Amid a global recession, which has been exacerbated within the automotive industry, many aftermarket companies are in dire straits. As a result, the automotive aftermarket has experienced a rapid increase in distressed situations over the last six months. In the face of declining sales and a challenging lending environment, many business owners are questioning the viability of their businesses and exploring the idea of filing for bankruptcy protection. Whether it’s General Motors or a neighborhood repair shop, there are myriad issues, and misconceptions, facing owners in a distressed environment. There are two major forms of corporate bankruptcy: Chapter 7 and Chapter 11. Under Chapter 7 of the bankruptcy code, a company ceases all operations and a trustee is appointed to liquidate the company’s assets to pay off debt. Very few owners voluntarily file for a Chapter 7 bankruptcy, but may find themselves in this process as a result of an involuntary (forced) bankruptcy or a failed reorganization attempt. Instead, most business owners try to file under Chapter 11 because it allows them to operate the business during the bankruptcy process. Rather than simply turning over its assets to a trustee, a company undergoing Chapter 11 has the opportunity to restructure its financial framework and be profitable again. If it fails, all assets are liquidated and stakeholders are paid off according to absolute priority. It should be noted that the rate of successful Chapter 11 reorganizations is extremely low and estimated at 10 percent or less. Some of the most common, and ultimately damaging, misconceptions surround the issue of bankruptcy. Some of these misconceptions are:
This is absolutely not true. Once the bankruptcy process begins, owners have little control over the outcome. While they may serve as the trustee or debtor-in-possession of the company, ultimately the bankruptcy court will decide what is in the best interest of the creditors.
While this statement was true for much of the last decade, the frozen credit markets have all but eliminated DIP financing. The rare exception to this is an existing lender to a company who is willing to provide additional debt in hopes of being made whole. Under no circumstances should a company expect to obtain DIP financing once they enter bankruptcy; rather, the financing should be pre-arranged. All post-filing financing requires approval by the court and creditors.
Most businesses have sought out bank financing via a line of credit or term loan. For businesses with less than $100 million in revenue, personal guarantees by owners are generally required. The bankruptcy process can actually expedite the bank acting on these personal guarantees depending on the specific loan provisions. Considering that 90 percent of Chapter 11 filings become liquidations and liquidation values, already dramatically lower than book value, have been deteriorating, the personal guarantee is the only attempt the banks have to make up for shortfall. Filing for bankruptcy should be used as it was intended, a last resort. The alternative for many companies is finding the right equity partner before bankruptcy. An equity partner will provide a strong capital structure, remove personal guarantees and provide upside potential for owners and management. There are many investors that are looking at a longer-term picture and understand that today’s distressed situations can be turned around. These situations are typically a win-win-win situation for owners, employees and creditors. Distressed companies should review all available options, including an equity partner, before losing control of the company in the bankruptcy process.
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