How a small business can exit bankruptcy with Debtor in Possession (DIP) Financing
All businesses, large and small alike, experience setbacks. Production difficulties, service disruptions, lost customers, you name it—there are as many things that can go wrong in business as there are businesses themselves. When problems escalate, financial pressure often follows, creating stress for the business and for business owners. Left unchecked, difficulties can threaten the continuation of the enterprise itself. But not always. Debtor in possession (DIP) financing from Businesscash.com is a tool that can be employed to great advantage to save business value, preserve jobs, and allow companies time and the means to get back on track.
What is debtor in possession financing?
Debtor in possession financing (sometimes referred to as DIP financing), provides financing for a business while it takes the time to reorganize its business affairs under the umbrella of protection offered by US bankruptcy statues. It is only available to companies once they have filed for protection under the bankruptcy laws.
The first step then if for a business owner to determine whether to seek shelter under these provisions. If so, then ownership will need to weigh alternatives carefully, such as developing an orderly plan for fixing the company or taking necessary steps to promote a sale of the business or liquidation of assets. Regardless of the pathway or chosen strategy, financing is a critical consideration in keeping an enterprise alive and functioning during any bankruptcy. For this reason, every small business owner should know the rudiments of this borrowing technique—just in case.
How Debtor in Possession financing works
Financing a company while it’s under bankruptcy protection is a unique form of financing, but in many ways, it is among the most straightforward. Simply put— a lender provides financing against the business’ working capital, and in return gets a first-priority lien on the assets of the business as protection, meaning the lender is first in line to be paid upon successful refinance of the business, or upon a sale or liquidation of assets. The loan is “margined” against the assets of the business—meaning the lender estimates the realizable value of the various asset classes (accounts receivable, inventory, fixed assets, and intangible assets) in arriving at a loan amount and structure, allowing for a buffer of safety.
A business typically undertakes DIP financing at the start of a bankruptcy filing. The financing plan is approved by the court as part of the protection granted to the business, and administration of the loan by the lender is subject to court authority as well. Once in place, the business owner now has the liquidity needed to continue to run the business, while an exit strategy and tactics can be thoughtfully developed.
Choosing a Debtor in Possession (DIP) Lender
Choosing a good DIP lending partner is as important as deciding whether to seek bankruptcy protection in the first place. In this short DIP financing primer, there are generally three high-level considerations to be weighed thoughtfully:
- Lender capability. (Less obvious than it seems) Not every lender is equipped to work closely with a borrower during the bankruptcy period, nor prepared to take the time required to understand and properly assess owner’s restructuring plan. Other lenders and capital providers though make it a point to specialize in this type of financing – and make it a priority to work closely with companies when they need help the most. Debtor in possession financing is not like regular lending—businesses should align with a DIP specialist.
- Existing lender relationship. Assuming the existing lender has DIP capability, a business owner should next ask, “can I still work with my existing lender, or is our relationship past the point of no return?” At times, stresses giving rise to a bankruptcy filing produce an irreversible and unreconcilable difference between borrower and lender. Other times, matters get unavoidably personal, making starting fresh a reasonable, practical, and oftentimes necessary alternative.
- Help going forward. Often a new source can provide more than just required funding—but also a relationship that may prove helpful for the business once debtor in possession financing is retired. Ease of doing business during the DIP period is often a key determinant and a proxy for how well a relationship will work going forward.
Areas of expertise to look for in a DIP Funder:
- an online application process
- streamlined information requests
- helpful, timely dialogue with knowledgeable professionals
- straightforward documentation
- transparent, easy to understand rates and fees
- ease of reporting
- quality and timeliness of lender reporting
- ancillary services available beyond lending
A DIP Financing Example
John ran a successful import business for many years in Miami—buying flowers from farms in Central America, and selling to major retailers in the US. Relations with suppliers were good, and customers paid on time. John was cautious about expanding too quickly – the warehouse and redistribution facility he rented was a manageable size, and his payroll modest. One winter, unusually cold weather settled over the mountains in Colombia, and John’s supply of flowers was disrupted for a time. Unable to have their orders filled, customers soon looked elsewhere. Others slow or short paid as John struggled with quality control in the aftermath of his supplier problems. Debt service on equipment leases and rents brought the company quickly to a decision point.
After consulting with his attorney, John elected to seek relief for the business under Chapter 11 of the US bankruptcy code. He then cemented his plan by seeking out debtor in possession financing—financing that would allow him to operate the business profitably while giving him time to work out a restructuring with creditors.
None of John’s existing lenders provided DIP financing, so attention was quickly turned elsewhere. After careful online research, John turned to a factoring company for an effective solution. Within days he was able to arrange for his invoices to be sold to the factor in return for immediate cash. Recognizing the need for additional liquidity, John’s existing term lenders were content for the factor to take a first lien position on the business assets. Once he commenced selling invoices, acceleration of cashflow helped John rebuild his cash position, allowing him to work out payment plans with his creditors and rebuild relationships with customers.
John’s new lender also took pressure off the company’s back office by taking over the credit and collection functions. New customers were screened and pre-cleared by the factor, and collection work was now handled by trained professionals. Business improved, the balance sheet was restored, and John was able to exit Chapter 11 on a strong footing. He kept the factoring relationship in place afterward, as a permanent means of managing cashflow, credit adjudication, and collection functions.
Debtor in possession financing gave John the liquidity and time he needed to restructure and relaunch his business. Suppliers maintained an outlet for their product. Customers were taken care of. Jobs were preserved. Business value was protected.
Setting DIP Lender Expectations
While debtor in possession financing has unique benefits, there are also important practical considerations:
• Fees and expenses for debtor in possession financing are generally higher than “regular” working capital borrowing arrangements.
• Small business owners should expect to be asked for a personal guarantee to back up the debtor in possession loan. This may seem superfluous, or like overkill- but lenders take this as an important sign that the owner is committed to working in good faith and have the DIP perform properly.
• Chapter 11 proceedings are approved by the court, and a judge’s oversight extends to the borrower’s compliance under the DIP loan, making it essential that the business adhere to the terms and conditions of the loan agreement.
• Having debtor possession financing in place is not a guarantee of solvency or ultimate survival of the business. While it represents an invaluable tool for operating during a restructuring, the business owner must still address the systemic difficulties facing the enterprise. DIP provides breathing room necessary.
Debtor in Possession (DIP) financing can sound complicated, but it does not have to be. At its core is a very simple arrangement: the lender provides maximum possible liquidity to a business while it is under bankruptcy protection. The lender is protected by a priority lien on business assets, and a personal guarantee from the owner confirming his or her commitment to the program. The Borrower receives operating capital to keep the business running during the restructuring period. Borrower and lender operate under a credit agreement that is approved by the bankruptcy court, with the court maintains some oversight on the subsequent trajectory of the lending relationship.
Choosing the right DIP lender is an important consideration. Not only does the capital provider need to offer this lending specialty as table stakes, the business owner should reflect carefully on the state of the company’s existing borrowing relationships, and the potential value of lining up a more suitable partner.
Ease of doing business, straightforward documentation, transparent pricing, helpful reporting capability, and professional personal interaction are all good indicators of a successful debtor in possession financing, and perhaps an improved, more beneficial lending relationship post-restructuring. In this way, DIP financing from BusinessCash.com need not be approached with apprehension, rather as a chance to start fresh—and prosper in the process.