Companies stay afloat when they have enough cash to keep them going. It is as simple as that. Businesses who may be hurting for cash will most definitely struggle. And as we have seen in the past few months, many in this situation are often forced to close their doors. So what sources of liquidity do companies have at their disposal beyond daily cash flow? Some have to go to lenders or banks and inquire about business loan financing; from short term loans to lines of credit, it's a way to bring that much-needed cash in. Others may approach vendors about extending credit and thereby freeing up some of their cash that would have to otherwise be spent on vendor invoices. Still, others may have access to investors or other such insider parties willing to provide an influx of money.
Those companies who do find themselves in difficult straits in terms of a lack of liquidity, unfortunately, tend to do so when the availability of business loan financing is decreasing because of their situation. In many ways, it is a Catch 22. And this in turn can transform quickly into a vicious cycle for that business. Because they are falling deeper and deeper into a hole, they may find that vendors are unwilling to extend any more credit. Lenders are less likely to approve any loan application for financing. Because the company is in distress, there is very little they can do to help get things back on track financially. Business loan financing is likely a no-go and other avenues as well suddenly become inaccessible. Without this access to liquidity, they could fall deep into crisis mode.
And then of course in terms of investors and/or any insider loan possibilities, that may be a lost cause as well. Investors, seeing that a company is in crisis, are probably going to be concerned about putting any more money into a firm that is sinking. In a bankruptcy situation—if this were to materialize—the investor could ultimately lose any loans they issue the company as a bankruptcy trustee could very well challenge it.
There could be one solution that may be of use to those companies that are experiencing deep financial distress, such that could gain them access to liquidity. If a company is indeed in a fair amount of economic trouble, odds are they are already considering selling the business, restructuring, or are looking at a workout. Ideally, such workouts would be out of court; however, Chapter 11 bankruptcy in this sort of situation can prove helpful under certain circumstances. Ultimately, filing for Chapter 11 might be able to help the company gain access to business loan financing. Because of the Bankruptcy Code, a lender gets the peace of mind that a loan issued to the distressed company will not be challenged. This then gives the company some much-needed leverage in terms of trying to procure any form of financing. In this scenario, this is referred to as DIP financing. To help you better understand what DIP financing is, we wanted to offer a brief overview…
A Breakdown of Business Loan Financing During a Chapter 11 Bankruptcy
- Upon filing a Chapter 11 bankruptcy, the company's board and management team do maintain possession of the company. The company is thus referred to as "debtor in possession" or DIP. Under Chapter 11, DIP financing does become an option.
- The debtor company then has the choice of trying to procure funding. Once the company has found a lender, they can then approach the Bankruptcy Court and seek approval for DIP financing. The terms involved most often will include priority security interest, usually a premium interest rate, a budget that gets approved by multiple parties, and any safeguards that the lender wants to be put into place. Now, keep in mind, the creditors involved in the bankruptcy do have the option of contesting a DIP loan. Especially, if the lender in question is an insider, DIP loans often get challenged. It is then up to the court to determine whether or not it will allow the loan.
- A bit of a wrench is thrown into the plan if the company already has secured debt. If this is the case, then the company will need to get the existing lender to agree to the DIP loan proposition, or they will have to convince the Bankruptcy Court that the first lender's position will be protected. So that if the DIP loan is approved, the existing lender will not be adversely affected.
- There is also the case in which the existing lender might be willing to do a DIP loan. Many such loans are made by existing lenders. There are several reasons why a lender may opt to do this—given that a company to which they've already issued a loan is in distress. One such reason may be that they want to enhance their position.
- The good thing again about a DIP loan is that it cannot be challenged. So once the court does approve the loan and finds that it was made in good faith, then the DIP financing, in this case, is not subject to any legal challenges. So, put differently, within the context of bankruptcy, a loan that could otherwise have been challenged outside of bankruptcy is safeguarded. Even if the lender is an insider, this still stands.
- While the process may be timely and somewhat complex, for a company in financial distress, it may be one of the only options available to get the liquidity it needs to survive. This could then help the organization afford a restructuring during a Chapter 11 bankruptcy. Whereas outside of bankruptcy, it is unlikely that that company could have gotten any sort of business loan financing.
Why Chapter 11 May Be The Smart Move
If indeed business is sinking financially, Chapter 11 provides certain protections that can help that business get back on its feet and potentially back on track. There is an automatic stay for one. There is also the ability to restructure debt and thereby make it more manageable while the company works to become profitable again. Additionally, Chapter 11 has helped some faltering companies sell for an amount they would never be able to get had they not filed for bankruptcy. And then of course there is the option of DIP financing which allows business access to liquidity when it is needed most.
Any company found itself in a financial crisis, without access to adequate liquidity should seriously consider talking to an attorney experienced in matters of restructuring and bankruptcy. It could be as easy an as out of court restructuring; then again, however, a Chapter 11 may be the most beneficial route a company can take given its circumstances. And if DIP financing can come into play and alleviate some of the business's cash flow problems, this could potentially be what ultimately saves the company.
First Union Lending is here to help. If you need additional cash to weather this storm, we have the funding solutions to accommodate your individual needs. Call today to see how we might be able to assist you during this challenging economic time.