What are my options if my business is running out of money and can’t pay its debts?

Is your business about to run out of money and can’t pay your debts? This is unfamiliar territory for most business owners. But depending on the situation and your goals, there may be something you can do. No two cases are the same. It’s most important to remember that delaying is costly, so act quickly.

When a small business is short on time and short on cash, the options are often few and are largely dictated by the owner’s motivation and ability to close, sell fast, or restructure.

Choosing a tactic before deciding your priorities can work against you. Decide what you want to get out of it. Do you want to maximize your asset value, keep your employees in work, or find a soft landing for your technology or IP? Your strategy will be different for each.

Four Strategies

In order to execute on any of these, four strategies could be used: restructuring the company’s debt, a managed wind-down or liquidation, an assignment for the benefit of creditors (ABC), or bankruptcy.

The choice of which insolvency tool to use depends on both goals and finance. While all tools in the toy box have their uses, it’s important to review all of them before choosing because one solution is only ever as good as its next best alternative. Advisors tend to favor tools based on what they are familiar with, so lawyers (such as bankruptcy lawyers) tend to favor what they know best (bankruptcy). Similarly, an ABC specialist will often push the ABC; make sure to get a view across all four tools before you decide. The next few sections break down each option one by one.

Restructuring debt is a consideration if new terms could allow the business to survive. In this case, a skilled professional is hired to review the company’s debts and renegotiate with its creditors, who might end up taking less in bankruptcy or in an ABC. New terms also often avoid court costs and could, for example, be a short period of paying interest only.

A restructuring is flexible and can offer, for example, a key vendor a few months to get paid, while offering a one-off supplier less now. The flexibility available in a restructuring is one of the major advantages it offers because when a formal process such as bankruptcy or ABC is involved, all vendors must be treated the same, as 50 cents on the dollar, for example.

Restructuring only works if there is something the business can put on the table as an incentive to get its creditors to agree to a deal. For any restructuring to succeed, the creditors who sign the deal must see that they would be better off than they would if the company filed bankruptcy or an ABC. For example, if new funding is on the way for the company or if the business is about to land a large project, the restructuring gives the creditor an incentive to take a lump-sum deal in exchange. Otherwise, they won’t play.

A managed wind-down is an orderly way to close shop when a business can cover its debts, whether with cash in hand or by selling assets to cover what is owed. There is no court or other formal process. Instead, creditors are paid and the company is formally dissolved.

Dissolving a business sounds easier than it looks. It is best left in the hands of a professional to handle. There is a lot more to do than just filing dissolution documents with the state. Come tax time, final tax returns must be filed, and then licenses cancelled. A professional will also follow-up with both federal and state agencies, not to mention any contingent liabilities that could surprise an owner, even after dissolving. Where owners get tripped up in doing something like this is trying to do it themselves. A professional has the checklist and, more importantly, can see the risks coming from a mile away.

A State-level Cousin of Federal Bankruptcy

An ABC is a state-level cousin of federal bankruptcy, where an insolvent company liquidates what is left to pay its creditors. But there are some key differences.

About 35 states have an assignment statute. Depending on the state, an ABC can cost 5 to 10 times less than a Chapter 11. An ABC also gives you the chance to choose who will be the assignee, whereas in Chapter 7, the trustee is chosen by the court. He or she may not know anything about your business or industry. In an ABC, you are able to choose someone who does. You can also pull more levers, creating more value. The opportunity to choose an assignee who understands the business and knows what to do to create value, as opposed to someone who hasn’t a clue what she is doing, can’t be understated. For an owner that wants to have control over how their company goes out of business, the draw of an ABC is having that say, along with the cost.

It’s easier to sell an asset in an ABC. During an assignment, assets can be marketed pre-assignment, and they can even be sold as soon as the assignment is filed. During a Chapter 7, a sale is subject to court approval, which can take months.

An ABC’s main downsides are that the rules can change depending on the state and some are better than others (like California and Delaware); that the shareholders must approve the ABC; and that the secured creditor will have to approve the sale of their collateral, and if there is no support, there is no ABC. So before signing on to an ABC, know your state’s rules and get your shareholders and secured lender on board early.

Chapter 7 or Chapter 11

Businesses filing bankruptcy have two main choices, Chapter 7 or Chapter 11. In Chapter 7, the company goes out of business. An impartial trustee from a court panel will be appointed to close the business. She will liquidate any assets that are left and pay creditors whatever she can raise. Usually creditors get little, and they know it. It may be a last resort. In a Chapter 11, a company negotiates a plan with creditors to run its business, or sell assets in an extended auction.

Sometimes bankruptcy works better than an ABC, particularly with complex companies. In some cases, for example, the court may be able to force a result. In a bankruptcy, it is possible to reassign leases, despite the language in the lease. As an example, a debtor may have a lease and while the lease forbids assignment, in a bankruptcy, the court could assign the lease anyway, regardless of what the lease says. In an ABC, if the lease says no, there can be no assignment of the lease. In another example, bankruptcy may be able to force new payment terms on different classes of bonds, which an ABC cannot.

What is the cut-off? Often a firm’s size. For small and mid-sized companies valued at less than $50 million, an ABC can be the best alternative; for larger companies, particularly those with numerous leases or complex debt, bankruptcy is often the better choice.

The earlier the better. The earlier a company addresses the issue, the more tools are still on the table. When running short on time and money, some, like restructuring and wind-down, require time and money, which may put them off limits. Talk to a professional at the first sign of trouble. Waiting too long may eliminate the option for an orderly close or a restructuring and could lead only to an unplanned ABC or Chapter 7.