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Why Bankruptcy and Financing Does Not Work As The Solution To A Problem

Guest post by: James Sinclair

Article Overview: When you don’t fix the core problem, neither bankruptcy nor the provision of fresh money can help, they both just delay the inevitable failure. One of OnSite’s areas of expertise is keeping clients experiencing severe difficulties out of bankruptcy through restructuring and programs to improve (or initiate, in some cases) profitability. We are often asked why we do not agree with bankruptcy and why when a bankruptcy is inevitable; we believe we need time prior to filing to prevent conversion to liquidation?

Why Bankruptcy and Financing Does Not Work As The Solution To A Problem



When you don't fix the core problem, neither bankruptcy nor the provision of fresh money can help, they both just delay the inevitable failure. One of OnSite's areas of expertise is keeping clients experiencing severe difficulties out of bankruptcy through restructuring and programs to improve (or initiate, in some cases) profitability. We are often asked why we do not agree with bankruptcy and why when a bankruptcy is inevitable; we believe we need time prior to filing to prevent conversion to liquidation?

Another surprising piece of advice we often give our clients is to stop seeking new financing until the company is ready to receive it. When a business is not profitable and cannot service current or historic debt there is no question that it is insolvent. Here it may technically be illegal for it to continue trading without filing for bankruptcy or without an infusion of cash. So why would we be so adverse to the two requirements that seem the only option for a desperate and struggling business?

For so many distressed clients we meet, they are on an eternal quest for financing. ‘If we can just get money, we can solve the problems of yesterday and expect a brighter future' and feelings to that effect. In fact many clients choose not to retain us until they have exhausted all of their contacts and network to raise funds. This is unfortunate as in reality; money does not solve the problem, in most cases: It merely delays the inevitable crisis.

Fresh money is useful if you have a business you have ‘fixed' and there is confidence that continued trading will turn the financial position around. Borrowing money to pay historic debt simply leaves you in the same position: Owing someone money but with the same poor performing business. It does not change the lack of profit or the fact the business is essentially insolvent. Too many operators are waiting for the wind to start blowing in the other direction, the next economic or calendar event that is sure to turn sales around or the fixation on the pipe dream that it can only get better (because it seemingly cannot get any worse). Not so in our view.

When your business lacks of profitability and you have high historic debt, you have a business in trouble. Core operations become strained as does management. Cash problems mean employees and owners are often working under stressful conditions which are not conducive to generating business or making the swift decisions need to restore profitability. When it rains it pours and for an insolvent business struggling to handle the day to day challenges this means less time is spent on the business and more time is spent fighting fires. This downward spiral serves to exacerbate the ultimate failure of the company.

For many, a Chapter 11 does not work solely because the man hours and actual cost of a Chapter 11 is so onerous that a business which is already experiencing severe cash issues cannot handle it. These new costs coupled with a long list of creditors do not provide the solution so many expect. In many cases, a Ch.11 is so cost prohibitive with a high retainer and the more complex the case, the higher the bankruptcy attorney is going to want upfront. We have been in many situations where we work with a company without the cash flow for a retainer and wanting an attorney on an unbundled fee agreement / limited scope representation. Here, the risk of malpractice is generally too high for a law firm to accept this type of fee proposal and we therefore have yet to see this scenario implemented

Whilst a Ch.11 seems the only option at times, it can in fact be the final nail in the coffin. The success rate of a Ch.11 is low in many instances and the risk of conversion to a Ch.7 is extremely high. Even if a business is able to support the cost of the bankruptcy, which is rare in many of the turnaround cases we see, the owner still has to convince the court and creditors that the plan of reorganization and the debt plan are viable. Arguably if you could not do it out of bankruptcy, it is doubtful that you can make a convincing case within the bankruptcy process.

Assuming through repositioning in bankruptcy and perhaps the provision of debtor in possession financing you are able to exit a Chapter 11, with the core problems still not actually fixed there is a strong chance that your business will be in the same position as soon as the cash runs out. Your business has not changed so a Chapter 22 is almost a given and serial bankruptcy never works and always leads to liquidation (Ch.7). So much so that perhaps a Chapter 22 would be more aptly named a Chapter 18. Being financed in bankruptcy even with the debt restructured is only going to cover the deficit for so long and the problems that created the first bankruptcy will return, they always do.

Creating a financially viable business and/or making the hard decisions to sell off or even close business units is a tough job - but one no owner can ignore. Fixing a business is about understanding the product, the supply chain and the customer and finding a process that allows all parties to profit. Finding a profitable model based on the existing volume is a better value proposition that racing to a break even by generating increased volume off the back of poor operations. Rather than hide over the cracks of a poorly managed business with increased volume, it would be wiser to focus on fixing underlying problems, improving operations and finding a business model that is sustainable.

As specialists, we know that throwing money at the problem doesn't fix it - it extends the life of the problem, exacerbates it and creates more debt. We are called in to fix businesses at all stages in their life cycle but in the case of very distressed businesses, call us in before things become unsustainable. If you are able to find financing, use it to bankroll a business that has a chance of succeeding - which we can help you do - instead of merely sustaining one that is likely doomed to fail. Don't get a loan to finance a loan.

Bankruptcy and financing are not solutions to a problem. They are tools to be used as part of an overall plan where these are the only viable options.

When our firm is retained we see clients through the chaos and assist them in understanding and evaluating the business and its processes. We implement the solutions required to bring about profitability and service the historic debt. Only once this has been completed and the creditors are still not willing to negotiate the debt or you have proof of a viable model should a Ch.11 or financing even be considered.

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Article Tags: conversion, profitability, restaurant bankruptcy, restaurant distressbankruptcy, restaurant financing, restaurant help, restructuring



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