Bankruptcy 101

Immunicon's glory days were in 2004. The company, which had developed a tumor screening technology for cancer patients, had landed $85 million in venture capital, then went on to raise $55 million in an initial public offering. Each year, sales more than doubled. "We believed that Immunicon had the potential to be a company with a $500 million-plus market cap," remembers Byron Hewett, Immunicon's chief executive at the time.

But Immunicon had yet to turn a profit. It had burned through $150 million on research and development and was eating up $20 million to $30 million a year in operating costs. In 2006, the company began to stumble. It sold $30 million in convertible debt, greatly restricting management's flexibility. The next year, it became embroiled in a protracted and costly arbitration with its marketing partner, a subsidiary of Johnson & Johnson called Veridex. Immunicon ultimately had to shell out $16 million. "It was a death sentence," Hewett says. "There wasn't enough revenue growth to sustain the business, and we were out of momentum. We could not go back to the public market to raise money."

Immunicon decided to seek Chapter 11 bankruptcy protection in June 2008, in hopes that this would facilitate the sale of the company. Far from the heady days of going public, its management now raced to put together a reorganization plan to pay off creditors and shareholders while staving off liquidation.

No one wants to learn about bankruptcy the hard way—which is why, with the economy struggling, it's critical to understand how it works. In the third quarter of 2008, Chapter 11 filings numbered 2,485, up 94% from the same quarter in 2007, according to the American Bankruptcy Institute in Alexandria, Va.

If you're faced with insolvency, Chapter 11 may let you reorganize your company while shielding you from creditors and discharging unsustainable debt. It's fundamentally different from Chapter 7, which hands your business over to a court-appointed trustee for a formal liquidation. Chapter 11 lets you retain control and, in many cases, emerge with a clean slate. While the sale of a business is a frequent outcome of Chapter 11, that may still be better than shutting down.

Keep in mind, though, that bankruptcy is expensive and time-consuming. And 9 out of 10 companies never emerge from Chapter 11, experts say. "Most struggling small businesses have maxed out [management's abilities], and it is an incredible drain on resources to have to divert management time to running Chapter 11," says Cathleen Moran, an attorney with Moran Law Group in Mountain View, Calif. She says small business bankruptcies can cost $15,000 to $25,000 in legal fees for a retainer, and larger cases often run into the millions. Immunicon's legal bill was $500,000.

In most cases, you'll need a bankruptcy attorney. But you'll also need financing to meet the immediate financial obligations of the business while you're in Chapter 11. Then you'll need to file a reorganization plan and negotiate with your creditors to get the plan approved. The faster this gets done, the better.


The beauty of Chapter 11 is that it can help you get rid of unsustainable debt. But unless you have enough personal savings to float the business, you'll need so-called debtor-in-possession (DIP) financing, which is senior to all other debts and claims. In what is probably the best-case scenario, your bank will renegotiate an older secured loan on new terms. Or a new bank may agree to take on a renegotiated loan from the previous bank, and perhaps extend more financing.

With credit tight, however, DIP financing can be hard to come by. Cincinnati's Riemeier Lumber, an 84-year-old company with 100 employees, started looking for DIP financing in 2008. Two years earlier, the company had moved aggressively into residential construction, buying a local company that made trusses. But Reimeier, which had $58 million in 2005 revenues, saw sales halved to $29 million as the housing market nose-dived and customers stopped paying. The owners couldn't find DIP financing, so the company couldn't file a petition for Chapter 11. "We fell short," says Thomas Franke, the company's executive vice-president, whose great-grandfather started the business in 1925. Riemeier closed its doors at the end of 2008.

As you're lining up financing, you should also be preparing to file a petition in your local bankruptcy court, describing your reorganization plan. Once you file, the proceedings become a matter of public record. "You are in a glass house at this point," says Joshua Klein, bankruptcy attorney at Fox Rothschild in Philadelphia. "Anyone can take a look at the company." You'll also be required to file monthly operating reports, including your balance sheet and bank statements.

