Only in the United States, or so it may seem, can a struggling business on the brink of disaster use something as distressing as bankruptcy as a means of turning a business around. Bankruptcy laws favor the debtor, offering a chance to wipe the slate clean and start over by providing protection from creditors and an opportunity to make and implement a reorganization plan (with the proper guidance).
While bankruptcy can be used as a way to turn an ailing business around, it should always be a last resort. Timing is key: You should try to file for bankruptcy before creditors take you to court and force your hand.
Prior to considering this option, make sure to think long and hard about the process, which can be lengthy and stressful. Once you file for Chapter 11, you will have court protection and creditors will be kept at bay, allowing you time — typically 120 days by court order — to come up with a reorganization plan. Such a plan will need to be agreed upon by your creditors. To do this, you will work with a reorganization manager. Such a plan typically includes analyzing the problem, making changes in management, developing a strategy to bridge the time period until the business is reorganized (which often includes a need to address cash flow problems), and implementing an emergency plan. Such plans usually shrink the business in some manner, either through layoffs, the re-pricing of products or services, or even the elimination of entire departments.
It is the need for cash and the need to bridge the gap that presents the opportunity to seek Debtor-In-Possession (DIP) Financing. Such DIP financing is extended to creditors only for companies in bankruptcy. While interest rates are high, so are the risks for companies that may consider lending such money. However, like junk bonds, there can be a large payoff if the company in bankruptcy turns its act around. If there are good indications that the company can re-emerge successfully, it can be very profitable to lend to such companies, since they need money badly. Delta Airlines, because of its reputation and years of service, was able to borrow over two billion dollars from its creditors after filing Chapter 11. DIP financing came from other major companies including General Electric and American Express.
The option to file for bankruptcy, restructure, and obtain the financing necessary to bridge the gap — and as Delta might say, “fly again” — is heavily dependent on the reputation of the business and its core problems. Management changes, poor decision making, overspending, and poor planning in a down economy are correctible under new management and with scaled-down corporate spending. Delta and Northwest Airlines were both able to cut their labor and pension costs. However, if the products or services offered by the bankrupt company are simply no longer marketable or the competition is too intense to reclaim a significant market share, then neither a turnaround nor the chance of obtaining DIP financing may be possible.
It is also important to consider the impact bankruptcy will have on the reputation of your business. Companies such as Delta and Northwest Airlines have long-established histories as service providers and are still important players in the transportation industry. However, for a small business, the company’s reputation can suffer, making it very hard to rebuild and subsequently making investors less interested. Therefore, before going the bankruptcy route, the reorganization plan has to be strong and address any potential public relations fallout.