Getting Into and Out of Trouble

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Getting Into and Out of Trouble

Most developers experience nail-biting episodes of financial stress at some time or another, often frequently. Underbudgeting a release, finding another project for a team that's wrapping up, and not getting paid on time are the three most common causes of financial trouble. While developers can't necessarily control these realities, there are certain measures they can take to buffer against them.

Preventive Measures

• Be realistic about your budget and schedule. When creating the budget and schedule for your release, hire a designated pessimist to question your assumptions. Add in twice as much fudge factor as you think you'll need. While it seems impossible that your project could possibly cost more/take longer than you've accounted for, somehow, falling behind is the rule and not the exception in the business.

• Make your budget and schedule scalable. Be humble and assume that you won't be able to accomplish everything in your plan within the time and budget allocated. Prioritize and benchmark the development so that at regular intervals you can compare your progress to where it needs to be and scale back features and scope as needed.

• Plan for your publisher to pay you late. Whether due to your tardiness on a milestone, or theirs in paying you, money usually does not arrive when it's supposed to. Keep at least two milestones in the bank or a few months' of burn. This requires a lot of discipline, both in terms of keeping a lid on project scope and avoiding the illusion of comfort that a swollen cash reserve can create. Don't be fooledit's called a reserve because you'll need it at some point.

• Finding new projects. As a general rule, companies start beating the pavement for work once a team hits alpha on its current project. Start earlier if you're less established or trying to get an assignment on a new platform.

• Staffing up. Payroll is a developer's most worrisome expense; if you doubt your ability to keep enough work coming to have everyone on a project, consider hiring contractors (see Chapter 4, "Human Resources") instead.

Remedial Actions

The faster you recognize and address problems, the more leverage and credibility you will have with your creditors. Before planning your strategy, first make a spreadsheet of all outstanding creditors, what they are owed, for which assets, how overdue you are, with amounts more than 60 days put in red, and estimates of amounts that will be coming due in the next two months. This can be a difficult, scary job, but keep a few things in mind: (i) the fact that your company is having trouble does not make you a failure or a bad business owner; (ii) your company's best chance for survival depends on your grabbing the situation by the throat; (iii) having everything in black and white can put a floor on your anxietyat least you know it's no worse ; and (iv) you set the tone for the company's morale , so you have to keep a positive attitude.

Prioritize Your Creditors

If you have a limited amount of capital to go around, you want to get as much time per dollar spent as possible. Look at your creditor list and try to prioritize in order of whose cooperation is mission-critical. Once you have this list, take a look at the mission-critical creditors ( employees and landlord, for example) and start figuring out how much cash you have and will have over the next few months to allocate among these debts and the debts that will come due in the next few months. Now you know what your cash shortfall is for the next few months, and you can start looking for options to meet it.

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TIP

Remember that one of your options is partial payment, so think about a reduced payment that might be acceptable to those creditors.

Figure 3.8. Sleep tight.

Core creditors can include:

• IRS and State Taxing Authorities

• Landlord

• Computer/Equipment Lessors

• Utilities

• Employees

Options

Once you know what your shortfall is, you have five basic options: going to your creditors to negotiate a different payment plan that will help you through the rough patch, known as a workout ; going to your publisher for more money; going to your investors for more money; filing Chapter 11 bankruptcy, which stalls creditors while you try to get the company on its feet; or closing up shop, which may or may not include filing Chapter 7 bankruptcy. Because a development company's

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CAUTION

Any party who has personally guar anteed any of the company's debts (including the lease) and any gener al partners should consult their own attorneys to assess their expo sure to the company's liabilities.

main creditors are usually employees, Chapter 11 is generally not much help with keeping the company going and will not be discussed at length.

Any changes to your obligations or the status of your relationships with third parties need to be adequately documented and structured with your attorney's help, or you could end up down a deeper hole, shovel in hands, wondering how you got there.

