| Chapter 11 usually happens when a company has a level of debt that was issued at a certain valuation or time in their business performance. And then for whatever reason, the company has poor performance and the debt level no longer makes sense. Good example is oil and gas companies that raised debt when oil was $100, and now have to operate in a ~$50 oil world. Their operating cash flow has decreased a ton (>50% due to fixed costs), and it's unclear on whether they can make interest payments (and probably can not repay their principal). The equity will clearly not make any money and the business does worse in the long-run which presents more risk for more junior creditors (the company can not re-invest in growth, business contracts are more onerous as you have credit risk, low morale w/ employees, etc.).[1] But Chapter 11 is not something a company can do at anytime. You have to prove that the restructuring of the equity and debt makes sense to either (1) your shareholders and creditors or, if that fails, (2) a judge. Additionally, employees and the board will have equity that will get cancelled or receive pennies. So if it's marginal on whether there could be equity value someday, the company is not going to do it. On the flipside, it's pretty frustrating if you can't issue stock options that will have value someday. Overall Chapter 11 bankruptcy is a great thing for business... it allows companies to breathe again and re-invest in growth. As far as cons...obviously the equity investors and maybe some of the creditors lose a call option on their investment (not worth anything today, but could be in the future). But that call option may be compensated for in the restructuring agreement. But the biggest con IMO is that Chapter 11 is expensive, and usually bankers / lawyers make outrageous fees here. That was a lot and sorta of scattered. But if you see "Chapter 11" bankruptcy you shouldn't always think "this business sucks" or "this business doesn't make a profit," but should put more blame on a financier somewhere who created a capital structure that wasn't sustainable. [1] The company may also have upcoming maturities in more junior debt, and the more senior creditors don't want them to pay the principal. Liquidation preference is a good search term if you're interested in this. Edit: Also worth noting that creditors don't always take a 0. Sometimes their debt is reinstated, sometimes they receive equity for their debt, and sometimes they receive pennies just to get them to agree (cheaper and faster for everyone to agree than to have a judge decide). All depends on the valuation of the business and where their debt sits. |
That's intended as a good example (in the sense of "clear, characteristic")? I thought oil extractors were expected to hedge or buy financial instruments that ensure they'll be able to sell at a good enough price given a project's costs. And even if not, it doesn't seem accurate to call that a case of "poor performance" but rather, external factors.