Over the last several years, companies have continued to file for bankruptcy protection at growing rates as a result of struggling markets and economic conditions. The good news is that bankruptcy can be a viable option for turning a company around if the proper time and planning is invested.
But how do you know if your company is headed for bankruptcy? Beth A. Savage, CPA, the director of financial advisory services with GBQ Consulting LLC, says there are several indicators that can put financial strain on companies and possibly lead to a bankruptcy filing.
“Significant declines in sales, trouble managing cash flow, strained relationships with vendors, and limited or no access to capital can heighten a company’s financial distress and, thus, result in a bankruptcy filing,” says Savage.
Smart Business spoke with Savage about the steps you need to take when considering a bankruptcy filing and how to prepare your company and employees for bankruptcy.
What are some key things you need to be aware of regarding bankruptcy?
First, most companies wait too long to file for Ch. 11 bankruptcy protection. Management often does not want to believe that the financial crisis is as bad as it is. This is common in every industry and in every size company. Management needs to take a true look at the company’s financial position, not what they hope it will be. This involves understanding sales forecasts, financial projections, current cash position of the company, and what access to additional capital the company has, including refinancing options to improve liquidity. The challenge is that the further a company goes down the path of financial decline, typically, the fewer the options.
It would be the equivalent of someone spending all the money in their checking and savings and then liquidating all other assets including 401(k), and then saying, OK, now I need help. The time to do it is when you still have some options and financing opportunities available. In fact, bankruptcy is only one of the options that a company can utilize for a successful turnaround. Today, we see less true Ch. 11 turnarounds than in the past; instead many Ch. 11 filings ultimately involve a sale, potentially a Section 363 transaction selling the company or certain assets of the company. A new surviving entity is created from the sale of assets and then the remaining components of the business are liquidated, often through the creation of a Liquidating Trust. Other business turnaround options include an out-of-court restructuring plan that could involve a refinancing, possibly tied to selling certain subsidiary companies or divesting certain operations to streamline the business.
What is involved with filing for bankruptcy?
Management should contact an attorney who is familiar with corporate bankruptcy proceedings, as well as a financial adviser, as soon as possible. An attorney and a financial adviser can advise the company on its options and what makes sense for the business.
A Ch. 11 filing typically allows the company (referred to as ‘Debtor in Possession’) to do the following to restructure its business operations, which are true advantages to filing:
- Negotiate and acquire financing/loans on more favorable terms.
- Reject certain leases and cancel business contracts. Debtors in Possession are protected from other litigation against the business through an automatic stay.
- Vendors that continue to do business with companies operating in bankruptcy have more assurance that they will be paid for their post-petition goods and services than if they continued to do business with the company without the Ch. 11 filing.
How do you prepare your company and employees for bankruptcy?
There’s a lot of work that has to be done behind the scenes. The communication strategy is absolutely critical to the success of the turnaround. Management should communicate expectations and timelines to employees, business partners, vendors and others with the intent being to clearly explain how the filing is most likely to affect them. In most cases, it’s also helpful to explain the reason why you’re taking this step to file — so you can restructure the company and return the business to financial health. That’s the most important thing to emphasize.
What preparations can you make to get the company out of bankruptcy in the future?
When companies begin to see a significant decline in financial performance, one of the challenges is that this information may not be coming quickly enough for management to react. More erosion of the business can occur before management reacts. Accurate and real-time management reporting and a good business plan are paramount for the financial improvement of the company.
What are the risks and benefits associated with filing for bankruptcy?
Bankruptcy still has a certain stigma to it, but, in reality, when handled professionally and executed with good information, a Ch. 11 bankruptcy filing can be the best thing to enable the company to turn around. It just depends on the factors that are involved with the business. It also depends on the marketplace. Some business models are just not going to succeed no matter what turnaround they attempt.
Beth A. Savage, CPA, is the director of financial advisory services at GBQ Consulting LLC. Reach her at email@example.com or (614) 947-5297.