, an ABC is often less expensive. The process is dictated by state law, but in the roughly 35 states with established ABC laws, you will likely pay five to 10 times less by going through ABC versus a Chapter 11 bankruptcy. The ABC process also gives you more control, because you get to choose an assignee. This person manages your remaining assets and figures out how to monetize everything to pay off the creditors. As a result, you can pick someone who understands your industry and can maximize your value during the insolvency. With Chapter 7 bankruptcy, the courts pick a trustee to handle everything, and this person may not know anything about your business.
It's also easier for the ABC assignee to sell assets. You can market assets before the ABC and sell them right away to free up some cash as you go through the process. With bankruptcy, you have to get court approval to sell assets, which can take months.
The downside of an ABC is that every state has different rules, and some are better designed than others. (California and Delaware are two of the best.) Also, you need approval of the shareholders to go into an ABC and the secured creditors to sell their collateral. If they don't support this move, you cannot proceed.
There are two types of bankruptcy for businesses. Under Chapter 7, you shut down the business and a panel trustee is appointed to eventually pay off your creditors out of your remaining assets. Under Chapter 11, you need to develop a plan—that creditors will agree to—to renegotiate payments on your debts and keep your business running, or sell the assets through an extended auction-type process. Chapter 7 might be your only option if you don't have the funds to wind down or restructure your debt and your creditors/shareholders won't accept an ABC, but creditors typically get little.
There are also situations when a bankruptcy can work out better. If you have a larger, complicated business, having a court available may allow you to force agreement. If you have multiple leases, bankruptcy gives you the ability to get around the contract terms to reassign the lease—allowing you to sublet to another tenant. In an ABC, you still need to follow the language of the lease, which could restrict your ability to assign it. And if you have a complex debt structure with different classes of bonds, bankruptcy can force a modification to different payment terms, whereas ABCs cannot.
The best choice often depends on the size of the firm. ABCs usually make more sense for lower and middle market companies worth less than $50 million. Bankruptcy makes more sense for larger organizations, especially if they have multiple leases or a more complicated debt structure.
For all of these strategies, the earlier distressed companies start planning, the better. If you meet with a professional as soon as you start running into trouble, you keep your options open. If you wait too long and don't have the cash to negotiate for a debt restructuring or plan a managed wind-down, distressed companies might have no other choice than to enter an ABC with no plan, or declare Chapter 7 bankruptcy and shut down.
Find more helpful insights for financially distressed companies from Armanino's Restructuring team."
