“No one teaches Bankruptcy. The only way to learn about Bankruptcy is to experience it.”
Turnaround CEO
No ever expects their company to file for Bankruptcy. When it happens, it can be both shocking and expected at the same time. While Bankruptcy is a well-known term, it is not well understood by the masses. You see headlines of companies filing for Chapter 11 or Chapter 7. You hear about how student debt is leading to Personal Bankruptcy. However, as I recently learned, you never understand the minutiae until you go through it. In full disclosure, I recently went through the process leading up to Bankruptcy and the initial filing. I didn’t go through the emergence of the company after Bankruptcy, as I chose to leave. So my opinions here will only cover what I experienced.
When you are considering joining a private equity-backed company, and one in a turnaround phase, make sure you have a detailed review of the business’s financials. Explore how the company makes money, what the cash cycle looks like, how much money is available for reinvestment, who the critical debt holders are, how much debt is outstanding, when it matures and, the annual obligations to serve that debt. You can then determine how much profit the company is producing and how much is going back into reinvestment for growth or transformation vs. servicing its debt.
If you are joining as a senior leader or executive, and specifically, if you are going to go under contract with the company, you need to have an employment lawyer review your employment agreement. Second, you need to fully understand the company’s legal structure and how it may impact your contract and ability to execute it. Third, if you can negotiate a clause that gives you the power to trigger the contract, such as in the situation that the company files for Bankruptcy, it gives you more control. Finally, request to interview with at least two board members. In discussions with the board members, you will want to see if you can tease out the board’s culture and how it functions. Be sure to research the executive team and each board member. You will want to go a bit deeper than a basic name search and tie words like “turn around,” “bankruptcy,” “chapter 11”, and “private equity” to their names to draw out different results. I would also recommend reaching out to prior employees or executives and see if they will chat with you about the company’s culture and operations.
When I first realized that Bankruptcy was a possibility, I had to research what Bankruptcy was all about. I learned that there is a whole industry around it. The companies range from consultants that come in to review contracts, accounts, and financials, to companies that specialize in the filing and petition process, and companies that specialize in distressed debt financing to bring companies out of Bankruptcy.
I truly realized that there is a pecking order to the debt holders, and the primary holders mostly get to dictate the show. Employees’ wages can be deemed an essential expense, but how those employees are compensated is dictated by the court’s ruling on the First Day Motion. Employees have no rights during Bankruptcy, nor does the Executive team have any power to influence how the proceedings will go. While the executives can certainly advocate for the employees, key vendors, and how customers are treated, the debt holders and the court have the final say at the end of the day.
Effectively the court can deem who gets paid, how much, and when.
The second realization I had was that the executive team loses control of the decision making process. You are surrounded by 3rd party consultants and your Debtor in possession, meaning the primary debt holder is in charge of your outcome. While you may influence and provide context, your best course of action is to move into execution mode and run the business the best you can. Including driving revenue and containing or reducing expenses, but also included keeping the overall employees engaged and frequently communicating with them. One thing to note is both the courts and the debt holders ultimately hold the executive leadership responsible for Bankruptcy.
My company filed for Chapter 11 bankruptcy. This process essentially allows a Debtor (i.e., company) to restructure its assets to reduce its debt burden, creating a healthier balance sheet, allowing it to emerge with new financing and serving its customers and generating revenue. As part of a Chapter 11 process, the company can be its own trustee, submits a restructuring plan to the court for approval, and continues to operate throughout the process. During this process, a company will often partner closely with its largest debt holders or solicit new investors as partners in helping restructure its debt. The company leverages the court and the restructuring process to seek relief from certain debt obligations to suppliers and minority debt holders, reducing its overall accounts payable burden, increasing free cash flow.
In Chapter 11 Bankruptcy, there is an auction to buy the Debtor. Often the largest creditors, if they believe in the business, put together a Stalking Horse Bid that sets the floor price. This is more often than not equal to the debt owed the creditors, essentially allowing them to take over the business without additional capital. The auction process is public, and anyone can come in and bid for a company. If they win, they will, of course, have to finance the operations to enable the company to emerge from Bankruptcy while continuing to operate successfully. The financing provided is in the form of additional debt, with interest and payments often deferred for some time, allowing for higher free cash flow. There is a lot of irony here by taking a bankrupt company and buying it by loading more debt onto it.
Throughout the bankruptcy process, there are often many consultants and companies paid to come in and help. Some of the key players include FTI Consulting, Oliver WymanAkin Gump, Covington Burling, Paul | Weiss, Young Conaway, and Prime Clerk. For the most part, the bankruptcy process is a public process, and you can follow along on any proceeding through sites like Prime Clerk.
After going through this process, I did become fascinated by the process of Bankruptcy and how common it is in business. A great resource is a newsletter called The Petition. They report on new filings and then dissect the filings. The Morning Brew, another newsletter, put together an excellent Bankruptcy 101 a few months back. Finally, a web site called PE Hub, can give you insights into the private equity (PE) world. PE companies are in the middle of many, if not the majority of Bankruptcy. Understanding their operating models, how they use debt to finance acquisitions and operations is essential if you choose to work in a PE-backed company.
Finally, the company that I was with is on the final stages of emerging from Bankruptcy and seems poised to restructure itself for hopefully what will be a bright future.
Key Terms
Debtor: person or entity filing for Bankruptcy
Creditor: businesses that are owed money by the Debtor
Trustee: a person appointed by an office of the DOG to represent the Debtor’s assets during bankruptcy proceedings
Chapter 7: Process of liquidating a business and all assets. Proceeds go to paying down the Creditors in a pre-arranged order defined by the court.
Chapter 11: Process of restructuring a debtor to keep operating as a business and generate revenue.
Stalking Horse Bidder: an initial bid on the bankrupt company’s assets, setting the low-end bidding bar so that other bidders can’t underbid the purchase price.
Debtor-in-possession (DIP) financing is a particular form of funding provided for a company in financial distress (i.e., Bankrupt) during the restructuring process. This debt is considered senior to all other debt (meaning they get paid first) and is used to keep a bankrupt company operating during the restructuring process.
First Day Motion: This is the first time a debtor is in front of the court. A series of motions are filed, usually including motions to continue funding payroll, motions to dismiss specific contracts, debts, or claims against the Debtor, and the restructuring plan. This motion occurs within four business days of the petition (filing) date.
Second Day Motion: This is a follow-up to the first-day motion and can occur within 30 to 60 days of the first-day motion. It often is a chance for the Debtor to refine its ask of the court on certain obligations it has to creditors or suppliers.
