If you or someone you know invested in a company that is now bankrupt or filing for bankruptcy, it’s time to take a step back and understand your situation and options. People say that if you’ve invested in a company that has recently filed for bankruptcy, you’re pretty much screwed. You’ll most likely receive nothing back, and if anything, it’ll be the tiniest amount of return. But people are starting to discover that may not be true. Whether you’ll receive anything back depends on the case.
Every bankruptcy filed works based on the company and the proceedings. Even if you are to receive something back, usually companies take care of secured creditors first. Not fair, right? Let’s find out more about bankruptcy, and how it affects businesses and investors.
What Happens When A Company is Filing For Bankruptcy
Let’s first talk about Chapter 7. According to the U.S. Securities and Exchange Commission, “the company stops all operations and goes completely out of business. A trustee liquidates the company’s assets, and the money pays off debt.” Want to hear something ridiculous? Secured creditors are the priority when it comes to getting money back. When a company goes bankrupt, they are paid back first, before bondholders. That is why absolute priority can be so frustrating.
Creditors are taking the least risk, and accept very low-interest rates in exchange for the added safety or assets a company pledges. In a Chapter 7 bankruptcy, equity holders may not receive compensation for their shares. This is despite the fact that they have full potential to see their share of retained earnings. But with the risk-return trade-off, it’s understandable that bondholders are first, and shareholders fall second.
Now let’s move onto Chapter 11 bankruptcy. If a company is looking for a fresh start, Chapter 11 is the perfect move forward. This U.S. Bankruptcy Code does not need a business to shut down permanently, because there is hope that the company will return to financial health and continue to grow in the future. Sounds like the better of the two chapters, doesn’t it? Well, it is! But what Chapter 11 bankruptcy does need is a total reorganization of the debtor’s assets and business affairs. Usually, corporations that need time to restructure debt but still run their business will jump to filing Chapter 11.
But if the process fails, the assets get liquidated and payment made accordingly. Now, what about the shareholders? Shareholders may have a vote on the plan, but it is never guaranteed (because they are second to creditors.) Let’s learn more about the investors of a bankrupt business.
Investors Vs. Bankruptcy
You may ask yourself, now what about investors? They spend money on shares, and lose the assets in the end if the company fails? The truth is, no one intentionally invests money in a company that is bound to start filing for bankruptcy. The risk is always there, and when you decide to invest in a business, you are accepting the consequences of potential bankruptcy.
If you are a shareholder, the value of your shares will decline as your company approaches bankruptcy. The results? I’m sorry, but it’s bad news. There is a very high chance you won’t see any of your money back. Another negative, your opportunities, and rights as an investor reflect the company status. According to the SEC, “During Chapter 11 bankruptcy, bondholders stop receiving interest and principal payments, and stockholders stop receiving dividends.
If you are a bondholder, you may receive new stock in exchange for your bonds, new bonds or a combination of stock and bonds. If you are a stockholder, the trustee may ask you to send back your stock in exchange for shares in the reorganized company. The new shares may be fewer in number and worth less. The reorganization plan spells out your rights as an investor and what you can expect to receive, if anything, from the company.”
Shareholders and unsecured creditors have to wait for the compensation of secured creditors before they can see anything in return. As an investor, Chapter 11 is always better than Chapter 7, but either way, don’t expect much back. Even if the company becomes profitable again, the process of returns is slow.
What Should I Do?
So what should you do as an investor if the company you invested in is filing for bankruptcy? Treat bankruptcy the same way you would treat your stocks. The question is whether it is still worth the commitment, and make the best decision possible. Learn to let go of a failed investment, and save yourself from the stress of bankruptcy. If you or someone you know wants to learn how to handle the struggles of bankruptcy, talk to someone here.