As our sluggish economy slides into a painful recession, a growing number of small companies will find that the debt they assumed in the optimistic 1980s has come back to haunt them in the '90s. Responding to this, many will search for a fresh infusion of working capital to restructure their debt, thus easing the credit crunch. But in most cases, this search will turn out to be a wild goose chase.
"With many lenders and investors now cautiously sitting on the sidelines waiting for business conditions to improve, finding capital to reorganize debt will be a difficult, if not impossible, challenge," says Michael Busch, chief executive of the Wharton Resource Group Inc., a management consulting and investment banking firm. "That's because the pool of money available for this is shrinking in tandem with the nation's economic outlook.
"Does this mean that debt-burdened companies or those struggling through a cash-flow squeeze are dead in the water? Not necessarily. One strategy, which can be effective in all but the most dire cases, calls for reorganizing debt without securing additional capital."
To understand how this works, let's explore the concept of a Chapter 11 bankruptcy. Under this legal arrangement, a debt-burdened company is granted protection from its unsecured creditors, using this breathing room to draw up a plan for reorganizing its finances and, ultimately, for paying its debts.
Interestingly, companies can accomplish similar objectives without the cost and complex legal provisions of a Chapter 11 proceeding. This is done by having an intermediate step between the company and its creditors, replacing the anger and emotionalism with a plan for paying off the company's obligations.
"In a recent case, one of our clients owed its trade creditors more than $300,000 in delinquent bills," Busch says. "With that kind of money at stake, management was getting up to 30 calls a day from creditors, all demanding immediate payment. Faced with a barrage of threats and complaints, the company's management would promise to meet the payment deadlines, only to let them slip by or to see their checks bounce. Given this atmosphere of panic and mistrust, the situation was deteriorating rapidly.
"What was needed was the kind of breathing room afforded by a Chapter 11 bankruptcy. With this in mind, we sent a letter to the creditors saying that no payments would be made for 60 days, after which the company would begin to satisfy all of its obligations under set payment schedules.
"Equally important, we asked that all correspondence be addressed to us, rather than to the beleaguered management, which needed to focus its efforts on stabilizing and then turning around the business."
Before this informal reorganization was set in motion, major creditors were tempted to throw the company into bankruptcy, hoping to use legal powers to salvage some of their debt. But with the company acting responsibly on its own, the creditors were willing to work with management, continuing to ship goods on a COD basis while the new payment plan was developed.
As another means of easing a company's credit crunch, management can seek the cooperation of their lenders for restructuring current debt. As we have seen so clearly in the well-publicized case of Donald Trump's ailing empire, banks prefer to restructure loan agreements rather than seeborrowers default on their obligations.
"Providing the borrower is open and honest with us, and that he has kept us informed of the company's financial condition, we will try to work with him to make the debt manageable," says Howard Weinberg, vice president of the First New York Bank For Business.
"For example, if the borrower puts up more collateral, we may be able to extend the term of the loan. Or we may be able to reduce current loan payments by building in a balloon payment that comes due at a later point.
Restructuring debt brings benefits beyond the immediate ability stabilize a company's finances. It puts management in a stronger position to obtain growth capital for building the business on a long-term basis.