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Ending

the

Venture

McGraw-Hill/IrwinEntrepreneurship, 7/e Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 17

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Bankruptcy

Bankruptcy act (1978; amendments added in 1984 and 2005) ensures: Fair distribution to creditors. Protect debtors: unfair depletion and demands.

Most common types of bankruptcies: Chapter 7: liquidation (70%). Chapter 13: installment payments (29%). Chapter 11: reorganization (1%). Prepackaged bankruptcy.

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Business and Nonbusiness U.S. Bankruptcy Filings, 1984–2004

<<Insert Figure 17.1>>

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Bankruptcy’s Lessons

Too much time and effort spent on diversifying in markets where entrepreneurs lack knowledge.

Bankruptcy protects entrepreneurs from creditors, not from competitors.

Difficult to separate entrepreneurs from the business.

Entrepreneurs recognize failure too late. Bankruptcy is emotionally painful.

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Bankruptcy Act Provisions

The Act provides three alternative provisions for a firm near or at a position of insolvency:

Reorganization, or Chapter 11 bankruptcy. Extended time payment, or Chapter 13

bankruptcy. Liquidation, or Chapter 7 bankruptcy.

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Chapter 11: Reorganization

Least severe alternative: “breathing room”. Cash flow problems can be overcome. Plan prepared and approved by court.

Decisions made reflect one or a combination of the following: Extension: postpone claims. Substitution: exchange something for debt. Composition: prorated settlement.

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Surviving Bankruptcy

Can be used as a bargaining chip to restructure and reorganize.

File before failure of cash or revenue. Chapter 11 should be files only if chance of

recovery. Be prepared for examination of transactions for

fraud. Maintain good records. Understand completely. Transfer litigation to bankruptcy court. Realistic reorganization plan.

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Chapter 13: Extended Payment

Individual creates a five-year repayment plan under court supervision. A court appointed trustee receives money from

debtor. He/ she is responsible for making scheduled

payments to all creditors.

This budgets future income to outstanding debt. Requires payment of all priority claims.

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Chapter 13: Priorities

Secured creditors. Administrative

expense. Claims from

operations. Wage claims.

Contributions to benefit plans.

Claims of consumer creditors.

Taxes General creditors.

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Chapter 7: Liquidation

Voluntary vs. involuntary. Voluntary: entrepreneur’s decision to file for

bankruptcy. Involuntary: Petition of bankruptcy filed by

creditors without consent of entrepreneur.

Involuntary Requirements Debts not being paid when due (1 – 3 creditors). Custodian appointed. Fair value of assets < debts (balance sheet test).

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Liquidation under Chapter 7 Involuntary Bankruptcy

<<Insert Table 17.1>>

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Strategy During Reorganization

Prepare plan. Sell plan. Communicate. No checks that can’t be covered.

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Requirements of Keeping a Venture Afloat

<<Insert Table 17.2>>

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Bankruptcy Warning Signs

Financial management becomes lax.

Inability to document/ explain transactions.

Large discounts given to speed up cash flow.

Contracts are accepted below standard amounts.

Bank requests subordination.

Key personnel leave. Lack of materials. Unpaid taxes. Demand for cash

payment. Customer complaints

increase.

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Failure Reality

Entrepreneur should:

Consult with family/friends. Seek outside assistance. Drop venture that is draining resources.

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Business Turnaround

Entrepreneur needs to recognize the warning signs of bankruptcy.

Consider following principles: Aggressive hands-on management. Management must have a plan. Action.

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Succession Planning Issues

Senior management committed to plan.

Well-defined job descriptions.

Open process.

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Succession Planning Tips

<<Insert Table 17.4>>

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Succession Planning

Transfer to family member Role of owner- full-time/ part-time/ retire. Members able to work together? Income. Transition business environment. Loyal employees. Tax consequences.

Transfer to non-family Train key employee: retain some equity. Retain control: hire manager. Sell.

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Harvesting

Direct sale.

Employee stock option 2-3 year plan to sell to employees. Create trust fund.

Management buy-out: based on value of goodwill & asset appraisal.

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Direct Sale

Requires time and planning. Buyer payment method. Business broker. Business plan. Employment contract. Covenant not to compete.