Selling Your Distressed Business

November 11 2020 | 4 Min Read Time

Michael Poole

E: mpoole@pcecompanies.com

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Selling a distressed business is challenging. Buyers are wary of purchasing an underperforming company, and sellers are unlikely to see a purchase price high enough to pay all the creditors. Owners of a distressed business have many paths out of this situation, but although the journey is different, the destination is the same. The choices all come down to one thing: making the best of a bad situation.

When selling a distressed company, owners’ goals typically include maximizing the speed of the transaction, minimizing losses to their creditors, preserving continuing operations, and eliminating their liabilities. Some of these goals may conflict with each other, so compromise is required.

We recommend that owners stay in control of the distressed sale process and avoid any practices that hand the power of decision-making to a third party. Unless there are proven improprieties or an owner just does not want to be bothered, retaining control over the process usually can be achieved.

In choosing the best path for selling, the owner should first answer an important question: Is there a viable business to save? In a distressed business, operations are often burdened by debt and a lack of working capital, and the path back to positive cash flow may be too long to remain in business. If the company is not viable, the discussion turns to a different approach: the best way to liquidate the company assets.

Liquidation vs Bankruptcy

Closing a company is the most difficult decision an owner can make. The emotional strain is enormous. However, it is also the quickest way to physically distance yourself from a failing business. Bankruptcy is one option, most likely achieved through a Chapter 7 filing in federal court, like approximately 64% of all bankruptcies. A liquidation may be a better choice in some scenarios, however, and can be achieved through an Assignment for the Benefit of Creditors, or “ABC,” which occurs in state court instead. Both strategies involve an independent person taking control of both the company and the liquidation process.

Article 9 of the Uniform Commercial Code offers another court liquidation process. This process, which is essentially a transaction between your lender and a buyer of the company’s assets, is practical when your lender has a lien on substantially all the assets of the company.

You can also liquidate the company yourself, outside of any of these court proceedings. Your success when following this strategy, however, will depend on the cooperation of creditors and lenders.

Each of these liquidation strategies comes with its own pluses and minuses. The best option for your distressed business will depend on your specific situation. Lean on your advisors to help you understand the options and how each would impact both you and the company.

Selling your company while in financial crisis is difficult. Buyers are reluctant to buy distressed assets of a company without ensuring that those assets are free and clear of all liens and claims. For that reason, some owners instead choose bankruptcy to accomplish a sale. Bankruptcy is like hitting the pause button. The court process allows you to regroup and pursue an organized sale.

Buyers typically prefer to purchase a financially distressed company in bankruptcy in a “363” sale, where the assets are acquired free and clear of all liabilities and creditor claims. At times when leases and contracts cannot be assumed without approval of the other party to the agreement, the cash proceeds are dispersed to creditors after the sale occurs, through the approved reorganization plan.

Another tactic is to sell your company while retaining the existing corporate entity. In this approach, the existing shares are retired and new shares are issued to the buyer. This type of sale takes longer, because the sale is a required part of the approved reorganization plan, but offers benefits to the buyer – such as easier-to-retain leases and agreements, and tax benefits that include the use of net operating losses.

Choosing Bankruptcy to Reorganize

Reorganizing in bankruptcy through a Chapter 11 filing is your opportunity to restart your company and create a strong financial foundation for the future. This is not an easy path. Although many companies attempt to file Chapter 11, most do not complete the journey; studies have shown that only 10% to 15% of such companies are successfully reorganized. The rest either are sold or revert to liquidation, although this does not necessarily mean the reorganization was a failure, as sometimes Chapter 11 is the best way to liquidate or sell the company.

The reorganization process allows all parties to the bankruptcy – equity holders, lenders, and vendors –to have a voice in the reorganization. Once you elect the Chapter 11 filing, you become the “debtor-in-possession” (DIP). The DIP manages the company, files the appropriate reports, and creates the plan for reorganization. The reorganization plan is accompanied by a disclosure statement, which provides information that will assist creditors in determining how to vote on the reorganization plan. The court typically will need to approve the disclosure statement before allowing creditors to vote.

The reorganization plan needs to be approved within 120 days (six months) unless the court allows an extension. If the DIP has not filed a plan within 18 months, the creditors can file a competing plan. In a Chapter 11 filing, creditors are categorized by “class,” with unsecured creditors in a different class from secured creditors;. The majority of creditors need to approve the plan. However, the court does have the right to approve the plan despite objection by a class of creditors.

Once the reorganization plan is approved, the company is required to follow the plan and repay creditors as agreed.

An Expensive And Lengthy Process

The Chapter 11 process is expensive and takes significant time, especially if there is friction between the DIP and the creditors. As the owner of the distressed business, you will need to ensure you have access to enough capital to get through it. Successful reorganizations occur through negotiation and require trust among all the parties. Your legal and financial advisory costs could easily be $100,000 or much more, depending on the size of the company and the time required to approve the plan.

The bankruptcy court process, and all the required proceedings associated with it, can be tedious. The DIP has up to four months to file a plan of reorganization; time is then added for creditors to review and approve the disclosure statement, and finally to vote on the plan. Added to these major milestones is the potential that parties may appeal to the court, which adds more time to the process. When estimating the costs and time required to successfully emerge from bankruptcy, you should plan for the worst and hope for the best.

As with all major business decisions, having trusted professionals close by to provide advice is critical. Most business owners have not been in this type of major crisis before, so stress is at the maximum level. Reach out to your advisors for help.