The Ultimate Guide To Business Debt Solutions For Trusted Advisors

As an accountant, CPA, lawyer or financial planner, you have unique expertise, licensing and education that earns you the designation of Trusted Advisor. As such, you assume the responsibility to deliver value by doing what is in the best interest of your clients’ business, whether in good times or bad. Because your clients have comparably little understanding of your field, they are unable to see the scope of their position clearly, and therefore, they often place blind trust in your advice. They do this because they believe you know what’s best.

You are in this business because you care about your clients’ well being. Your expertise and ethics are the foundation of your book of business, and thus its growth. Hollywood tells us, “with great power comes great responsibility,” and that certainly resonates in this industry. A clear understanding of your client’s distinct situation and all pertinent background information is critical to your collaborative and collective success. Knowing how to best solve a difficult problem or carefully plot the safest path for your client to reach her projected goals requires a finely-curated toolbox, especially in the context of unsupportable debt.

We live in a society based on capitalism, and with that comes inevitable business failure. For clients whose businesses are in financial distress, conventional knowledge has created what we at Second Wind Consultants, Inc. (“SWC”) call the “Pay or Fail Dichotomy,” which refers to the only two historical, self-explanatory and extreme options for businesses and their debt. Defaulting on a loan carries potentially devastating consequences, including destruction of the company, liquidation of assets and lawsuits to collect on personal guaranties. This leads most trusted advisors to recommend either taking on new debt or filing for bankruptcy.

In this article, we will show you the falsity of this dichotomy, and that an alternative exists to bankruptcy or new debt that can save your client in these dire circumstances. Understanding this method leverages your expertise as an advisor who knows all the options, even those that are little-known. Furthermore, utilizing this strategy allows you to retain clients you might otherwise lose to insolvency.

Your client’s business is failing, and they’ve come to you for help.

Failure is an inevitable part of doing business, and if unsupportable debt has become a reality, the next steps are crucial to avoiding a complete client collapse. For a completely insolvent enterprise, the exit strategy becomes the most important objective. Reducing losses and diminishing damage to whatever degree possible becomes your top priority, ideally positioning the business operator to regroup and enter the business arena again at a later date. For a business that is merely struggling, however, several strategic moves can be made to preserve the underlying business operation. These paths are both different and vital respectively, but neither can be made until a crystal clear picture is painted of the operational posture.

First address why the debt has become unsupportable.

Unsupportable debt is not the cause of failure. It’s merely a symptom of mismanagement, extenuating circumstances or a combination of both. Sometimes it’s phenomena you have no way of predicting: political and socio-economic upheaval, changing demographics, fluctuating markets, unexpected weather issues or sudden decreases in demand. Even something as random as municipal road improvements cutting your client’s foot traffic in half can have a devastating effect on cash flow.

On the other hand, some problems present themselves slowly, and a manager with a keen eye and a fine-tuned profitability and performance plan should be able to avoid a downturn. Here are just a few of the internal problems that could cause business failure:

• Lack of an effective sales program
• Fierce competition
• Loss of key employees
• Untrained employees
• Too many employees
• Overhead that is too high
• Too much inventory
• Ineffective collection practices for accounts receivable

Without effective management, any of these factors could lead to the demise of an enterprise.

The Traditional Options

As previously discussed, what follows are the two historical options available for distressed businesses and trusted advisors alike, options you are familiar with and have likely advised in the past: new debt and bankruptcy.  

Sometimes these options work for your client, but they are always accompanied by a laundry list of downsides. In other instances, they fail completely.

Taking On More/Consolidated Debt

First, let’s take a look at why more or consolidated debt creates problematic circumstances:

New debt doesn’t address the underlying problem that led to insolvency in the first place.

An enterprise begins to encounter distress when it has insufficient revenue to operate and service its debt obligations. Why and how did this happen? Why was management unable to foresee and fend off this disaster?

Unfortunately, new debt doesn’t provide an answer to these critical questions. As a result, the same issues will continue to undermine the business while the new debt simply replaces or compounds the old. A new loan should be allocated to growth, development, creating revenue and expanding profitability—not just to retire old debt and dig that hole even deeper.

Bad financials limit consolidation options.

Unlike more debt, a consolidation loan is a reorganization of the debt you already have.  The intent of debt consolidation is to lengthen the amortization period and possibly reduce the interest rate so that the new consolidated debt costs less each month than the old. This is often difficult to achieve, however, if the financial condition of the struggling enterprise renders it unable to qualify for one or both of these terms.

