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Despite Being on the Decline, Business Bankruptcies Are Still a Possibility

By Tim McPoland, CPA/ABV, CVA, CFE on February, 5 2013
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Tim McPoland, CPA/ABV, CVA, CFE

Financial Professionals Can Assess Severity and Risk

Author: Tim McPoland

Business bankruptcies are finally on the decline after several consecutive years of high and rising rates. According to the American Bankruptcy Institute, in the first nine months of 2012 U.S. commercial bankruptcies fell 22% over the same period in 2011.

Of course, favorable statistics don’t mean much to the thousands of companies still in financial peril. If you have clients facing bankruptcy, you want to help them make the best decisions. And to do so, you need financial experts on your team. Accounting, valuation, damages, and merger and acquisition (M&A) professionals can help assess the severity of the financial crisis, determine whether liquidation or reorganization makes sense, and provide guidance on everything from selling assets to shareholder disputes.

Cut losses or keep going?

The recovery process starts by identifying ways the troubled business might regain control of its cash flows. After working with the business to establish a daily cash budget to stop the immediate bleeding, a financial expert can determine 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 expert can develop financial projections for several reorganization options, including best-, probable- and worst-case scenarios. Using a Z-score formula, he or she begins to assess a struggling company’s financial strength and estimate the risk and probability of whether the business will go bankrupt.

Chapter(s) and verse

When a company’s liquidation value exceeds going concern value, most experts recommend that it consider filing for Chapter 7 bankruptcy protection. Liquidation value is often seen as a “floor” for a company’s value.

But sometimes businesses are actually insolvent, meaning they can’t pay their debts. In such cases, a financial expert 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.

If, on the other hand, a Chapter 11 filing is deemed appropriate, a financial expert can help “sell” a reorganization strategy, such as debt forgiveness and restructuring, to lenders and other creditors. Due to the tight credit market and recent conservatism of lenders, many loans are over collateralized. By appraising assets (including inventory, equipment and receivables), a valuation expert can assist in renegotiating working capital covenants. As debt terms are eased, cash can be freed up.

Selling smart

Alternatively, a reorganization might call for divestitures of unprofitable segments, so the company’s owners can refocus on core operations. Or a distressed business might solicit offers to buy the company or its assets. An M&A expert can help your client find potential buyers and evaluate whether divestitures and offers appear reasonable.

When minority shareholders or creditors contest a divestiture or sale, distribution or other transaction, a valuation expert 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 the CFO’s compensation package includes a “golden parachute” clause.

End the squabbling

Another unfortunate side effect of financial distress is shareholder disputes. When management squabbles impair daily operations and decision-making, owners may decide to split the assets — or one owner may choose to buy another’s interest. In these cases, buyers tend to undervalue the business while sellers tend to overvalue it.

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

Move forward

When so much has already gone wrong, financially distressed businesses just want to make the best possible decisions going forward. Whether that means an immediate Chapter 7 filing or an elaborate reorganization plan, the input of financial professionals is essential.

If you have any questions about business bankruptcies, give us a call at 716.847.2651, or you may contact us here.

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