Exit Outcomes and Firm

Value: Bankruptcy
FIN 6400: Entrepreneurial Finance
Week 7
So it hasn’t worked out….
• For entrepreneurial firms facing bankruptcy, there isn’t much to decide.

• Would it be cheaper to just shut it down and turn it over to an

assignee, or should you pay for a formal bankruptcy proceeding?

• If you are a sole proprietorship, is there enough income to try for

Chapter 13 bankruptcy?

• For the most part, we covered what you should know about the process
in FIN 6100, and there isn’t any point in rehashing it. But there are a few
things related to bankruptcy that you should consider.
What is Chapter 13 bankruptcy?
• In a past course, we covered Chapter 7 bankruptcy (liquidation) and
Chapter 11 bankruptcy (reorganization).

• But for individuals, which includes sole proprietorships, Chapter 13 is

often an option.

• Chapter 13 allows for a partial repayment of debts over a period of

3-5 years. If payments are made consistently, the remaining debt
can be discharged.

• This chapter is based on individual bankruptcies, but if you are

guarantor of business debt and obligations, it can be rolled into your
filing.
Can partnerships file for bankruptcy?
• Only for Chapter 7 liquidation. The partnership can liquidate their assets and
apply them towards their debts.

• But all debts are guaranteed by the partners! So any unpaid liability will fall onto
the individual partners.
• Limited partners are only liable up to the amount they invested and cannot
be pursued for unpaid obligations.
• General partners can be pursued for further payment, and it is not
necessarily limited to the percentage of ownership they had in the
partnership.

• At this point partners can choose to file Chapter 7 or 13 themselves, or they can
pay to cover the debt.
Bankruptcy clauses in the partnership agreement
• Because other partners can be held fully liable for all debt incurred by
the partnerships, one partner filing bankruptcy can leave a greater
potential debt obligation on the remaining partners.

• Therefore, many partnership agreements will have clauses written into

them dictating what happens in the even a partner declares individual
bankruptcy.
• Often, they will lose any voting rights in the firm or input on major
operating or financing decisions.
• Cash flow rights will continue for the partner until his share is
purchased by the other partners.
• Creditors cannot assume a role as partner in the existing
partnership.
Things to avoid!
• Once you decide to declare bankruptcy, the lawyer will walk you through
your optimal choices at that point.

• Your job is to be smart leading up to the actual filing.

• Do not pay back particular debt obligations as opposed to others
immediately before the filing (particularly family!).

• Remember the agency problem of debtholders! Don’t take on

riskier and riskier projects to try and get the return you need to
survive.

• Don’t try to raise money to fill the gap in a failing business. Sunk
cost is an important idea.