The threat of a debt spiral remains.

Typically consolidation removes the worry of default and liquidation in the short term. Unfortunately, if the interest rate remains high and the underlying operational problems are not resolved, the only thing consolidation offers is a longer time period before the company finds itself in this position yet again. The proverbial debt can is simply kicked down the road.

Even more troublesome is when the short-term resolution involves a cash advance (most often a Merchant Cash Advance or MCA). Payment terms for these easy-to-acquire injections of capital can quickly become unsupportable, often leading debt-saddled owners to acquire another advance just to pay back the last, and so on.

A critical note: many owners and even advisors erroneously believe MCAs come with personal guaranties. If an owner is under the assumption that personal assets are at risk in default, they are further incentivized to take on additional MCA debt, known as “stacking.” The truth, however, is that MCA contracts are not loans and are subject to “personal guaranties of performance”— meaning that if the owner acted in accordance to terms, the only security interest is in the business receivables upon which the advance was based. In other words, if something goes wrong and the business shuts down, the business owner is not personally obliged to pay down the remaining balance.

Bankruptcy

If taking on new debt doesn’t seem feasible for your client, the other way you might suggest preventing a “pay or fail” scenario is bankruptcy.

Unfortunately, despite a client’s belief that this is a cure-all solution, it also has many downsides.

Here are some of the problems associated with Chapter 11:

Bankruptcy doesn’t ease the debt load.

In a Chapter 11 bankruptcy, your client must still repay 100% of her debt over a period of five years, almost without exception. This means no actual debt reduction while her business credit gets destroyed. Furthermore, things will get a lot worse if the plan falls apart, which is very likely to happen. Even Chapter 7 can leave a lien on your client’s home and a flood of unresolved legal and financial issues.

Bankruptcy isn’t a safety net; it’s a money pit.

On top of paying back 100% of her debt, your client will need to add the exorbitant legal costs necessary to prepare the plan. From there, objections from creditors will inevitably arise, and every single issue becomes its own legal proceeding that must be resolved before her main bankruptcy case can proceed. Add the cost of a lawsuit to each objection that arises, and her legal fees grow exponentially.

Your client won’t have control.

Your client’s life will get complicated as she loses control to Trustees, the Judge, and opposing creditors. Any of them can create delays to the plan with endless objections and other obstacles. With so much time and money at stake, she’ll have absolutely no leverage or control over the process and will be at the mercy of the system, while her funds are bled dry trying to hold the plan together.

Chapter 11 doesn’t guarantee the protection of personal assets.

This is the most dangerous aspect of Chapter 11 bankruptcy. Clients mistakenly believe there’s a firewall between the business and their personal assets. The truth is, the risk of conversion to Chapter 7 is extremely high. So now, after being drained financially and emotionally, your client’s business is shut down, and all of her assets are liquidated. She risks the loss of everything for which she has a personal guaranty, and such guaranties are a universal requirement these days.

Chapter 11 failures are the rule, not the exception.

Chapter 11 bankruptcies fail an astounding 75 percent of the time, in part due to the difficulties mentioned above. The concept itself is fundamentally flawed because, to make it through the process, a debtor needs to demonstrate her ability to afford the plan the entire way through. If debtors could do that, they wouldn’t need to file in the first place.  

How to Preserve the Client’s Business Value and Offer an Exit

Both of the above options can actually leave a client worse off than where they started. As a trusted advisor, what if you had an alternative to offer your client that wasn’t so much of a gamble?

There is, in fact, a better way. This alternative mimics bankruptcy in part, fully resolves debt, and keeps the business in operation, but does so more effectively than Chapter 11.

A reputable third party like Second Wind Consultants, which specializes in debt workouts and corporate reorganization, can reorganize the business so that it can emerge stronger and healthier. There’s no reason to risk destroying the company your client created or the jobs that depend on its success. Second Wind will provide business strategies for avoiding financial and emotional devastation and put your client back on the path to success. At the same time, an Alliance with Second Wind offers numerous advantages to you.

You’re on the cutting edge.

Keeping abreast of new trends is just as critical to your success as utilizing what you’ve learned from past experience. Continuous development of your skills and a high commitment to ethics maintain your advantage and are the basis for building a reputation of excellence. These efforts can position you as a leader in your community and enhance your brand recognition.

You’re saving clients from destruction.

