SBRA Subchapter V – A Viable Option for Business Recovery
In our previous post on Business Recovery and the SBRA, we wrote about the difficult choices businesses are making as they seek to remain solvent, retain control of their business, and chart a viable course for the future. Much of the difficulty in these choices is evaluating the pros and cons of each. The SBRA, passed in 2019 and expanded by the CARES Act, added a new Subchapter V to Chapter 11 of the Bankruptcy Code designed to make it faster and cheaper for small businesses to reorganize while still ensuring a fair and equitable outcome for creditors. Scenario modeling and analysis can help to determine whether SBRA and Subchapter V reorganization is the best path for your organization’s business recovery.
This case study analyzes a fictional business in one of the sectors hardest hit by the 2020 pandemic – restaurants. As this chart (below) from CNBC shows, months of modest but steady pre-COVID sales gains were wiped away by plummeting patronage and subsequent revenue losses post-COVID. Many restaurateurs are now struggling to find the right path forward.
SBRA Case Study – Restaurants
XYZ Restaurants is a 10-location restaurant chain that specializes in traditional Gaelic fare accompanied by live music and a deep selection of ales and whiskeys. Already struggling prior to the pandemic, XYZ faced cashflow that was barely enough to service debt and had deferred a much-needed investment to refurbish several locations. The company’s efforts to increase market share by keeping prices below market significantly shrunk its margins. Below is a summary of the organization and its financial position.
Prior to the pandemic, XYZ began working with external finance and reorganization experts to evaluate its options, which included a potential consolidation of the real estate funding and asset-based loan debt into a long-term SBA loan.
XYZ’s struggles have been amplified by forced closure of bars and decreased in-store dining. All but one of its restaurants are in a state experiencing a COVID-19 case resurgence and, notwithstanding that no executive orders have been made for dining rooms to close, patrons are deciding not to eat out.
The owners are committed to the company and believe they can rebuild the business over the next three years if the debt burden is relieved and leases can be temporarily modified until revenue is restored. Their primary lender has communicated a willingness to work with the company, including taking a discount on any part of their debt that is repaid now and restructuring the terms of the remaining debt subject to reviewing the company’s turnaround plan.
“If you want peace, prepare for war” – Roman General Publius Flavius Vegetius Renatus
However, even with the proposed debt cancellation and restructuring, XYZ is not viable as currently constituted. Management must, therefore, make tough and consequential decisions and engage all of its lenders and creditors in a decisive manner to achieve an outcome that ensures the long-term viability of the business.
The proposed approach is to calculate the impact of several different scenarios and then approach counterparties with a “hard way / easy way” argument that makes the case for a negotiated out of court settlement as a win:win scenario vs other options available to the company. For this strategy to work, preparation is essential. This might mean that in order to achieve the preferred strategy of an out-of-court restructuring, it might be necessary to make preparations to file under SBRA Subchapter V of Chapter 11 so that creditors realize the seriousness of the company’s position.
The SBRA Alternative
The SBRA, which was enacted in August of 2019 and became effective in February of 2020, provides a new option for court supervised reorganization of small businesses. The Act itself makes this option available to any business with less than $2,725,625 in total debt. The CARES Act raised the debt limit from $2,725,625 to $7.5M, but only for filings through March 27, 2021. The program is much more favorable for small business owners than a standard Chapter 11 option, which is significantly more complicated and more expensive.
Proceedings under SBRA / Subchapter V are much faster compared to traditional bankruptcy options. A reorganization plan must be filed within 90 days of an initial court filing of intent to reorganize. There is no creditor committee involved. If the plan is approved and if the debtor complies with the terms, generally using all free cash flow to repay debts over a 3-5 year timeframe, then at the end of the plan period, the company is discharged and the business owner retains ownership and control of their company.
Steps for a Successful SBRA Decision
For any strategy to succeed, preparation is essential. Failing to prepare is preparing to fail. Any business in need of restructuring that fits eligibility guidelines should consider the following steps in making the best decision for their business.
Step 1: Prepare a Detailed Financial Forecast
Before they can properly evaluate options, XYZ’s leaders must form a clearer picture of the road ahead. This begins with preparing detailed five-year pro-forma financial projections to determine free cash flow (FCF). FCF equates to Funds from Operation minus Maintenance Capital Expenditure (FCF = FFO – MCE) and is the amount available to fund debt service. XYZ should then:
- Prepare a debt schedule showing the priorities for debt repayment under current terms.
- Calculate the debt load the business can carry with available free cash flow (this becomes the object of negotiations with creditors).
- Develop a proposed alternative debt restructuring plan that shows the amount of debt forgiveness that would be required along with proposed terms for the remaining debt (e.g. principal amount, interest rate, amortization period).
- Assess whether the plan meets the “fair and reasonable” test?
Step 2: Assess All Available Options
XYZ’s options include:
- Liquidation of Assets
Many of the assets are attached to the real estate and are not saleable. The realization of remaining assets would yield a relatively small sum relative to the debts.
- Surrender the Business to their Lenders and Walk Away
This is not the desired outcome.
- Sell the Operating Units
This option should be evaluated in conjunction with an experienced business broker. It is unlikely to generate sufficient funds to satisfy all creditors. There are likely few buyers for restaurants in the current environment, and those that are buying are bottom fishing.
- Out of Court Restructuring
This would be the most desirable option, but it might be tricky to facilitate. It would look a lot like the proposed SBRA Subchapter V proposed plan without the involvement of the court. It would require the voluntary cooperation of numerous parties who would need to be convinced that it is in their best interests to offer such cooperation (see the prisoner’s dilemma).
- File for Bankruptcy Protection under the provisions of the SBRA – (Subchapter V of chapter 11 of the Bankruptcy Code).
- File for Chapter 7 Bankruptcy – (see #1 above).
In consultation with the company’s attorney, strategic financial advisers, and restructuring specialists, management should consider all options and perform further detailed analysis on the most viable options (likely 3, 4, and 5 above).
Step 3: Execute Preferred Option(s)
In addition to fully evaluating their preferred and default (fallback) outcomes of creditor negotiations, XYZ should formulate a detailed pitch for its creditors outlining XYZ’s proposal and presenting compelling reasons for the creditor to accept. It is recommended that an SBRA filing and first draft restructuring plan be prepared before entering into substantive conversations with creditors. These can be previewed with creditors as the alternative to an out of court settlement. If such a settlement cannot be reached the company can quickly execute on its Plan B and file their plan with the Court.
Make an Informed SBRA Decision
As restaurateurs and other business leaders experience the pressures of business performance and solvency wrought by government restrictions and public fears in response to the COVID-19 pandemic, they should carefully examine all the options available to them for restructuring and seek the insights of external experts and counsel that have helped other similar businesses through these tough times. The good news for XYZ, and others like them, is that SBRA is making it much faster and less costly for businesses to reorganize and plan the rebuilding of their company instead of remaining mired in wrestling with the problems of the past.
Need assistance in determining the best path to reorganization and rebuild your business? Request a free consultation from a vcfo expert who can help you determine whether the SBRA or another option is right for you.