Chrysler and General Motors have done what was previously unthinkable — filed for bankruptcy. Even for your small business, there may be circumstances where bankruptcy is your best option. Chapter 11 bankruptcy protection is a tool that can be used to help a struggling company survive bad times.
Three types of measurements give a profile of a small business’ financial health, says Jack Williams, the American Bankruptcy Institute’s resident scholar and a bankruptcy professor at Georgia State University in Atlanta. These three yardsticks size up if an owner needs to reach out for help:
Income Statement. Check out your revenue. Compare the revenue you’re generating now to the revenue you were generating a year ago. Is it increasing, decreasing or static? Decreasing revenue is a bad sign. Always keep a close eye on your month-over-month and year-over-year revenue.
Cash Statement. Assess your liquidity needs and whether you’re meeting those in the short term. Your cash position is the ability to take your revenue and convert it into actual dollars. Are you able to pay your debts as they become due?
Balance Sheet. Look at the capital structure of your business. What percentage of your business’ capital can be attributed to equity, and what percentage can be attributed to debt? Even if you are able to pay debts that become due now, certain loans may be coming due in the future that would be a substantial drag on your cash flow.
“The idea is that once you see signs of financial distress, you can’t ignore them. They are not going to go away. They’re usually a symptom of a deeper concern. Businesses oftentimes recognize the signs, but they don’t do anything about it, and hope that if they just redouble their efforts, they will work themselves out of it. That usually is not the appropriate response,” says Prof. Williams, a lawyer who does a lot of pro-bono work in Atlanta’s vibrant black small business community.
For a company that is in serious financial distress, filing for Chapter 11 bankruptcy may be a reasonable option. It affords the firm protection from its creditors. It allows the firm time to reorganize itself so it can stay in business, get back on its feet and emerge stronger. But because small business owners tend to wait too long before they seek relief, bankruptcy is unsuccessful more often than it is successful, warns Williams.
The great irony is that just when a small business doesn’t have a lot of money, Chapter 11 bankruptcy relief is expensive. For a “microbusiness” with under $1 million in revenue, a bankruptcy may cost $15,000 to $25,000 — if that business is well-operated, but has too much debt. Chapter 11 fees increase for larger small businesses. Prof. Williams says typical costs for small business bankruptcies are in the $25,000 to $50,000 range, provided the financially distressed companies react to warning signals in a timely way.
Where does that money go? There are filing fees and a quarterly United States Trustee fee to be in bankruptcy, but the bulk of those fees go to attorneys and other professionals, like bankruptcy accountants.
Small business owners should consult a trusted professional when they realize their firms are in financial distress. “Almost always, the wrong call is a call to a lawyer — and I’m a lawyer,” says Prof. Williams. “They are great experts in the law, but not necessarily in running a business. What you’d want to do is bring in somebody who has the skill set to help you manage the debt and manage the business so that you can turn it around. We call those folks turn-around professionals.” Another non-lawyer professional to consult is a “restructuring adviser,” who helps assemble financial information for making meaningful decisions. Books, records, inventory systems and accounting tools that monitor revenues, cash and debt are their expertise. A CTP, a certified turnaround professional, or a CIRA, a certified insolvency and restructuring advisor, charge $200 to $400 per hour. For a small business, 40 hours of work may deliver an assessment and game plan.
Prof. Williams says that though there probably would be a market for bankruptcy insurance, he’s not
aware of such a product. Short of that, a business might keep a reserve of cash in case they need to file bankruptcy. A well-documented loan from a shareholder is sometimes used to pay for bankruptcy, and often business owners sacrifice their salaries for it.Sometimes a business bankruptcy should NOT be used. Liquidation is best — and may cost less than $5,000 — if a limited-liability company (LLC) is beyond hope of saving for continued operation. Owners hire an attorney to help liquidate the business under state law, operate a going-out-of-business sale until inventory is sold, pay what they can to creditors and move on to begin a new business as a different entity.
The stigma of bankruptcy depends largely on what is perceived to have caused it. The rare owner who is bankrupt because of sucking out too much cash for personal reasons is villainized as taking advantage of the business, his employees and the community. Stigma doesn’t stick, however, to owners who simply made bad decisions like growing an unsuccessful product line, taking on extra debt that an acquisition’s revenues can’t pay off or expanding to an unprofitable store. “In those situations, we have found that customer loyalty is strong, particularly in the black community in Atlanta,” says Prof. Williams.
That doesn’t mean that the owners don’t feel bad. “I have yet in my work in the black
community in Atlanta dealt with an owner who didn’t feel like an absolute failure for not making the business work. These are usually driven people, very passionate about what they are doing. And many of them have never failed in their adult life. What makes this particular economy different than the others in my lifetime is you’re having people that have been successful in everything that they’ve done, probably since the time they went to college, and have never fundamentally failed in anything they’ve ever done — failing in what is one of the most important and oftentimes self-defining roles in their life,” says Prof. Williams. “So I don’t think their business is tainted with the stigma, but oftentimes they’re struggling with it.”TIPS ON BANKRUPTCY
Stay on top of three financial measurements: changes in revenues, cash available for paying off expenses and debt versus equity in your capital structure.
Respond quickly to signs of financial distress.
If you need help making operational decisions based on accounting information you already have, consult a CTP, a certified turnaround professional who has credentials from the Turnaround Management Association (TMA).
If you need help compiling accounting information, consult a CIRA, a certified insolvency and restructuring advisor who has credentials from the Association of Insolvency and Restructuring Advisors (AIRA).
Consider liquidation instead of bankruptcy when the current business is beyond hope of saving.