Workouts

A workout is a renegotiation of the amount or payment schedule of your debts that usually occurs directly between you and the creditor. Before approaching any creditors with a proposal, you'll need a credible budget for the next few months. While some creditors may be willing to restructure your debt based on a good relationship, others will want to see some indication that you won't come back in the same situation at the end of three months. Be conservative in your estimates, and don't allocate every last dollar to creditorskeep a reserve to be sure you can fulfill your workout commitments. Creditors value predictability almost as much as cash: many would probably prefer to have you pay 30 cents on the dollar for three months and make the payments on time than pay 40 cents and be late again. Be sure that you and the creditor document any changes in your obligations in a signed writing. Your attorney will tell you if you need a simple letter or something more formal like a settlement and release (for example, if a creditor agrees to take a $3,000 lump sum payment in settlement of a $5,000 debt) which legally establishes that the creditor is accepting your payment in full satisfaction of the debt and relinquishes any other rights against you, or is accepting a revised payment schedule and will not later sue you for breach under the original terms of the debt.

Publisher Assistance

First, don't count on your publisher's stepping up to loan you money. While it is entirely possible that they will, there may be any number of reasons why they won't. If your original champion has left the company, whomever inherited your project may not be inclined to extend the company any further than its current commitment. Other problems with a scheduled release may arise that make it more logical for a publisher to let a project drop than invest more money, so if you give them the opportunity to get out of a contract for free (by breaching your agreement to deliver milestones), they might take it. Don't forget: publishers run into cash flow problems, too.

That said, if you are in a squeeze, don't linger in denial until the last minute and then ask for help. A popular delusion when a schedule starts to slip is that the shortfall will get made up later: odds are, your project will be late, and you will have to cover more months of burn than you'd originally budgeted.

When you start missing milestones, talk with your publisher about options should the situation persist. If a publisher gives you more money to complete the project, it is likely that it will need some kind of compensation for this, possibly in the form of a lower royalty. A better choice for both parties may be to review the milestone schedule and reduce the scope of the project. With a modified milestone schedule, the publisher can meet its revenue projections, and you will have the benefit of delivering a project on time.

Investor Assistance

Company investors, including friends and family, may be willing to either lend the company money or to exchange a cash infusion for another piece of the company. If you need the cash right away and there is not enough time to fully negotiate a stock purchase, a bridge loan may be in order: it's basically a short term loan (usually unsecured) that will convert into equity upon the occurrence of a milestone event or a future round of financing. Investors might prefer this where the company is on the verge of insolvency (remember debt gets paid before equity).

Chapter 11

Chapter 11 is like a workout, but generally used when the company's debts (and number of creditors) are more significant and complex. Under Chapter 11 of the bankruptcy code, a company's debts can be "reorganized" while continuing operations. Various committees (of creditors, equity holders, and others) may be appointed to oversee the reorganization, and the reorganization plan is submitted to the bankruptcy court for its blessing. The aim of Chapter 11 reorganization is to dispose of obligations under pre-petition debts and make a fresh start for the company. Note that a company that is on its last leg can't file for Chapter 11 reorganization just to avoid dealing with creditors (see discussion of Chapter 7 bankruptcy in the next section).

Closing up Shop

You will be remembered as much for how you close a company down as for how you ran it. If you wait until the last minute and tell your employees on a Friday not to come back on Monday, you are hurling a karmic boomerang that will eventually come back right between your eyes. Of course, developer employees tend to be a very bright bunch and can sense when the company is in trouble, but they will appreciate the respect of some kind of warning and/or severance .

Closing down can be done without filing for Chapter 7 bankruptcy, and even has some benefits. However, it requires a dedicated and disciplined management team to acknowledge that the company needs to close down and then stick around to perform the clean-up.

How do you know it's time to close? This varies from situation to situation. One suggested benchmark would be when you get down to liabilities plus three weeks' severance for your employees.

Chapter 7 Versus DIY

The choice between filing Chapter 7 and liquidating your company yourself (without the bankruptcy courtbut you should still have an attorney's help) will depend on the assets to liquidate (for example, if they need an expert to sell them correctlyas is likely if most of your salable assets are intellectual property); how motivated your creditors are to work with you; and whether management can handle sticking around to deal with the wreckage.

