Bankruptcy 101

How to seek Chapter 11 protection, which can help you reorganize while shielding you from creditors

By Jeremy Quittner

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Immunicon's bankruptcy lasted just five months, says Hewett, but morale suffered Bill Cramer

Immunicon's glory days were in 2004. The company, which had developed a tumor screening technology for cancer patients, had landed $85 million in venture capital, then went on to raise $55 million in an initial public offering. Each year, sales more than doubled. "We believed that Immunicon had the potential to be a company with a $500 million-plus market cap," remembers Byron Hewett, Immunicon's chief executive at the time.

But Immunicon had yet to turn a profit. It had burned through $150 million on research and development and was eating up $20 million to $30 million a year in operating costs. In 2006, the company began to stumble. It sold $30 million in convertible debt, greatly restricting management's flexibility. The next year, it became embroiled in a protracted and costly arbitration with its marketing partner, a subsidiary of Johnson & Johnson called Veridex. Immunicon ultimately had to shell out $16 million. "It was a death sentence," Hewett says. "There wasn't enough revenue growth to sustain the business, and we were out of momentum. We could not go back to the public market to raise money."

Immunicon decided to seek Chapter 11 bankruptcy protection in June 2008, in hopes that this would facilitate the sale of the company. Far from the heady days of going public, its management now raced to put together a reorganization plan to pay off creditors and shareholders while staving off liquidation.

No one wants to learn about bankruptcy the hard way—which is why, with the economy struggling, it's critical to understand how it works. In the third quarter of 2008, Chapter 11 filings numbered 2,485, up 94% from the same quarter in 2007, according to the American Bankruptcy Institute in Alexandria, Va.

If you're faced with insolvency, Chapter 11 may let you reorganize your company while shielding you from creditors and discharging unsustainable debt. It's fundamentally different from Chapter 7, which hands your business over to a court-appointed trustee for a formal liquidation. Chapter 11 lets you retain control and, in many cases, emerge with a clean slate. While the sale of a business is a frequent outcome of Chapter 11, that may still be better than shutting down.

Keep in mind, though, that bankruptcy is expensive and time-consuming. And 9 out of 10 companies never emerge from Chapter 11, experts say. "Most struggling small businesses have maxed out [management's abilities], and it is an incredible drain on resources to have to divert management time to running Chapter 11," says Cathleen Moran, an attorney with Moran Law Group in Mountain View, Calif. She says small business bankruptcies can cost $15,000 to $25,000 in legal fees for a retainer, and larger cases often run into the millions. Immunicon's legal bill was $500,000.

In most cases, you'll need a bankruptcy attorney. But you'll also need financing to meet the immediate financial obligations of the business while you're in Chapter 11. Then you'll need to file a reorganization plan and negotiate with your creditors to get the plan approved. The faster this gets done, the better.

CRUCIAL LOAN

The beauty of Chapter 11 is that it can help you get rid of unsustainable debt. But unless you have enough personal savings to float the business, you'll need so-called debtor-in-possession (DIP) financing, which is senior to all other debts and claims. In what is probably the best-case scenario, your bank will renegotiate an older secured loan on new terms. Or a new bank may agree to take on a renegotiated loan from the previous bank, and perhaps extend more financing.

With credit tight, however, DIP financing can be hard to come by. Cincinnati's Riemeier Lumber, an 84-year-old company with 100 employees, started looking for DIP financing in 2008. Two years earlier, the company had moved aggressively into residential construction, buying a local company that made trusses. But Reimeier, which had $58 million in 2005 revenues, saw sales halved to $29 million as the housing market nose-dived and customers stopped paying. The owners couldn't find DIP financing, so the company couldn't file a petition for Chapter 11. "