Trying to decide whether to file for bankruptcy or attempt to negotiate an out of court “workout” could have been the situation the person who coined the term “stuck between a rock and a hard place” was in. There is no right answer when one is in such a position, and moving forward is guaranteed to be painful.
Let’s Back Up A Minute
Many people think that declaring bankruptcy is the only way to get out of a tough financial situation, but that is simply not the case. Many businesses are able to avoid bankruptcy by negotiating new deals with their existing creditors. The renegotiated deal is called a workout.
Creditors are often willing to enter into a workout agreement because they know that the alternative is having a debtor file for bankruptcy. In the post-financial crisis world, lenders and other creditors (like suppliers) are very familiar with bankruptcies. They know that having just one business in a chain of production file for bankruptcy can bring down a larger group of businesses connected to it, or even a whole industry. These creditors don’t want to risk the health of their own business or industry, so they are willing to be flexible.
Pros and Cons of a Workout
A workout can be a great solution, because they can be done quickly, cheaply, and discretely. But they are not the right choice for every business.
In order for a workout to provide long-term relief, the business must have enough cash flow to keep the business running in the short-term, and a plan to pay back debts in the long-term. Simply pushing bankruptcy off to a later date does not serve the interests of any of the parties involved, and is not what a successful workout should do.
The business must also have a really good understanding of what debts are currently owed, and what is coming due in the future. Once again, delaying an inevitable bankruptcy is not what a workout is for.
Pros and Cons of Filing for Bankruptcy
If a debtor lacks liquidity, or has a lot of creditors, filing for bankruptcy may be a more realistic path forward. Bankruptcies are disruptive, but what happens after an initial filing is relatively predictable, making it easy for the debtor and all the creditors to move forward.
From the debtor’s point of view, filing for bankruptcy provides a bit of breathing room that can be used to get back on one’s feet since creditors cannot collect any debts after a filing until the court gives the okay.
Bankruptcies are known for their ability to give debtors a clean slate, but they can also be good for creditors and those looking to buy business assets at a lower cost. Filing for bankruptcy removes liens and other on a debtor’s assets, making them attractive to buyers.
Bankruptcies are by their very nature transformative experiences. The business that goes into bankruptcy is never the same business than emerges.
There Is No Right Answer
When a business is in dire financial straits, it is very unlikely that a clear path forward that has no downsides will magically appear. Oftentimes none of the options available are great. With good advice, sound planning, and a bit of luck, whatever path a business owner chooses will lead in a good direction.