Chapter 7 vs. Chapter 11In the Houston area, and many other parts of the country, economic uncertainty persists. The American Bankruptcy Institute reported in the first quarter of 2016 that total commercial filings increased 24% from the year before. Valuation professionals can help businesses facing bankruptcy by determining whether liquidation or reorganization makes more sense, and provide guidance on everything from selling assets to shareholder disputes.

Evaluating Chapter 7 vs. Chapter 11

When is the best time for struggling business owners to hire a valuation expert? The need for outside help typically arises after several years of financial losses, skipped loan payments, foregone salaries, maxed out credit lines and sleepless nights. A valuator who specializes in bankruptcies brings financial expertise and fresh perspectives to the situation.

The first step is to establish a daily cash budget to regain control of cash. From there, a valuator can run financial scenarios to help assess which form of bankruptcy is more appropriate — Chapter 7 (liquidation) or Chapter 11 (reorganization). There might also be a third option: Take steps to avoid bankruptcy altogether.

The valuator will assess a struggling company’s financial strength and estimate the risk and probability of whether the business will go bankrupt by developing financial projections for several reorganization options, including best-, probable- and worst-case scenarios.

Implementing an action plan

Most valuators recommend that the business consider filing for Chapter 7 bankruptcy protection when liquidation value exceeds going concern value. Liquidation value is often seen as a “floor” for a company’s value.

Some businesses are actually insolvent, meaning they can’t pay their debts. In such cases, a valuator might act as a court-appointed receiver and turnaround consultant who can facilitate the liquidation process — including winding down operations and paying out creditors in order of legal preference.

However, if a Chapter 11 filing is deemed more appropriate, a valuator can help “sell” a reorganization strategy, such as debt forgiveness and restructuring, to lenders and other creditors. Many loans are overcollateralized. By appraising assets (including receivables, inventory, and equipment), a valuator can help renegotiate working capital covenants. As debt terms are relaxed, it frees up cash.

Getting creative

Alternatively, to refocus on core operations, a reorganization plan might call for divestitures of unprofitable segments. Or a distressed business might solicit offers to buy the company or its assets. A valuator can evaluate whether divestitures and offers appear reasonable, and help find potential buyers.

When minority shareholders or creditors contest a transaction, the valuator can write a fairness opinion to help demonstrate that management exercised good judgment in analyzing a transaction. Fairness opinions are especially important when transactions involve related parties, or if an executive’s compensation package includes a “golden parachute” clause.

Staying level-headed

Shareholder disputes are another unfortunate side effect of financial distress. Owners may decide to split the assets, or one owner may choose to buy another’s interest when management squabbles impair daily operations. In these cases, buyers tend to undervalue the business while sellers tend to overvalue it.

A valuator can help bridge the two sides by objectively estimating what the company and its underlying assets are worth. They help the parties identify assets that aren’t on the balance sheet — including customer lists, brand names, business goodwill and contingent legal and tax liabilities. They can also explain the tax implications of buyout terms, such as installment sales and earnouts.

Spending wisely

While it’s tough for businesses on the verge of bankruptcy to spend more money on outside professional fees, valuators will bring analytical skills, experience and objective insight to the situation. They can help overwhelmed owners crunch the numbers and consider all their options from a financial point of view, rather than an emotional one.

© 2016