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Case Study: Going for Broke
 

Few small companies survive Chapter 11, which makes filing for bankruptcy a last resort for the average privately held business.
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Case Study

In the second week of 2002, Ken Cranston sat staring at the telephone, his brain churning. The previous year had been awful for his company, Terion, which sells systems that help trucking companies keep track of their vehicles. The business, which had $10 million to $15 million in yearly revenue, was deep in debt. Cranston had sought additional financing to no avail. So in consultation with his six-person board of directors, he was at the point of attempting the Hail Mary pass of turning around an ailing venture: filing for Chapter 11 bankruptcy protection.

No business owner takes the decision to file for bankruptcy lightly. Only about 25% of businesses that enter Chapter 11 emerge as operating companies, and the stats are worse for small businesses. Still, "if the company is being bothered by creditors, then filing for Chapter 11 could be a good idea, because it's probably going to have its assets grabbed anyway," says G. Ray Warner of the American Bankruptcy Institute, based in Washington, D.C.

A year ago, Terion had reached that point. The company's problems stemmed from one service, Driver Datacom, that was eating up the profits of the more popular FleetView offering. Terion had kept promoting the former service even as the latter one eclipsed it for several reasons:

  • Terion charged more for Driver Datacom.
  • Driver Datacom was developed by Terion employees, while FleetView had been acquired.
  • The team members who worked on Driver Datacom were based in the company's home office, in Melbourne, Fla., while FleetView was run out of a satellite office in Plano, Tex.

Despite his attachment to Driver Datacom -- which competed head-to-head with a service provided by the telecom giant Qualcomm -- Cranston knew that FleetView was Terion's salvation. Still, getting rid of Driver Datacom was only half a solution. Terion would still carry the debt it accrued developing the system. Secured claims totaled $36 million, and unsecured claims topped $23 million.

Chapter 11 offered a clean start, since a filer is allowed a one-time chance to make any contract null and void. But creditors are not powerless. If Cranston failed to negotiate a restructuring plan with the creditor committee -- which would be appointed by the U.S. Trustee if Terion filed for bankruptcy -- the company might be liquidated. And some individual creditors could deal a death blow unilaterally. For example, to run the FleetView system, Terion leased time on a cellular network from Verizon Wireless. "I was concerned that they would just shut our service off, which would shut down all communications for all of our clients immediately," Cranston recalls.


AT THE BRINK: Even after laying off 70% of his 240 employees, Ken Cranston struggled to service his company's debt.

Creditors were not the only group that Terion would have to calm. There were customers, too. If Terion dumped Driver Datacom, leaving customers with thousands of dollars of useless hardware, it'd be nearly impossible to convert them to FleetView down the road. And FleetView customers would be watching to see how Terion comported itself. Of those customers, the most important were JB Hunt, the second-largest publicly traded trucking outfit in the country, and Xtra Lease, a subsidiary of Warren Buffett's Berkshire Hathaway. If Terion were to file for Chapter 11, it would need the support of those two companies. Cranston sat in his office searching for the right words to use in raising the explosive subject. "If one of them says, 'You know what? That's it. We're done with you guys,' it will be over," Cranston recalls thinking as he picked up the phone.

The Decision

Ken Cranston's calls to JB Hunt and Xtra Lease went well. Both companies would back Terion, based perhaps on Cranston's sweet-talking or on the quality of Terion's product -- or on the fact that between them they had purchased tens of thousands of units that would have been rendered worthless if Terion shut down. On January 22, 2002, Terion filed for Chapter 11 in U.S. Bankruptcy, Middle District of Florida. Cranston and his board put together a plan to sell some assets and cut costs further. They negotiated a partial-payment arrangement with some creditors and turned some debt into equity, erasing nearly all the $60 million that Terion owed.

A supplier of two-way-radio equipment bought Driver Datacom's hardware and assets, while Qualcomm acquired the customer list. Though it pained Cranston to help a rival, he felt it was smart to take care of his Driver Datacom customers. " Eventually, we wanted to try and sell them our other product," he explains. "We didn't want to further the black eye we had given ourselves in the industry."

Cranston says the reorganization was painful. On a typical day, he says, "the lawyers need a bunch of documentation. The investor group wants to see a five-year business plan. Our key customer is threatening to pull out, and our supplier is threatening to cut service off that day if we don't work out future payments. I'd go home and say, 'I don't know if we're going to get through this." As it turns out, Terion did get through it. On August 30, the company emerged from bankruptcy and announced it had raised an additional $11 million from new and existing investors.


The Experts Weigh In


Should Terion Reorganize?

Robert Hartnett, CEO of Houlihan's Restaurant Group and survivor of two Chapter 11 bankruptcies

Rating: 10 (on a scale of 1 to 10, with 10 being "absolutely yes")

"What's good about Chapter 11 is that it's an organized format to deal with all the creditors, especially in this case, because it looks like Cranston can't take care of the unsecured debt. If Terion has around $10 million in revenue and owes vendors $23 million, even if 100% of the revenue is profit, it would take him more than two years to pay it back. And most vendors usually have 30-day terms. I don't know how long it's been since Terion paid its vendors, but I get the sense that it's been a while. If that's the case, a few creditors can get together and force Terion to file for bankruptcy involuntarily. If that happens, the company wouldn't have an opportunity to get together with its vendors, investors, and employees and devise a plan. Cranston would suddenly find himself in a world where he has no control over his business. I think he should file as soon as he can effectively plan for a filing."

John Beiter, former bankruptcy lawyer and founding partner of Resolution Partners, where he invests in distressed companies

Rating: 8

"Generally speaking, I'm a big proponent of filing for bankruptcy. Nobody likes having to file for bankruptcy. However, more than anywhere else in the world, in the United States, Chapter 11 provides a more efficient and transparent process for businesses to reorganize, refocus, and eliminate unprofitable divisions. It gives them a second chance, and it can actually be a very healthy process. In this case, it appears as though Terion wasn't generating sufficient revenue. It needed additional capital, and Cranston had already exhausted all his other potential resources. Perhaps he should have sold Driver Datacom earlier if it wasn't performing, but that's easy to say in retrospect. Given the situation, I'd say Terion is definitely a good candidate for Chapter 11."

Kenneth N. Klee, law professor at the University of California in Los Angeles who specializes in bankruptcy law

Rating: 7

"It sounds like Terion has a viable product line, so it makes more sense to file for Chapter 11 than to sell the assets off. Often companies wait too long to file for Chapter 11, because most managers see it as a failure. If Terion continues to cut back on research and development and lay off employees, it will be only so long before morale dips extremely low. Cranston has two big questions to ask himself: After operating costs, is there anything left? And if he files for Chapter 11, can he get debtor-possession financing (lending on a super-priority basis)? In many cases, it's actually easier to get financing in a Chapter 11. I'd recommend that he call a meeting with suppliers, customers, and investors and propose a prepackaged reorganization plan."


Please E-mail your comments to editors@inc.com.

Last updated: Feb 1, 2003




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