How To Save Your Company

The COVID-19 pandemic has had a devastative impact on American businesses. Such household names as Brooks Brothers, Ruby Tuesday, and J.C. Penney Co. have declared bankruptcy and closed their doors forever. 

The pandemic is having a greater impact on small businesses because they lack the financial resources to weather an extended economic downturn. At the early stages of the pandemic, the government provided financial assistance in the form of grants and low-interest loans. As the pandemic has lagged on, additional government assistance has been minimal. This has left many small businesses with few options. The options facing small businesses are: continue to struggle, in most cases, with reduced sales, layoff workers, or declare bankruptcy.

It’s the companies that have chosen option 3, bankruptcy, that I want to spend the remaining time discussing. In declaring bankruptcy a business has two options. The first option is in Chapter 7. In Chapter 7 bankruptcy, the business owner loses control of the company. The Bankruptcy Court appoints a trustee to determine if it is best to sell the business as a whole or break it up to sell the business assets to satisfy the business creditors.  

A Chapter 11 bankruptcy enables the owner to maintain control of the company while negotiating a reorganization of the company. The other important distinction is that if it is a corporation only the business liabilities and assets are included in the bankruptcy. In the case of a sole proprietorship, both business and personal assets and liabilities of the business owner are included. 

Prior to a company entering a Chapter 11 bankruptcy, they can obtain Debtor-In-Possession (DIP) financing. One type of DIP financing is a priming loan. The proceeds of this financing can only be used to maintain the operations of the business ie: payroll, inventory, and the upkeep of the business’ facilities. A priming loan must first meet the approval of the bankrupt company’s existing creditors. The priming loan lender will be taking on additional risk, by lending to a bankrupt company. The courts afford the lender additional protection for the additional risk. Such protections include first priority to pre-bankruptcy secured lenders and first priority to the debtor's inventory, receivables, and cash. An inducement for the pre-bankruptcy creditor to agree to the DIP financing may be a requirement for the bankrupt company to make payments on their existing debt.

Advantage of DIP Financing.

The primary advantage to the DIP financing, it allows the business cash to continue operations while going through a reorganization process. This will also increase the possibility of the pre-bankruptcy creditors being paid. 

Once the reorganization is completed, the business owner will be able to maintain control of the company. 

DIP Financing is short term financing allowing the business to emerge from a reorganization with less debt than it entered the bankruptcy. 

The Disadvantage of DIP Financing. 

The business owner no longer is the sole decision-maker for the business. The bankruptcy court now will have a say in the operations of the business.