Exit Strategy in Bankruptcy

An exit strategy is a very important part of the reorganization process. It is often said that a clear, concise, and well-defined exit strategy is often the difference between a successful reorganization and an unsuccessful one.

Many times, the only reason that a company wants to file bankruptcy is to fend off certain creditors. However, it would be fair to say that this approach is myopic, to say the least. Even if the company is able to fend off creditors at this point in time, soon, a different set of creditors will be aggressively stalking the company. The root cause of the problem is that the company does not have adequate defense.

Successful reorganizations are known to have a clear, well-defined exit strategy right from the very start. In fact, these organizations are known for collaborating with their creditors before this strategy is formulated.

In this article, we will have a closer look at the steps which need to be followed while defining an exit strategy.

Identifying the Objective

In this stage, the shareholders, as well as the creditors, brainstorm so as to understand the root cause of the bankruptcy. Bankruptcy is almost always caused by financial distress. However, the financial distress itself could be because of several reasons.

  • In some cases, financial distress can be because of the external financial environment. Slowdowns in the economy, often become the cause of bankruptcies for many companies. In such cases, the company already has a viable business. It just needs to spend some time until the external environment improves, and so does the cash flow to the business. In such cases, the exit strategy should focus on obtaining moratorium from lenders until the business starts generating cash flow again.

  • In other cases, companies may have a lot of existing debt. In such cases, the company may be generating a reasonable amount of cash flow as compared to its peers. However, the excessive debt on the balance sheet may be draining out all the money in the form of interest payments. These cases can be managed by convincing the debt holders to accept equity in lieu of their debt. It may be more profitable for them also given the fact that if the company goes into bankruptcy, they might not get any money back!

  • In yet other cases, the company may be following financial discipline and may not have undertaken excessive amounts of debt. However, the core product itself may have become obsolete because of new technology. In such cases, the top line of the company will not be sufficient to meet its expenses. In such cases, the exit strategy should focus on improving research and development so as to become more competitive in the market.

Each of the above-mentioned cases has a different root cause leading to bankruptcy and hence needs a different kind of exit strategy. There is no “one size fits all approach.”

Actionable Tasks

The creation of the reorganization plan is a big part of the reorganization strategy. The objective is to take the main objective and then further break it into a set of actionable tasks. These tasks should be arranged in a chronological as well as logical order. Also, the tasks should be given an end-date. Some of the common action items mentioned in exit plans are as follows:

  • Infuse equity in order to ensure that the company has funds to meet its working capital requirements. This will ensure that the operations continue unhampered.

  • Reduce debt, which has accumulated from past leveraged buyouts. This can be done by renegotiating better terms with the creditors. Alternatively, it can also be done by increasing cash flow to the business in the form of more sales.

  • Narrowing the focus of the company by closing down divisions or subsidiaries which do not contribute positively to the cash flow of the business.

  • In some cases, companies openly look for other companies to merge with. If they are unable to find suitable candidates by a certain date, then liquidation of the business may also be on the cards.

Implementing the Strategy

After the objectives have been identified and broken down into actionable items, the next step is to implement the strategy. This can also be difficult to accomplish since the range of actions that a company can take is severely restricted by the bankruptcy court. Hence, using the tools and procedures provided by the bankruptcy court also becomes an important part of the exit strategy. Many times companies have to hire many experts like forensic accountants and valuation experts to help them accomplish their goals.

The perception of the company in the media and the role of the public relations professionals should not be underestimated in the entire process.

It must be understood that the early identification of an exit strategy does not mean that the company is going to implement that exit strategy. In a lot of cases, the material circumstances surrounding the bankruptcy change, and hence the strategy also has to change mid-way. Flexibility is an important tool in the entire process.

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