Having a clear vision of the client’s business and financials gives you the power to anticipate imminent destruction and offer solutions for fixing the problem before it occurs — or at least before it gets out of hand. Thus the ability to predict a downturn, or knowledge of who can provide this evaluation, is critical to being the best in the business.

Knowing how to minimize loss and preserve the value of the business or how to extricate the business owner with as little personal damage as possible will greatly enhance your skill set.

You’re retaining clients you would have otherwise lost.

It’s a selfless motivation that leads you to act in your client’s best interest and provide appropriate counsel, but it benefits you as well. If your approach — that is, directing her toward a debt workout with SWC — succeeds in saving her business, she’ll likely be a client for life. Not only will her trust be absolute, but it’s also possible she’ll provide the good word of mouth that all business owners hope to achieve. You may become known for your ability to deliver winning options to anyone in a distressed situation.

Your value increases.

Once you utilize this innovative alternative and see its myriad benefits, you’ll now have the ability to deliver results that others in your field can’t. This lends you a competitive edge and elevates your worth in the marketplace.

The Ins and Outs of Reorganization

Is this the first time you’ve heard of this solution? There are a few reasons for this.

Even though reorganization preserves a business’s core capabilities, it’s only the largest of corporations deemed “too big to fail” that have had access to its approach in the past. This applies to Fortune 100 companies or any others that have huge revenues, vast resources and substantial asset pools and can afford the most sophisticated experts to help them navigate their financials.

SWC thinks that excluding the smaller business organizations is counter to the American Dream and causes damage to the country’s economy every single day. This is especially so because small, family-owned companies and businesses in the mid-cap sector comprise the overwhelming majority of business ventures and jobs in this country. They are just as necessary to the economy as the Fortune 100 corporations, and just as deserving of having the best shot at survival.

At its core, reorganization is a second chance for a business. It gives a company a clean start-up opportunity without any of the previous issues or debts following it into the newly reorganized entity. If all businesses are considered “too big to fail,” and every job preserved collectively represents the core of our economy, then it is the duty of people in our position to offer something other than “pay or fail.”

So how does it work?

Article 9

SWC uses a transactional reorganization approach which involves a controlled short sale of the distressed business’ assets to a bona fide third-party purchaser. Through the sale, the subordinate liens are stripped from the assets, and the business operation can maintain continuity while transitioning into the purchasing entity. This is called an Article 9 sale which derives from the Uniform Commercial Code, a set of laws uniformly adopted by all fifty states that control the flow of goods across the country. The idea is relatively simple and based on the following assumptions, which are almost always proven true:

• The forced liquidated valuation of business assets are heavily depreciated, and won’t be sufficient to cover even the first position creditor’s note.
• The liquidation process itself is inefficient and expensive, driving the recovery value down even further.
• Subordinate creditors aren’t going to recover anything anyway.
• First-position creditors need a way to sell those assets privately and without the worthless liens.

Article 9 was the mechanism created to allow first-position creditors to transact on their collateral more efficiently. As a result, they avoid the typical liquidation process to maximize recovery value and strip away all subordinate liens so they can ensure the sale of the assets to a third party. No third party would ever purchase assets that are encumbered by subordinate liens, which renders collateral valueless.

The result of all this is that business emerges even stronger and lives to see another day, the business owner has an opportunity to resolve any personal guaranties with performance-based incentives in the reorganized company, the employees of the company keep their jobs, and the families reliant upon those jobs continue to thrive.

Please note, the ideal candidate for an Article 9 sale is a business that doesn’t have the asset base or income sufficient to pay debts in full, meaning this method can’t be used by business owners just to avoid paying subordinate creditors.

Additionally, there must be adequate value consideration of the assets based on third-party appraisals, and a ten-day notice must be sent to subordinate creditors. If this time elapses without challenge, the assets can be delivered to a buyer free and clear of liens.

The real advantage of this method is that while Article 9 protects the interests of the first-position secured creditor, everyone involved in the transaction stands to benefit.

