The COVID-19 pandemic has wreaked havoc on small businesses across the United States. Public safety measures that have been instituted have resulted in closures, furloughs, layoffs, supply chain disruptions, and dwindling cash reserves for businesses of all sizes. These closures have had a greater impact on small businesses. In response to this unprecedented economic disruption, the federal government has allocated $350 billion to small businesses in a historic effort to help them cover their operating expenses and remain open during the crisis. Congress is expected to pass additional stimulus legislation in the near future to help an already ailing American economy from worsening any further.
For many small businesses, though, the financial support is a welcome yet ultimately insufficient cash infusion. What is the owner of a small business struggling to remain afloat in the middle of a pandemic to do? One option – filing for bankruptcy – is an extraordinary measure that may be suitable for one small business but entirely ill-advised for another. Until restrictions on operations are lifted, it will be difficult for many small businesses, particularly those in the service industry, to project their income over any meaningful period. Such projections and cash flows, however, are often necessary before insolvency professionals can determine the best path back to the “black” for the business or its owners. That does not mean, however, that businesses facing financial hardship should sit idle waiting for “normal” to return. Rather, now is the time to understand the options and alternatives available to small businesses as they map out their recovery.
Understanding the various alternatives to bankruptcy that are available to small businesses during these trying financial times can help the small business owner to avoid the consequences of certain actions or inactions during this “wait and see” period that may imprudently limit the options for recovery later on. The below is a brief outline of several alternatives to bankruptcy.
Loan Workout
A small business that has been adversely affected by the COVID-19 pandemic may experience difficulty repaying its loans in a timely manner. In lieu of defaulting on a loan, the owner of a small business might want to consider pursuing a loan workout. The goal of a loan workout is to renegotiate the terms of a loan with the lender as a way to get the payments back on track. A loan workout can entail various changes to the original loan agreement, such as lengthening the repayment period, lowering the interest rate, and writing off part of the loan balance.
If it is properly negotiated, a loan workout can be mutually advantageous to the debtor and lender alike. The debtor can more easily make payments and avoid default, while the lender can avoid expending resources on debt collection. Both debtors and lenders can benefit by negotiating loan workouts as an alternative to the bankruptcy process.
Refinancing
The term “refinancing” refers to the process of taking out a new loan to help pay off one or more existing loans. Similar to refinancing a home mortgage, refinancing a small business loan can result in a lower interest rate, smaller monthly payments, and a healthier bottom line for the small business overall. Refinancing can be done through commercial banks, the U.S. Small Business Administration (in partnership with private lenders), and non-bank commercial lenders.
There are, however, a few potential drawbacks to refinancing that a small-business owner should be aware of. First, applying for a new loan can temporarily lower your credit score. A small-business owner who already has poor credit should be wary of lowering it any further. Second, paying off an existing loan through refinancing could lead to prepayment penalties, offsetting any savings created by refinancing in the first place. Third, a small-business owner who chooses to refinance may have to put up collateral – physical assets that could be lost in the event of default.
Assignment for the Benefit of Creditors
Another alternative to filing for bankruptcy is called an assignment for the benefits for creditors – or “ABC,” for short. ABCs are created by state law while bankruptcy proceedings are governed by federal law exclusively. A financially distressed small business that is unlikely to recover can use the ABC procedure to assign (transfer) its remaining assets to a third party who will sell them and distribute the proceeds to the business’s creditors. Winding down a non-viable small business using the ABC method is generally faster than doing the same through bankruptcy and can be accomplished more discreetly.
Receivership
A troubled small business can also potentially avoid bankruptcy through receivership. The goal of receivership is to wind down an insolvent business in an orderly fashion and preserve its value for creditors. Receiverships are common in lightly regulated industries that are prone to fraud, and are often used by secured creditors and other stakeholders to “right the ship” of a badly failing company. Although akin to bankruptcy, a receivership is generally less expensive, more flexible, and shorter in duration thanks to far fewer procedural requirements.
Asset Sale
The current economic slowdown has created extreme liquidity problems for countless small-business owners. To avoid bankruptcy, a small business with little or no cash flow and financial obligations coming due may need to liquidate some of its assets for money. The cash that is obtained through an asset sale can used to repay loans, make payroll, and simply keep the business running. For businesses with multiple revenue streams, selling off assets that service less-profitable business activities can benefit the profitability of the company as a whole.
Deliberate Planned Action is Best
As with any business decision, determining the best strategy to overcome financial hardship takes careful thought and planning. Oftentimes those who have invested their sweat and tears into growing a small business are unable to step back from the day-to-day emergencies in order to diagnose and treat whatever ailments may be impacting their business. Early consultation with an insolvency professional can mean the difference between workout and liquidation.
Thomas H. Curran Associates, LLP may be able to provide your small business the strategic guidance that it needs during these challenging economic times. Our legal team offers a wealth of experience with respect to a wide range of corporate legal matters, including the many alternatives to bankruptcy described above that are available to small businesses.