In recent years, an average of 22,000 businesses have filed for bankruptcy each year in the United States. Bankruptcy is a type of business failure that allows the business special ways to operate or pay its debts during its failed state.
To file for bankruptcy successfully, a company has to show that it has more debts than its assets and cash flows can pay off (called insolvency).
In most cases, this would mean that no new debt can be made, but some bankrupt businesses still have access to debtor-in-possession financing. To find out how this is possible, keep reading this handy guide.
Chapter 11 Bankruptcy: Reorganization
If a company goes insolvent, it can file for bankruptcy under chapters 7 or 11 of the US Bankruptcy Code. Under chapter 7 rules, the company’s operations cease and all its assets are sold (called liquidation). Chapter 11 bankruptcy, however, allows the company to continue its operations.
To continue operating responsibly, the bankrupt business can reorganize its financial structure. They also have to work with a committee that represents the affected creditors. The company then has a shot at becoming profitable again.
Debtor-in-Possession Financing
The vast majority of companies need some form of debt for their operating cycles to work. This creates a problem for companies in Chapter 11 bankruptcy because they already have more debt than they can pay off. That is where debtor in possession financing comes into play.
Debtor in possession or DIP financing is a way companies can get helpful lines of credit during this special bankruptcy. Since bankruptcy is a legal process, DIP financing needs to be approved by the bankruptcy court. If the loan fits into the reorganization plan, it can protect the business rather than hurt them.
Getting DIP Financing
DIP financing requires several people’s approval. The bankruptcy court judge needs to sign off on the plan, which also needs to look good to the stakeholder committee and the trustees.
Apart from getting court approval, companies also need to find debtor-in-possession financing lenders. Not every bank or credit provider offers this service. Moreover, if a suitable vendor is found, these loans come with higher-than-average interest rates.
When the company makes the financing plan with the financing vendor, the plan also needs to be meticulously worked out. The loan amount(s), interest rates, and repayment terms need to work very well within the company’s operations. Terms that are even a little off-target can sink the business.
Make the Right Financial Management Decisions Today
Insolvency doesn’t have to be the end of your company. If you file under Chapter 11, your company can continue to operate while paying back creditors under court supervision. Though Chapter 11 is more expensive, it offers your business a lifeline and even access to credit.
With debtor-in-possession financing, you can keep leveraging your operating cycle. You need to make sure you have a good financier, a good plan, and that you have all the permissions in order.
If you liked this guide to DIP financing, check out some of our other finance blog posts. Learn how to manage your personal or business finances like a pro today.
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