Here are the advantages of a reorganization utilizing the Article 9 short sale:

• The core business survives and continues operations without interruption.
• The assets remain out of range of creditor attacks, foreclosure or other collection efforts.
• Most of the debts are removed, while others are drastically reduced.
• Personal guaranties are decreased to affordable losses.
• The business can make necessary systemic adjustments on its own without the interference of courts or other interested parties.
• There is no public stigma or damage to the business’s reputation; it’s a fairly private transaction.
• The costs are affordable, and the fee is financed over a long period of time.
• Contracts and leases can be broken with minimal cost.
• Unsecured creditors may take a total loss, although if some can be paid, this supports ongoing relationships. Vendors, being unsecured as well, may take a partial or total loss, although experience has shown that the promise of ongoing revenue is enough of a motivating factor for continuing to do business with the new entity.
• Secured creditors face significant discounts. As a result, the secured parties get as much collateral as allowed per their original deal. Even if this amount falls dramatically short of repaying the loan, the results far exceed what they would get in the case of liquidation.
• Employees may continue working for the new entity without interruption, and under much better circumstances.
• Often credit scores are preserved and not diminished by debt workouts.

So not only does this method create a successful exit for the business owner, while preserving the business itself and providing the maximum return for secured creditors, but all paths remain open for the proprietor to participate in the company’s operation. While a reorganization requires an ownership change to create an arm’s length distance from the owner and her assets, the fact is, she knows the business better than anyone. Therefore, it’s generally in the enterprise’s best interest for her to be involved in the new company.

Many distressed owners will use reorganization as an opportunity to create a successful exit, freed from the threat of bankruptcy. At the same time, since the ongoing concern value is preserved, performance-based paths to re-entry remain open de facto, since the business operation was not destroyed.

Overcoming Objections

At SWC, we’re used to encountering skepticism when our clients first hear about our debt resolution and corporate reorganization services. It won’t be any different for you, so we thought we’d outline some of the objections that are likely to come up, so you can help your clients overcome them.

Your client thinks her board of directors will never approve reorganization.

Your client’s board of directors might consist of one person or more than 20. Getting a group of varying personalities to agree on something is always a challenge, and never more so than in the face of unsupportable debt. In this inherently stressful situation, emotions can cloud clear vision, and policies and procedures can interfere with finding a path out.  

The success of an SWC debt workout comes down to simple business principles and finance fundamentals; no fancy words or negotiation tactics, just facts and numbers. Numbers don’t lie; they are impervious to emotion, policy and disagreement. When using these figures to weigh your options, the choice becomes clear: retain control or submit to your client’s creditors. For these reasons, no matter how complicated a board of directors may be, SWC can navigate those obstacles to achieve success.     

Your client thinks his equipment and inventory are too valuable.

There is a significant difference between how much your client paid for her equipment and inventory and how much those assets are worth now. Certainly, you have heard that a car drops 5-10% in value the second it’s driven off the lot. The same concept is true when it comes to business assets, only to a much greater degree. Anyone could drive and use your car once it drives off the lot, but used, specialized business assets have much more limited use to a much smaller pool of potential buyers.  

Further, it takes time, money, resources, skill and energy to locate that pool of buyers to maximize the return on those assets. Banks are in the business of banking, and therefore they don’t have the resources and skills to go through this process efficiently. These are the fundamental reasons why equipment and inventory have very little value in a financially distressed context, regardless of how much was paid for those items upfront.

Asset valuation is a key component of the SWC strategy, and we always use third-party professionals to ascertain this information. We don’t try to change the value; we simply establish the context upon which it is valued — liquidation. For that reason, whatever the valuation is, it never becomes a barrier to our process.

Your client believes her company by-laws prevent a debt workout.

Quorums, corporate votes, managers’ meetings, procedure; it can all be cumbersome and complicated. In the thousands of transactions we have successfully completed, we have never encountered a set of by-laws or internal operating procedures that prevent a reorganization in the face of unsupportable debt. Generally speaking, by-laws are simply a rule book that guides the operation of a company. SWC’s approach doesn’t seek to break those rules, but rather to use those parameters to implement our strategies.

Your client feels his necessary subsidiaries make reorganization impossible.

Complicated business enterprises can have many layers. There might be a holding company that acts as the puppeteer, while different subsidiaries control raw material generation, manufacturing, retail, distribution, and any number of other vertically or horizontally integrated companies. It’s easy to believe these present nothing but complications and obstacles, but the truth is, we view these as beneficial options.

No two debt workouts are the same. The only thing that remains true in every case is our strategic fundamentals. How we apply them is based on the operation. Therefore, the more complicated a business organization’s structure might seem, the more margin we have for maneuverability to minimize loss and maximize return for all parties involved.

Your client fears his business pipeline and network of vendors will be ruined.

