Video Transcript: Restructuring During Bankruptcy

Hello, welcome. We're going to be discussing restructuring through bankruptcy.  So bankruptcy can be a creative corporate financial tool. Reorganization through the bankruptcy process can, in certain instances, provide unique benefits that  are unattainable through other means, restructuring your debt, being able to pay a lower interest rate, maybe having some of that debt forgiven, maybe you're  protected by the government and repaying some of this debt. So bankruptcy can be an effective tool to use to stay in business, liquidate assets, remove debts,  and kind of get a fresh start, but maintain assets and stay in business. Clearly,  bankruptcy is a drastic step that is only pursued when other more favorable  options aren't available. A bankruptcy filing is an admission that a company has  in some way failed to achieve certain goals, maintaining profitability, growing  revenue, controlling costs, reckless spending, bad investments, they can put  you in a cash flow pinch, which will not allow you to pay your debt obligations off as scheduled, so that can get you in hot water, and if you are too far underwater, then bankruptcy is an option. Bankruptcy overview, the bankruptcy act of 1978  or the bankruptcy code, is the main bankruptcy law of the United States that  organizes bankruptcy laws into eight odd numbered chapters, chapter one,  chapter 3, 5, 7, 9, 11, 13, and 15. Typically, we are going to as a business,  chapter seven or chapter 11 is where we will be having to go if we do file  bankruptcy, typically, either through liquidation or reorganization as a company,  economic failure is the is more is the more ambiguous. All right, for example,  economic failure could mean that the firm is generating losses. That is, revenues are less than cost. However, depending on the user and the context, economic  failure could also mean that the rate of return on investment is less than the cost of capital. It could also mean that we actual that the actual returns by a firm are  less than those that were forecast. So economic failure, we are either our costs  are outpacing our revenues, right? So that's unsustainable, right? Or our rate of  return is less than the cost of capital, right? So our cost to operate borrow funds, our weighted average cost of capital is 10% and our return is 9% that's  economic failure. We are operating at a higher cost of capital than our return. So we need to know how, if that happens, we need to know how to mitigate the  economic failure and improve and read verse course and become profitable  again. Financial failure is less ambiguous than economic failure. Financial failure means that a company cannot meet its current obligations as they come due.  The company does not have sufficient liquidity or cash on hand to satisfy its  current liabilities. Causes of business failure. The three most common factors of  business failure are economic factors, such as weakness in the industry,  financial factors such as inefficient capitalization. Maybe our debt to equity ratio  is too high. We have too much debt. We're over levered, and weaknesses in  managerial experience. That's why it's important to maintain the right talent, find  the right fit. Make sure your managers are experienced and and ready to be  leaders in their industry, such as insufficient managerial knowledge as well their 

skills aren't up to task. So, so the underlying causes, economic factors, okay, the underlying causes of business failure, economic factors, industry weakness and  insufficient profit, 41% right? So there's a lot of things that can't be controlled in  

the industry. We have no control over consumer demand, we have no control  over inflation. We have no control over costs of raw materials, financial factors,  heavy operating expenses, insufficient capital, okay, our heavy operating  expenses, maybe we are in a labor intensive. Industry right, and wages continue to go up, and that is hurting our profitability and our marginal revenue insufficient capital. Let's say we can't raise enough money. We we can't find any equity  investors. Maybe because we're a startup, not many banks will offer us a loan.  So we fail. Businesses may fail because they don't have enough capital.  Experience factors, lack of business, lack of business knowledge, lack of line  experience, lack of managerial experience, neglect, poor work habits, business  conflicts, fraud, disaster and strategic factors such as receivable difficulties and  over expansion and growth. So research and analysis shows that 10.7% of  businesses failed in one year or less. Just under 1/3 of the companies were in  business for three years or less, whereas 44.3% existed up to five years. And  you can see in the graphic here, it's broken down from one to 10 years, and you  can see kind of the percentage allocation on how long the businesses stayed  intact for. So causes of financial distress, financial distress and bankruptcy have  been linked to many of the highly leveraged deals that took place in the 1980s  so highly leveraged deals means overextended on your debt obligations, way  too much debt for this deal or project, right? 75, 80, 85% of the project's costs  are going to be in debt. You definitely don't want that. Studies have been  conducted of a study of 29 leveraged recapitalizations that took place between  1984 and 1988 they defined leveraged recapitalizations as transactions that use proceeds from new debt obligations to make payouts to shareholders. The  results show that 31% of the firms that completed leveraged recapitalization  encountered financial distress. First thing you don't want to do is you don't want  to go into debt to go pay your shareholders up their dividends. That is a very big  sign of weakness. If we don't have the free cash flow and the retained earnings  to distribute our dividends, we probably shouldn't be issuing dividends. We need to probably restrict our dividends down to zero until we can get our  recapitalization successfully transition to where we can not have so much debt  to equity. So we need to be able to get our equity up, have cash in retained  earnings so that we can pay that out to shareholders. Let's not go into debt to  pay out shareholders. CHAPTER 11 reorganization. The purpose of the  reorganization section chapter 11 of the bankruptcy code is to allow a  reorganization plan to be developed that will allow the company to continue to  operate. This plan will contain the changes in the company that its designers  believe are necessary to convert it to a profitable entity, right? So chapter 11 is  useful for businesses, because it will still allow the company to operate, and it'll 

contain changes in the company that its designers believe are necessary to  convert it to a profitable entity, so we can use the bankruptcy laws to kind of get  us out of out of debt and out of danger and allow us to continue to operate and  have an opportunity to reverse course and become a profitable entity. If a plan to allow the profitable operation of the business cannot be formulated, the  company may have to be liquidated. That means, sell off all the assets, take all  the cash, pay down the debt holders with its assets sold and the proceeds used  to satisfy the company's liabilities. Benefits of chapter 11 process for the debtor,  the ability to restrain creditors from seizing the debtors property or canceling  beneficial contracts, and to stay judicial actions against the debtor. We file  bankruptcy so that our debt holders, they are not able to come after us and get  the debt if it's on a judicial stay, the ability to continue to operate the business  effectively, without interference from creditors, the ability to borrow money by  granting liens on debtors assets equal To or superior to the liens of the existing  creditors. So chapter 11 allows us to actually get back into more debt, but only a  portion of that versus existing credit conditions, the ability to avoid certain  transfers that occurred before the filing of the bankruptcy petition, the cessation  of interest accrual on debts that were unsecure as of the filing date, the ability to propose and negotiate a single plan with all the debtors, creditors, the power to  bind to sending creditors to a reorganization plan that meets the Bankruptcy  Code standard the Receipt of a discharge by the bankruptcy court of all petition,  prepetition claims treated under the reorganization plan. Let's talk about chapter  seven, liquidation. Liquidation is a distressed firm's most drastic alternative, and  it is usually pursued only when voluntary agreement and reorganization can now be successfully implemented in a liquidation, the company's assets are sold and the proceeds are used to satisfy claims and this priority. Number one, secured  creditors. Number two, bankruptcy administration costs. Number three, wages of workers and employee benefit plan contributions, federal, state and local taxes,  unfunded pension liabilities, unsecured claims, preferred stockholders, common  stockholders. So if you have a pension and your company files for bankruptcy  chapter seven, you're probably not going to get paid, and you're not going to get paid, at least until ever your the company's taxes are paid. So liquidation is not a good position for a company to be in. And if you're an employee that's going  through liquidation,