In Silicon Valley it is not uncommon to hear the statement, “The road to success is littered with failure.” It is worn like a badge of honor for entrepreneurs who have survived the harrowing stages of starting and growing a successful company.

Thomas Edison, inventor of the incandescent light bulb, perhaps best captured the silver lining in failing. When asked how dejected he was with the staggering number of unsuccessful experiments he conducted before the light went on – figuratively and literally - his response was equally illuminating.

“Failure? I didn’t fail. I found 10,000 ways that won’t work.”

While one can argue such resilience and persistence is admirable in surviving as an inventor, those virtues do not translate the same way for a business owner staring at insolvency. Take it from a pair of restructuring veterans who have dealt with companies whose missteps, whether self- or market-inflicted, have left the people behind them wondering if a win even exists. The answer may be yes, but buckle up: The road to getting there can be bumpy.

Battling Through Bankruptcy

Many owners, particularly founders with deep emotional ties to their company, are understandably reluctant to let go of their dream. As such, re-organizing through bankruptcy seems appealing. Congress created a new Subchapter V of the Bankruptcy Code in 2020 with the goal of allowing the owners of small, closely-held companies to retain control while reorganizing their business.

When a company files a Subchapter V bankruptcy, an automatic stay against collection activity arises on filing and the company has 90 days to file a proposed plan of reorganization. If all goes well, the company gets relatively quick relief while taking remedial steps to put the business on solid ground, and ownership retains its equity under a confirmed plan of reorganization.

Confirmation of a plan of reorganization in a Subchapter V bankruptcy, available to smaller companies whose total non-contingent liquidated debt does not exceed $3.42 million, comes in two forms, both of which require detailed projections for payments in the plan:

(1) A plan can be confirmed as a consensual plan under section 1191(a) of the Bankruptcy Code if it otherwise meets the requirements for confirmation and the plan has sufficient creditor support by creditors by class; or

(2) If the company’s proposed plan fails to obtain necessary acceptance by creditors for a consensual confirmation it may nevertheless be confirmed as a non-consensual plan under section 1191(b) of the Bankruptcy Code. Under section 1191(b), the plan will propose to pay creditors its net disposable income over a three to five year period, usually on a monthly basis. Plan payments to unsecured non-priority creditors may be only a fraction of their claims, provided that the plan is “fair and equitable” as defined in Section 1191.

We tend to see more non-consensual rather than consensual Subchapter V plans coming across our desks.

While Subchapter V bankruptcy has significant advantages over regular Chapter 11, it should not be undertaken lightly because failure could lead to conversion to a Chapter 7 liquidation case controlled by a Chapter 7 trustee, or to dismissal. The company should have adequate cash and projected business income to pay for operations, and have a clear plan for reorganizing its business operations to create positive cash flow and pay expenses of administration, including its counsel and the Subchapter V trustee. If a company can’t complete its plan payments the company will likely fail even after plan confirmation.

An issue we often see with company owners is a false sense of security that a bankruptcy filing with protect their personal assets.  But the stay of bankruptcy doesn’t automatically shield the owner who has guaranteed a company obligation and perhaps backed the guarantee with a grant of security interests in the owner’s assets. This explains why company and personal bankruptcy petitions are often filed in tandem.

The Million Dollar Question

Assuming the owner wants to continue to fight the good fight and buy the expertise and time necessary to put the business on solid ground, he or she needs to ask themselves a fundamental question – and be ruthlessly honest with their answer.

“If relief is granted, what are you going to do differently this time around?”

Some will say they can sell assets. That may free up capital on a one-time basis, but if the burn rate continues, that does not change the financial calculus. And what if those assets are core to revenue generation?

Anther common refrain: “I will work harder (or invest more time in the business).”  Sounds great. In reality, it’s typically an exercise in self-deception. Most owners are already over-committed time-wise and have little added bandwidth to tap.

When Receivership is Right

Because of these risks, placing the company into receivership may be the preferred option. Management will be required to cooperate with the Receiver, but generally there is no more reporting or administrative responsibility for management, fewer stakeholders and advisors, relief from the constant harangue of creditor calls and threatened legal action, and the receivership estate takes care of the company’s bills to the best of its ability. All operational responsibilities transfer to the receiver.

That means, of course, ownership no longer controls the business, nor does it retain any equity. Although there are rare cases where founders or owners can eventually reacquire control, the business is effectively in the hands of the court-appointed receiver whose job is to maximize the value of the underlying assets to pay creditors and either close or sell the company or its assets.

A good operating receiver has the ability and experience to run a complex business and grow it, with the ultimate goal of selling it as a going concern to the highest bidder. Those larger proceeds can, in turn, satisfy more creditors.

Nobody plans to fail in business, but it happens – more often than most entrepreneurs realize. When it does, the key is to fail as painlessly as possible. If the goal is to retain ownership of the company and restructure it into a profitable business, ownership should consider Chapter 11 or Subchapter V bankruptcy. But if there is no clear path to a successful restructuring of the company, ownership should consider receivership. Getting good counsel from an experienced receiver or bankruptcy attorney is a great place to find relief.