Chapter 7 bankruptcy is a liquidation proceeding. It does not discharge the company's debts, but limited liability generally bars the creditor from coming after any owners or executives for satisfaction of the debt. Like Chapter 11, Chapter 7 bankruptcy can be voluntary or involuntary. Either the company or one of its creditors may file a bankruptcy petition under Chapter 7, usually when there are competing claims to limited assets and it is clear that the company cannot satisfy or work out all of its debts and continue operation. Once the petition is filed with the bankruptcy court by or against the company, there is an automatic stay, which is like an injunction that, with certain exceptions, stops creditors from taking the company's stuff back or suing it outside the bankruptcy court. Then the court appoints a bankruptcy trustee to liquidate assets, return equipment, and deal with creditors. Operations of the company cease except to the extent necessary to preserve the value of the company's assets.

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NOTE

According to special rules regarding the treatment of intellectual property licenses where the licensor is in bank ruptcy, a licensee may choose to con tinue to use the IP even after bank ruptcy is filed. Consult with a bank ruptcy attorney to analyze this issue.

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CAUTION

Outside of bankruptcy, you may find an angry creditor suing the offi cers as well as the corporation to collect his debt.This is usually little more than a nuisance thanks to limited liability, but any individuals named will have to appear and defend in the lawsuit, or a judgment will be entered against them. Also there may be directors and/or officers liability if the creditors claim breach of fiduciary duties (that is, man agement did not handle the assets prudently, or engaged in other shenanigans). You may be indemnified by the company, but without D&O (directors and officers) insurance, an indemnity isn't worth much.

If you choose to do it yourself ("DIY"), you become, in effect, the bankruptcy trustee and take on all of those tasks . You will be responsible for liquidating the company's assets and halting operations. Creditors will have a right to recover their claims from the assets of the corporation (not from the owners or managers personally if they are in a limited liability entity, see Chapter 2, "First Steps"), but once the corporation has no assets, any creditor lawsuits are probably moot.

Advantages of Chapter 7

The bankruptcy trustee has special powers under the Bankruptcy Code to maximize the sale value of company assets, including the ability to sell leases (for below-market rents, for example) despite anti-assignment provisions and to sell other assets that would otherwise be restricted by creditors' claims.

The automatic stay freezes creditors' abilities to take actions to get satisfaction for their debts. This can free up cash for the trustee to pay the most pressing needs like taxes, employees, and debts guaranteed by individuals.

The trustee and his lawyers will be in charge of most of the paperwork (less work for you).

Disadvantages of Chapter 7

Assuming you have the option of voluntarily entering Chapter 7 (as opposed to being dragged in by a petition to the Bankruptcy Court), the following are disadvantages of filing for Chapter 7 Bankruptcy:

• The bankruptcy trustee will probably lack industry-specific knowledge, so he is unlikely to get top dollar for saleable assets.

• Insiders may be prohibited from buying technology, intellectual property, or projects in development, which are usually the most valuable assets in a development company.

• The trustee will generally be paid before anyone else.

• Unlike a DIY, where management has latitude in deciding whom to pay, the bankruptcy trustee must repay claims according to priorities set out in the Bankruptcy Code.

• If you repaid certain insider creditors before entering bankruptcy, a trustee has the power to unwind those transactions if they are found to be legally fraudulent or preferences.

• Bankruptcy can be as slow as water torture, and about as pleasant.

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TIP

It is possible to blend DIY and bankruptcy: manage ment can liquidate as many assets as possible and then file bankruptcy to take care of the rest.

Advantages of a DIY

• Because you built the assets, you are probably best suited to sell them: you know the market, can explain the asset to potential purchasers , and have more motivation to get the best price than a bankruptcy trustee. Furthermore, outside of bankruptcy, you can sell assets to insiderswho may be uniquely positioned to take advantage of assets like proprietary technologyat fair prices.

• Outside of bankruptcy, you control who gets paid with the available funds. This can be a big deal when management or investors are exposed to debt they've guaranteed.

• You can take advantage of opportunities that might slip in the bankruptcy delay, such as subletting a below-market rental.

• Payments you make to creditors before filing for bankruptcy generally cannot be undone by the bankruptcy trustee.

