UNSUCCESSFUL STARTUP?

What you Need to Know if your Company isn't Succeeding

What You Need to Know if Your Company isn't Succeeding in the Marketplace

Blog_003While there are hundreds of success stories of startups that started in a garage and went on to change the world, many companies, for one reason or another, cannot succeed in the marketplace. There are a million reasons why a company may shut down, however, there are two primary means that a business will facilitate the closing of their business, bankruptcy and out of court dissolutions. In all circumstances discussed below, the company should file dissolution paperwork in the state they are incorporated, which officially ends the existence of the business.

Bankruptcy

Bankruptcy is the more formalized way of shutting down a business. It works through the court system, involves lawyers, allows for the orderly sale of assets, as well as a structured payoff to creditors. Legally, the bankruptcy code is broken down into chapters. Each chapter corresponds to different types of bankruptcies, targeting different kinds of debtors, with different rules and procedures, and designed to achieve different ends. For companies going through bankruptcy, there are two chapters that they are likely to utilize, chapter 7 and chapter 11. In both chapters, one major consideration for filing for bankruptcy is the automatic stay, which prevents creditors from trying to collect on debts of the business in bankruptcy.

Bankruptcy-01A chapter 7 bankruptcy is the liquidation and shutdown of a business. The company has ceased operations, and the goal is to pay back as many creditors (including equity holders) of the business as possible. An outside trustee is appointed to the company, who has the duty of finding as much value for creditors as possible, while also verifying that no creditors are trying to make illegitimate claims. The trustee will organize and facilitate the sale of all of the assets of the business and pay out all creditors. The benefit of a chapter 7 is that the trustee in the case will handle almost all of the administrative work on behalf of the bankruptcy estate, which allows for the principals to pursue new opportunities.

A chapter 11 bankruptcy, on the other hand, is about restructuring the business and debts so that it cannot emerge from bankruptcy a successful business. In chapter 11’s, the business continues to operate, and while there is a trustee of the bankruptcy estate, it is typically a representative of the debtor business. During the bankruptcy process, the debtor and creditors will renegotiate the terms of indebtedness and the business model of the company. Parts of the business may be sold or shut down in order to allow for the business to focus on profitable products or services. Obviously, the benefit of filing for chapter 11 is the chance of continuing business and being successful.

Out-of-Court Dissolution

The dissolution of a company in an out of court shutdown is not one set process. Different founders will handle the process in different ways, so it is important to have at least a general understanding of some of the different ways founders may shut their business down.

Commonly, when founders see their runway running down without the hope of a new round, or their product is not gaining traction, they may start shopping the business to competitors. While acquisitions are generally considered to be a successful outcome for a business, oftentimes businesses are sold at a fire sale price in order to try to pay down debts or secure future employment for their employees. This is known as an acquihire, or the acquisition for the purpose of hiring. If they cannot sell any part of their business, they are left in the unfortunate position of filing to dissolve without an opportunity to pay creditors or equity holders.

Sign Purchase Agreement-01Alternatively, there is the General Assignment for the Benefit of Creditors (ABC). This functions in a very similar way to a chapter 7 bankruptcy, but is an out-of-court process. A private company is hired to facilitate a liquidation of all of the assets of an entity to pay off creditors, who make claims in a way similar to bankruptcy. The company’s assets are all assigned to the third party who will then sell off the assets and use the proceeds to pay off debts as best as possible.

Sometimes founders will simply shut their doors. This is the least optimal outcome for everyone involved. Investors who would otherwise get to write off the loss on their taxes may be completely unaware until they affirmatively reach out to the company. Oftentimes, dissolution paperwork may not be filed with the state of incorporation, and the founder may not be responsive to phone calls or emails. In that case, a good way to determine whether or not a business has closed its doors is to see if the required regulatory filings have been maintained.

Why would a company choose to go through a bankruptcy process versus shuttering their doors and closing shop? The answer depends on a few factors.

First, the assets that the company holds. If the business is the type where it owns a lot of machines used to produce their product, the resale value of that hardware may be significant, and so going through bankruptcy to find a buyer may make sense. On the other hand, if the value of the company is mostly in IP specific to the company, then market to sell it may be small. With the apparent inability to recover some proceeds from business’ assets, it may make sense to dissolve the company.

Second is the type of debts the business holds and the corporate structure of the business. If the valuable assets of the business are primarily encumbered by secured debts, and there are not going to be other ways to pay creditors, then the time and expense of hiring attorneys to help through the bankruptcy process may not be valuable. Finally, there are considerations of size. It may be easy to shut the doors when all of your investors are friends and family, and you only have three employees. However, with a company valued at several hundred million dollars, hundreds of employees and investors, the bankruptcy process may make more sense. Finally, a company may consider the wishes of their investors. If there is only a small chance that a formal bankruptcy process will end up paying returns to investors, the investors may simply prefer a straight door closing in order to be able to take the tax loss in the short term. Bankruptcy can be a very long process, and without a guaranteed return of some kind, it may look like a less favorable outcome for that reason alone.

Topics: SPV, Post Close Activities, Bankruptcy

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