Weathering the Economic Storm

Businesses throughout the country are struggling as credit has tightened and customers who still order goods often place smaller orders than before. Although bankruptcy filings currently dominate the headlines, bankruptcy remains a last resort for most businesses.

The starting point for finding solutions is to identify the problems to be solved. Many businesses are structured as separate legal entities, such as corporations or limited liability companies, in order to protect the owners from personal liability for the business debts. Businesses rarely have sufficient cash for operations, and they must, therefore, borrow money from a lender such as a bank. Historically, lenders were willing to loan money if they were confident of being repaid. Lenders commonly obtained collateral to secure the loans and personal guarantees to give the lenders additional protection and to ensure that the guarantor had a personal stake in seeing that the lender was repaid. When a business owner guarantees a loan to his business, he is personally liable if the business fails to pay the amount due to the lender. The business owner then has dual objectives: to save the business and to protect personal assets.

Because of these intertwined relationships, the financial problems encountered by a business frequently have a personal adverse effect. The prudent business owner will enlist professional help to identify the underlying causes for the financial problems and to devise and implement solutions. The owner who procrastinates is likely to have more difficulty and fewer options for solving the problems than a proactive owner who acts decisively to turn the business around with an eye on protecting personal assets.

Symptoms of a business in trouble include greater aging of accounts receivable, bloated or outdated inventories and an inability to make payments when due. The problems are more severe if the business fails to pay taxes and diverts those monies to cover operational expenses. The failure of a business to pay trust fund taxes will also result in personal liability for the owner, officer or individual responsible for the payment of those taxes plus severe penalties and interest.

Maintaining good communication with suppliers and lenders during this difficult time is vital. An owner should only promise what can be delivered. Trust must be maintained in order to have a reasonable chance to turn the business around successfully. It may be necessary to request additional time to pay a vendor, or to request that a lender waive late fees or reinstate a non-default interest rate on a loan. Cooperation from vendors and lenders is more likely if they see steps being taken that demonstrate that the owner is serious about solving the problems. These steps may include hiring a turnaround professional, taking a lower salary, or eliminating unproductive positions. Taken together, they comprise a workout plan.

The workout plan ultimately results from negotiations among the parties, with the objective of cutting losses and returning the business to viability. The implied or express thread of bankruptcy might be a helpful tool. The plan may require an additional infusion of capital, providing collateral (or additional collateral, to an already secured lender) or providing personal guarantees. The plan should be evaluated not only for its effect on the business, but also on the owner who is charged with its implementation.

An owner must act cautiously when assessing the commitment required to save a business. Even when an owner has guaranteed the business’s debts, the owner may have personal assets that are sheltered from the reach of creditors. Legislatures have enacted exemption statutes for that specific purpose. Attorneys can assist business owners with exemption planning.

When pressed to raise funds to save a business, owners may be tempted to tap their retirement accounts for cash. Withdrawals from retirement accounts may trigger liability for taxes and penalties. If an owner withdraws funds from a retirement account to help the business, the owner is effectively losing the protection provided by the exemption and is also jeopardizing his or her retirement.

Early identification and intervention will minimize the adverse effect of these problems and increase the likelihood that both the businesses and their owners survive for years to come.