The big consolidation loan was turned down. The important thing is to recognize that the denial of consolidation is not the beginning of the end. Your first instinct may be to file for Chapter 11 bankruptcy, but before you throw up your hands, remember that a bankruptcy is always a last resort. A sale or out-of-court restructuring might actually get everyone - creditors, owners, employees - more money for less pain. And you have to think about the image problem, too. A bankruptcy filing carries a heavy cloud of negative publicity that can make a turnaround even harder to pull off.
This is how a typical small company gets in trouble, regardless of what industry they’re in. There’s a lender with a line of credit against receivables and inventory and equipment. There are trade creditors. Maybe a landlord and equipment lessors too. The bank loan might be current or just a payment or two late, but the covenants are violated and trade payments are late.
Keep the Lights on and Try to Restructure
The first major decision is whether you should keep the lights on and try to restructure or if you should shut it down and liquidate. That depends on whether there is still demand for your product or service. If the market is gone, then you’ll probably want to liquidate. You can sell your business as a going concern - perhaps to a competitor - or you can just shut it down immediately, whichever yields a better return for your assets. Whichever path you choose, bring in a turnaround consultant. An independent expert gives you street cred when you go to your creditors and negotiate.
You might be wondering why you’re supposed to squeeze every last penny from these assets. Here’s the thing: many owners had to sign personal guarantees when they got loans, so they are fully motivated to get the best value. Most just want the best outcome for everybody. The business also has to run close to break-even for at least 90 days if it’s going to be sold as a going concern. Otherwise, it has to close up shop.
If you’ve got a business that actually has demand and can manage to run close to break-even, you can draft a two-part business plan. The first part is just about surviving the immediate cash crunch: generating enough revenue to cover payroll and taxes, rent and utilities, and any critical supplies or transportation costs. This will mean, for now, limiting payments on overdue loans, leases and trade debt. It’ll also mean reducing headcount and other expenses. Your plan will need current and future balance sheets, income statements and cash flow projections.
Different Categories of Creditors
The bank is your most important relationship here. It holds a lien on your assets and can foreclose. The biggest mistake you can make is trying to hide the crisis from your bank. Go in the door, admit you’re in trouble, and show up with a plan. The scariest part for owners is the fear that the bank will immediately take back their collateral. That almost never happens. Banks don’t want to own your assets either. Bankers respect the honesty and have seen companies go through similar challenges. Bring your turnaround consultant and your lawyer to the meeting. Better yet, call the banker first and say an attorney is coming, so they can invite their legal counsel as well.
Trust is not exactly high on a banker’s agenda following Enron and friends. I bet bankers are freaked out, worried their borrowers are skimming off the top. The trick is to volunteer total transparency: give the bank and its auditors unfettered access to the books. Now what you request is going to depend on the situation. In some cases you will just be working on waiving a technical default under a covenant. In other cases, you might be seeking a full forbearance of debt. If you are staying in business, request relief on the debt service - stop making payments altogether for some period while you get things on track, or just pay interest for a set time. If you are closing down, explain what you plan to do with the business, the cost to get it done, and how you will pay the bank from the proceeds.
Trade creditors are easier to get a break from, because typically they don’t have liens against you or the right to shut down your business. Here’s what I do: I make two lists. One list is for the vendors I really need to keep open, and the other is for the non-essential ones. I send a letter to everyone on the second list asking if they can grant a 60-day standstill. In exchange, I have to accept that they’ll stop extending any more credit to me, so I’ll have to pay COD for any future orders. The letter explains that the company is in financial distress, but details the steps we’re taking to get back on track. I attach whatever financials I can gather, and promise to reach out before the 60 days are up with either an update or a settlement proposal.
Here’s a tough pill to swallow, but you have to tell your creditors up front. If you try to hide it and they start calling for payment, your receptionist is going to say “sorry, she’s not in,” or one of the salespeople is going to promise a check by the 15th, or whatever you can come up with, and those things just make the creditor more furious when they find out. In my experience most trade creditors will agree to a standstill rather than sue. Remember, the point of all this is to avoid the costs of litigation. When a creditor sues and wins, it can force you into bankruptcy, and that defeats the whole purpose of our little dance here.
There are different categories of creditors. Some vendors are absolutely critical to the business. For those ones, you have to stay current, or at least negotiate a COD arrangement if you can’t. Other times, the biggest headache will be your equipment lessors. If you’ve got machinery or tools you no longer need, don’t just let them sit there. Give the leasing company a call and ask them to come pick it up. They might never bother, and they will keep sending you a bill every month. If the equipment is in use, keep paying as much as you can and, if you can’t, try and work out an extra few months on the payments.
Stage Two
Now we’ve reached stage two, which happens after you’ve cut costs and get the cash flow running positive again. If you’re lucky, you can now restructure or refinance your bank debt. You can use a turnaround professional to write up a pitch for refinancing to asset-based lenders, factors or investors. They’re generally more risk-tolerant than banks, so a rejection by one bank or lender isn’t the end of the world. Then go back to the trade creditors and send them a second letter offering either a discounted cash settlement if you have the funds or a larger percentage paid off over time. Most take the cash option. Ten to twenty cents on the dollar is a common settlement. If you’ve not turned around yet, go back to the bank and the vendors and ask for more time.
If you’ve decided to liquidate, you need to keep the bank updated at regular intervals. Send them progress reports on what you’re liquidating, and send similar updates to your major vendors. Some will push to be paid something right away. But if you’re already in default on a secured bank loan, any money from selling collateral assets that you pay to vendors or anyone else without the bank’s permission could be considered a crime. In Texas, it’s called “Hindering Secured Creditors” under Section 32.33 of the Texas Penal Code, and it’s a felony if the amount involved is more than $1,500. Banks almost never grant their consent. This often has the beneficial effect of making vendors think twice before hounding you for payment.
If a company has been honest and is trying to meet its obligations to creditors, an out-of-court restructuring generally works better for everyone than a bankruptcy. The creditors often get paid more and sooner. That honesty in a restructuring shows up when a company supplies any information creditors ask for and grants access to records. An experienced, independent turnaround professional increases the chances of success significantly. A single creditor that misunderstands its position can derail a restructuring by filing a lawsuit and obtaining a judgment in the hope of taking priority and gaining leverage. This is usually a mistake. A loan that won’t consolidate is not the end of the world.