The reorganization plan needs to include a myriad of details, starting with an itemization of your business assets and liabilities. You must provide information about business equipment you own, any commercial property you own or lease, and bank balances. You'll need to break out employees' wages plus the cost of any retirement and health insurance plans. And of course you'll have to spell out all your secured and unsecured creditors, and how much each is owed.

After Immunicon filed for Chapter 11, management had to work triple-time to deal with the court proceedings and still keep the business running. "It puts an incredible amount of workload on accounting staff," Hewett says. His company's 10-person accounting group worked nonstop to document all cash, assets, liabilities, and customers who had ever bought from the company. Bankruptcy experts warn that more complicated Chapter 11 cases require a separate "shadow" management team just to deal with the filing.

Once you're in Chapter 11, secured lenders are first in line to get paid, followed by taxing authorities such as state and local governments. Next come unsecured creditors, bondholders, and people with legal claims against the company. Shareholders are dead last. But even secured lenders have reason to negotiate. "Their other option is having to foreclose on all collateral, and that could take years in state courts and would cost a lot of money," says Klein. Unsecured creditors often take as little as 5 cents to 10 cents on the dollar. Some creditors may accept equity in the reorganized company in exchange for forgiveness of old debts.


In addition to the judge overseeing your case, your reorganization plan will have to be approved by creditors, who get to vote on it. In most cases, if you have assets of more than $5 million, the unsecured creditors can form a committee to look out for their interests—and review everything you do while in Chapter 11.

While in bankruptcy, you must pay all of your current expenses. Otherwise you'll be thrown into Chapter 7, which is liquidation. New loans, lines of credit, and bills take priority over the old ones, which gives vendors and financiers an incentive to keep doing business with you. That was the case for one New York City restaurateur who emerged from Chapter 11 in April 2008 (and who didn't want to be identified because he feared associating his bistro with the filing). He opened for business in winter 2006, but about five months later, major construction began outside the restaurant. That prevented outdoor seating and made indoor dining a nightmare of noise and dirt. "Who wants to sit inside a restaurant with holes and construction?" the owner says. "You see that and you keep walking." Annual revenues in that first year had been on track to reach about $100,000 but plummeted 40%. The restaurateur fell behind on his rent. He owed his purveyors $50,000, but they kept doing business with him under Chapter 11. "They did not want me to go under," the restaurant owner says. "They decided they would rather get paid later as opposed to never." They sometimes agreed to be paid every six to seven weeks instead of every two weeks, so shipments of fish, wine, and vegetables continued to flow in while the owner reorganized the business.

Chapter 11 also gave the entrepreneur leverage with his landlord, who gave him extra time to catch up on about $24,000 in back rent. Con Edison, his electric utility, had been threatening to cut off power, but agreed to allow the $6,000 in overdue bills to be paid over the course of a year. Now the 11-person company has worked its way back to solvency, posting $700,000 in sales last year.


One more thing to consider: "Time is the enemy," says Howard Brod Brownstein, principal at turnaround management firm Nachman Hays Brownstein in Narberth, Pa. If you don't emerge within 12 months you risk alienating customers, employees, creditors, and financiers. Hewett says Immunicon's bankruptcy, which lasted just five months, was still a blow to the company and employee morale. "But the employees stuck with us and pulled for us," he says. "We needed people to stay so we would have a business to sell." Ultimately the company reorganized, and its onetime legal foe, Veridex, bought it for $33 million, wiping out all its debts and obligations. All but 10 of Immunicon's 56 employees stayed on.

Hewett, who resigned from Immunicon in November 2008 and is now executive chairman at another biotech, describes the bankruptcy as "painful" and "not a process I was looking forward to or ever want to go through again." He adds: "For me, there were no benefits as CEO." But the company did benefit in other ways. "It allowed for an orderly transition, and I did my duty to the best of my ability." Given the alternative, that's not half bad. Return to the BW SmallBiz Feb/March 2009 Table of Contents

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