Most people equate business bankruptcy with liquidating a company’s assets and using the proceeds to repay creditors. That’s a Chapter 7 filing under the U.S. Bankruptcy Code, but closing shop isn’t a foregone conclusion in bankruptcy. Many companies instead file for Chapter 11 (reorganization) bankruptcy. This option allows a company to continue to operate, with the hope of turning things around.

In the first half of 2023, both types of business bankruptcy filings surged in the United States. In particular, Chapter 11 filings were up 68% from the same period last year, according to Epiq Bankruptcy, a provider of bankruptcy statistics. This figure reflects only businesses involved in formal bankruptcy proceedings; many others are involved in informal, out-of-court reorganizations. Here are ways business valuation professionals can help distressed businesses navigate the reorganization process.

Chapter 11 basics

When a company files for Chapter 11, it retains its assets as a “debtor in possession.” Meanwhile, owners relinquish control to a court-appointed turnaround specialist who works with creditors and the bankruptcy court to come up with a turnaround plan. A court-imposed reorganization protects the company’s assets from creditors until the plan is devised and approved.

Typically, a Chapter 11 bankruptcy proceeding offers protection of business assets while restructuring the following types of debts:

• Priority tax debts,
• Secured debts,
• Unsecured debts, and
• Leases and contract debts.

The bankruptcy process starts with a petition to the bankruptcy court. A voluntary petition is filed by the debtor. Conversely, an involuntary petition is filed by creditors after certain conditions have been met. In either event, the business typically has about four months to develop a reorganization plan. However, if “just cause” for a delay can be shown, the court may grant a business up to 18 months after the petition filing to develop its plan. The goal is for the business to emerge from bankruptcy in better financial shape.

Historically, Chapter 11 was cost-prohibitive for many smaller businesses. Recent changes to bankruptcy law provide greater access to protection under Chapter 11 for small businesses.

Valuable insight

Is this option right for a particular business? Companies contemplating Chapter 11 bankruptcy often seek the input of a business valuation professional to determine the appropriate course of action. Examples of ways valuators can provide guidance include helping management:

• Assess and mitigate the severity of the financial crisis with cash budgets,
• Determine whether reorganization makes sense,
• Develop and evaluate reorganization plans (including financial projections and sensitivity analyses),
• Appraise assets (such as inventory, equipment and receivables),
• Divest non-operating assets and unprofitable segments, and
• Restructure debts and loan covenants.

If Chapter 11 bankruptcy doesn’t make sense and a liquidation under Chapter 7 will be necessary, a financial expert might act as a court-appointed receiver and consultant who can facilitate the liquidation process. This includes winding down operations and paying out creditors in order of legal preference.

(This is Blog Post #1436)