Disadvantages of a DIY

• Spending time with the wind up will delay your moving on.

• You will probably have to coordinate your activities with your creditors and lessors. And if you truly do not have enough cash to go around, you will spend a lot of energy worrying and haggling with creditors.

• If, despite your best efforts to "work out" your debts, your company nevertheless subsequently ends up in bankruptcy, some payments to creditors made immediately before bankruptcy may have to be returned to the debtor's estate (the pool of assets remaining with the bankrupt company). This is due to the rule of preference : the court does not want you paying off your friends and then freezing everyone else out with a bankruptcy filing; they want the assets distributed pro rata in accordance with the bankruptcy rules.

• You will have a lot of people expecting you to "do the right thing" (see next section).

• Your latitude in deciding who gets paid may result in a spurned creditor (or even an equity holder) suing you as an individual to try to recover. Despite corporate limitations of liability, such a suit would nevertheless be a nuisance and a stressor.

How to Liquidate Your Company

If you decide to do some or all of the wind-up yourself, remember three things:

• The board of directors of an insolvent company owes its duty of loyalty to the creditors, not the owners.

• Creditors are paid before equity holders.

• Under certain circumstances management can legally pay some creditors and not others.

Figure 3.9. Some advantages and disadvantages to Chapter 7 liquidation.

First, create a schedule of the company's assets. Assets may include intellectual property, developments in progress, licenses, below-market leases that may be assigned (check the lease for restrictions on assigning or subletting), or anything else that can be sold. Assets may also include any prepaid expenses like security deposits and taxes. You may be able to access this cash by terminating or assigning your lease, or contacting the taxing authority and filing dissolution forms.

Dissolving a Business Entity

These are some of the steps that may be required to officially dissolve your business:

• Vote for dissolution.

• Surrender your Certificate of Authority to transact business.

• Notify your secretary of state of the dissolution of your business. This may take the form of Articles of Dissolution and/or a Notice of Intent to Dissolve.

• Notify your secretary of state that you are discontinuing the use of an assumed or trade name .

• File the appropriate forms with the IRS.

• Determine whether you will need to file IRS forms at a later date.

• Obtain and file a good-standing certificate with your state tax authority.

• Publish notice of your business's intent to dissolve.

• Contact your commercial insurance agent, notify him/her of the dissolution and determine the best protection against third-party lawsuits that may arise after your dissolve.

• Pay debts.

• Determine whether state statutes require that you notify creditors or the public of your dissolution.

• File an additional notice with your secretary of state stating that all debts have been paid and all assets have been distributed.

• Determine the statutory time limits for third parties to bring suit against you and plan accordingly .

• Collect your remaining assets, and sell or donate property that you are not going to distribute to owners or creditors.

If any assets are collateral for secured debts (where the creditor can take an asset and sell it if the debtor cannot repay the loan), those can't be sold without the permission of the creditor, and should be listed separately. An example of a secured loan is a car loan, which is secured by the car.

Next, create a list of the company's liabilities and creditors, separating out debts for which officers or individuals within the company are personally liable. These may include property and equipment leases, credit cards, and trade accounts where the contract is in the name of an individual or an individual has guaranteed the debt. Don't forget about taxes: officers, directors and those with check signing authority may be personally liable by law for unpaid employment taxes or sales taxes of the business.

As a rule of thumb, you will want to pay debts in the following priority: taxes, employees and vendors critical to the wind up, debts for which individuals are guarantors or otherwise liable, landlord, and all other debts.

Once you start selling assets, mind a few guidelines:

• Get fair market value, albeit liquidation value, for all assets sold ( especially if sold to insiders). The business's assets belong essentially to the creditors: management cannot give the assets away or sell them for less than their value.

• Keep records of the assets' condition, receipts of payments and your efforts to sell them in case there is a later accusation of mismanagement or self-dealing in the sale of assets (proving reasonableness of your efforts will help prevent an unwinding of any transactions).

• Arrange for final tax returns and issuance of W-2's to employees.

• Back up financial and other vital data now on computers so that the records remain available despite what happens to the computers.

• Keep copies of paper records.

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