Some businesses succeed, some fail, but all take risks. This is an unequivocal fact of entrepreneurial life. While we know business owners want to honor their debts to their vendors and strategic partners, sometimes that just isn’t possible. As the adage goes, blood cannot be squeezed from a stone. So while the preservation of these relationships is paramount, it’s easy to forget that most vendors would rather lose money than lose an ongoing business relationship. If reorganization a business while preserving its operations requires that certain vendors take a financial hit, keeping the end business relationship alive is truly a silver lining. It’s simply a short-term loss for long-term gain.

Your client is afraid these strategies will destroy goodwill.

Goodwill is only destroyed if the business fails. And the company is going to fail if it doesn’t get out of unsupportable debt. When SWC restructures an enterprise, it preserves the business operations and subsequently, the goodwill between all parties.

Your client has too many forms of debt.

In this economy, there are many lending vehicles out there: traditional loans, SBA-backed loans, merchant cash advances, seller-financed debts, vendor debts and landlord debt, to name a few. When addressing a multifaceted enterprise, it’s likely that many are involved in the operation in one form or another. This can look incredibly complicated. It’s easy to think that a debt workout would be impossible when there are so many different types of financial obligations.

The truth is, no matter how many creditors or how many kinds of debt there are, this picture can be simplified into a very straightforward “debt schedule.” It may seem daunting for those who aren’t experienced in the world of business reorganization or bankruptcy law, but the truth is, there is a very clear set of rights each type of creditor has depending upon the type of debt and the creditor’s order in the debt schedule. What looks hopelessly complicated is actually quite simple; once we ascertain who’s who and what’s what, we address each creditor based on their particular rights.

A common misconception is that we need the agreement of all parties involved. This isn’t true, however. We don’t take liberties or shortcuts; we just exercise standards that are fundamental to a capitalist society, which allows us to control the situation.

Finding the Win-Win

SWC has over a decade of experience addressing the following types of debt and provides a positive outcome in every situation:

Traditional or SBA (Small Business Administration) Loans

The SBA wins because they are the recipients of the majority of the funds from any offer in compromise. Because the offer in compromise exceeds what the SBA could collect through forced collection methods, SWC’s process results in a personal guaranty settlement that maximizes their return by ensuring they collect a value higher than they would if the guarantor filed for bankruptcy.

The purpose of the SBA is to support the emergence of small businesses and create jobs. It does this by reducing the risk for banks lending to small businesses through their guaranty process; without the SBA, hundreds of thousands of loans would never be granted. The bank gets a great loan and a guaranty that it will probably not lose anything in default. As a result, the SBA has helped an immense number of successful borrowers compared to the relatively few that fail.

The SBA incentivizes lending banks to lend to small businesses with the SBA guaranty. The bank’s obligation is to underwrite their lending appropriately and to maximize recovery in the case of default. At the end of the day, the SBA is an incentive program designed to stimulate the creation of economic activity. Preserving this economic activity via reorganization furthers the imperatives of SBA, whereas asset liquidation is simply a loss mitigator.

Every SBA loan comes with an approximate guaranty fee of 3%—paid by every borrower. The default rate of SBA loans is under 2%. Therefore, the premium collected by the SBA from all borrowers covers the loss experienced, so the program is technically self-liquidating. Of course, the cost of running the agency far exceeds collections, but if the losses from default are less than the profit from the 3% premium collected on the loan application, the program is being run successfully.

Merchant Cash Advances (MCAs)

The cost of default and failure is built into the business model of a merchant cash advance company, so it should be viewed as overhead, rather than a devastating blow. SWC’s reorganization process delivers the best return possible, given the loan is in default—all within a reasonable time period. This provides the MCA lender a quick resolution so they can move onto other matters.

Vendor and Unsecured Creditors

The ability to write off bad debt and cease expensive collection efforts is a boon to your client’s subordinate creditors, even in cases where they don’t recoup any money. A quick resolution benefits everyone, and because SWC’s strategy helps the business survive, vendors have the opportunity to re-engage in transactions with the new, more powerful entity, thus putting money back in their pockets.

What happens to personal guaranties?

Historically, personal guaranties tend to require a short path to a Chapter 7 bankruptcy, ridding the guarantor of all responsibility, but destroying future credit opportunities. Using SWC’s reorganizational strategies, your client’s personal guaranties are reduced to what we call “affordable losses,” leaving the guarantor able to continue his life’s pursuit, keep his home and remain solvent.

The RISE program has saved thousands of businesses across all industries. Ask us how.