The Lessons of Bankruptcy

Inc . Roundtable participants:

John Koss Age 60; in 1953 founded Koss Corp., in Milwaukee, which became a leading maker of stereo headphones. Koss filed Chapter 11 bankruptcy in December 1984; reorganized and reemerged in December 1985. Last year's sales: $27 million.

Bill Lewis Age 48; has started eight companies. Lewis filed personal bankruptcy twice, in 1977 and in 1986; now founder and CEO of Federal Refunds Inc., Jacksonville, Fla., which assists purchasers of petroleum products in recovering funds on overbilled accounts. Last year's sales: $1 million.

Paul E. Perkins Age 51; in 1978 founded Voyages International Travel Co., in Highwood, Ill., to disseminate travel information using optical disk storage and computers. Filed personal bankruptcy in 1989; currently driving school bus while beginning a new enterprise.

Michael E. Salvati Age 38; in 1985 joined Virtual Network Services Corp., in Oak Brook, Ill., a long-distance telephone-service provider, as a vice-president. Company filed Chapter 11 bankruptcy in 1986 and was sold three months later. Partner and bankruptcy specialist at KPMG Peat Marwick, Chicago.

In the minds of many entrepreneurs, bankruptcy means failure. But four small-company executives who have been through it contend that, although it's not a goal anyone is likely to aim for, it can be a tool: a painful but effective way to learn how to look at your company and your goals differently. And, they say, the lessons of bankruptcy are there even for -- maybe especially for -- those who have not gone through it.

Given the shape of today's economy, we decided that now would be a good time to take out of the closet and dust off a topic most Inc. readers probably prefer not to think about. Senior writer Tom Richman sat down recently in Chicago with three current or former chief executives and one former chief financial officer who had been through bankruptcy proceedings to discuss what it was like and what they had learned.

INC.: Each of you had to have done something somewhat unusual to be invited here. Can you explain what that was?

PERKINS: I had six little companies that I dissolved, and I wound up in personal bankruptcy. No, I didn't have condos, yachts, or a lot of expensive clothes. Instead, I had signed for a lot of expensive electronic equipment, so I took personal bankruptcy. We live on my wife's salary. I drive a school bus every morning because it keeps me alive.

INC.: John, your experience?

KOSS: We tried to diversify, to go into other areas, and we stopped paying attention to our core business, which was stereo headphones. We started to get involved with the Walkman-type personal electronic products. It didn't work, but we spent more and more time trying to make it happen and less and less time on what we knew. Other people took the opportunity to sneak into that market.

We wound up with horrendous debt. In four years we went from practically no debt to $14 million, and sales headed down, from $25 million at their peak. We tried to work with the banks, to get them to understand it was going to take a while to turn this around, and they said, "To us, long term is about a year." That wasn't going to be enough time. So we realized we were going to have to call the guy with the black robe to hold them off while we got this thing reworked.

LEWIS: I've had two sevens -- Chapter 7s. That should be lucky, and in a way it was. If I'd continued on the track I was on, I'd be dead. I've recovered, like an alcoholic, I guess. The only problem I have with it today is that I can buy a Porsche, but I can't rent a Ford. I can't get plastic.

SALVATI: I was at Peat Marwick, and one of my start-up clients was a long-distance phone company. It recruited me as vice-president for finance. I thought it would be a good opportunity to get into a business on the ground level and use my skills in a way I couldn't as a consultant. We lasted two years. We grew from no sales to $15 million in 12 months on an annualized basis. In fact, one of our problems was, we were growing too quickly.

We put in a new president and tried to restructure and sell the company. We found a buyer, but on the day of the signing he decided not to do the deal. We filed Chapter 11 bankruptcy instead, and within a week there was a hostile takeover attempt; some people wanted to come in and assume our position in bankruptcy, but I could see that they had no more cash than we did. We had to hold them off in court until we found another qualified buyer.

The new owners offered me a job as controller, but I decided to take some time to unwind. Now I'm back at Peat, working with companies in bankruptcy.

INC.: You frequently hear the phrase, "sought protection under Chapter 11 of the bankruptcy code." Is that accurate: protection?
SALVATI: That's the reason we filed. We were under tremendous pressure from our creditors because we owed them about $8 million. We were on a 24-hour disconnect notice from our long-distance carriers. By the time you decide to file for bankruptcy, you've got so many people ganging up on you, and it takes only one to ruin the business.

INC.: You believe, most of you, that you got a fair shake from the bankruptcy court?

SALVATI: Yes, but remember that the protection is just from the creditors. You're still out there competing in the marketplace with a weak capital structure, and your customers are getting phone calls from your competition.

One thing you learn in bankruptcy is that you no longer control your company. The court does. All the interested parties in the world are in there talking to the judge, and you're not out calling on customers. You're spending your time in court.

INC.: Nobody forced your company into bankruptcy.

SALVATI: No, we made the decision ourselves, and that's one of the hardest things an entrepreneur can come to: deciding to file. If we had waited another two weeks, we would have been shut down, and nobody would have bought us. A lot of companies moving toward bankruptcy have opportunities to file early, but they're reluctant. They keep looking for those little incremental successes to keep them going.

INC.: You mean people aren't willing to admit to themselves that they'd better get out while they can?

SALVATI: Not so much getting out but giving up control of the company. The entrepreneur's drive to succeed is so strong, but he can see success in only one way: in meeting the goal he originally had in mind. Maybe success to him was going public.

I viewed success differently; I viewed it incrementally. Success was going public if we got the $6 million in equity, but we didn't. So then success became getting to profitability, selling the business, and getting our money out. We came up short there, too, so you keep working your way back. But entrepreneurs typically hesitate to lower their goals, and they end up losing more control.