3 BankruptcyBankruptcy 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.
4 Business and Nonbusiness U.S. Bankruptcy Filings, 1984–2004 <<Insert Figure 17.1>>
5 Bankruptcy’s LessonsToo 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.
6 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.
7 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.
8 Surviving BankruptcyCan 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.
9 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.
10 Chapter 13: Priorities Secured creditors. Administrative expense.Claims from operations.Wage claims.Contributions to benefit plans.Claims of consumer creditors.TaxesGeneral creditors.
11 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 RequirementsDebts not being paid when due (1 – 3 creditors).Custodian appointed.Fair value of assets < debts (balance sheet test).
12 Liquidation under Chapter 7 Involuntary Bankruptcy <<Insert Table 17.1>>
13 Strategy During Reorganization Prepare plan.Sell plan.Communicate.No checks that can’t be covered.
14 Requirements of Keeping a Venture Afloat <<Insert Table 17.2>>
15 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.
16 Failure Reality Entrepreneur should: Consult with family/friends. Seek outside assistance.Drop venture that is draining resources.
17 Business TurnaroundEntrepreneur needs to recognize the warning signs of bankruptcy.Consider following principles:Aggressive hands-on management.Management must have a plan.Action.
20 Succession Planning Transfer to family member Transfer to non-family Role of owner- full-time/ part-time/ retire.Members able to work together?Income.Transition business environment.Loyal employees.Tax consequences.Transfer to non-familyTrain key employee: retain some equity.Retain control: hire manager.Sell.
21 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.
22 Direct Sale Requires time and planning. Buyer payment method. Business broker.Business plan.Employment contract.Covenant not to compete.