Why founders are closing their companies instead of filing for bankruptcy
- Chapter 11 of Celsius is rare in a startup world where companies are quietly dying.
- Startups typically burn cash rather than rack up long-term debt or an army of creditors.
- They tend to favor private, out-of-court liquidations to avoid scrutiny, lawyers told Insider.
When Celsius filed for Chapter 11 in July, it admitted in a Manhattan bankruptcy court that it owed answers to its massive 1.7 million user base who held various crypto assets that make up most of its 5 $.5 billion in liabilities.
But the high-profile bankruptcy of the crypto lender marks the relatively rare case of a startup that has run out of money and is looking to restructure in bankruptcy court. According to five corporate lawyers Insider spoke to, many startups are more likely to just liquidate and end their operations privately.
“Many startups don’t have long-term liabilities or debt other than venture capital debt and trade debt,” said Ronald Fleming, partner at Pillsbury Winthrop Shaw Pittman LLP – where he leads his ventures practice. emerging – said.
“They burn money to operate,” he said. “Bankruptcy tends to be a solution to fix balance sheet issues, which isn’t really the problem for startups that can’t raise money to fund operating losses in a tougher funding environment.”
As stock prices of public tech companies tumbled and venture capitalists cut funding during the recession, venture capitalists pressured portfolio companies to cut costs , which for many has meant a reduction in staff. Companies like Coinbase, Gopuff, Better and Noom have all laid off staff.
Others, like Fast, a one-click payment software company, shut down completely and dissolved. Some startups attempt to restructure their operations through a Chapter 11 filing to meet their responsibilities and become a leaner company, while others down the road dissolve and offload their assets as part of the process. extrajudicial procedures.
As the economic downturn hits startups, breakups become more likely. According to data from PitchBook, some 684 US startups ceased operations or filed for bankruptcy in 2020, and that number rose to 804 last year. As of July 28 this year, 356 startups had already closed or filed for bankruptcy, according to PitchBook. The number of bankruptcies in these groups is relatively low — just 60 U.S. startups filed for bankruptcy in 2020, which fell to 37 in 2021, according to PitchBook data.
The cost factor
In court filings, Celsius described significant physical hardware it uses to run its online business, including tens of thousands of bitcoin mining rigs among its $4.3 billion in assets. The crypto lender also said it owed millions to vendors who helped it build a new mining hub in Texas.
A formal Chapter 11 restructuring would help the company, valued at around $3 billion in December, by creating a regulated and transparent process to repay a broad base of creditors, leverage its physical assets and emerge with a business in the other side.
But the costs and rigors of a court-controlled process for Chapter 11 bankruptcy make it a less attractive option for many cash-strapped start-ups and emerging tech companies, attorneys have said.
The problem for startups is that they’ve burned their money, Fleming said.
“A lot of people don’t understand this, but you need money or financing to avail yourself of a bankruptcy restructuring process,” he added.
“Bankruptcy is expensive — the reality for many startups that can’t raise a venture capital round or other bridging funding, is to seek some sort of business combination,” he said. “If this process fails, the choices are either to close and liquidate or, more frequently, to orchestrate a ‘soft landing’ or an ‘acquisition’, often at a very low nominal purchase price, with another startup.”
Companies that restructure in federal court must continue to pay their bills while they close stores or offices and launch asset sales under the supervision of a bankruptcy judge. Bankrupt businesses must also obtain court approval to pay various business expenses, or even to access any financing they have negotiated with lenders and investors in the process.
Other Chapter 11 filing costs can be prohibitive for small businesses, as the bankrupt business must pay the army of professionals involved – bankers, consultants and top lawyers charging upwards of $1,500 an hour – on assets of its debtor.
A quick relaxation
For many emerging tech startups, it’s also less of a problem that they have major liabilities like long-term debt to carefully reduce through restructuring, or a large number of physical stores to close, or major assets like equipment to sell, lawyers said.
When one-click payment startup Fast exhausted some $120 million in funding, it simply laid off employees and shut down operations in April.
“Startups fail for many reasons, which Fast was obviously not immune to. But the decisions made that led to this result for which I take responsibility,” Domm Holland, CEO of the startup, wrote in social media posts at the time.
Startups can quickly shut down and liquidate their remaining assets — often whatever cash is left — and distribute them among remaining creditors, said Ed Zimmerman, a partner at Lowenstein Sandler who chairs the firm’s technology group.
“It’s harder to do some sort of reorganization or work when the assets are also…I don’t want to call it nebulous, but intangible, and maybe unusable without team members,” Zimmerman said. “It’s not like we have a lot of printing presses that can be sold.”
“Startups that prioritize growth over profitability run out of cash because they go from funding to funding,” he said.
This can become a problem when VCs withdraw. Deal activity among U.S. VCs has fallen significantly since record investments hit $342 billion last year, according to PitchBook and the National Venture Capital Association’s 2022 Second Quarter Report. According to the report, as of June 30 this year, trade activity was $144 billion.
The “ABC” process
One approach startups more commonly use to quietly end their operations is a combination of asset sales and liquidations they can operate under the radar with a process known as an assignment for the benefit of creditors, said restructuring lawyers.
The process, which the industry often refers to as “ABC” for short, follows state laws to unwind a business. States have different rules governing the process, and some states like Massachusetts and California — where many Silicon Valley tech companies have their bases — allow startups to handle their dissolution out of court, shielding them from the press. negative and scrutiny.
After Optimus Ride, an autonomous vehicle company, sold valuable assets like its intellectual property to Magna International, a Canadian auto parts maker, in January, it began the ABC process in Massachusetts to repay creditors, Brad Sandler, a partner at restructuring firm Pachulski Stang Ziehl & Jones, told Insider. Sandler is representing the entity that was reducing Optimus Ride’s remaining assets throughout the process, which is out of court.
“Because bankruptcies are expensive, an ABC is, in general, a cheaper and more efficient process,” he said.
The Chapter 7 option
Another option is a Chapter 7 liquidation, a court-supervised proceeding in which a trustee in bankruptcy oversees the distribution of liquidated assets to creditors. Unlike a Chapter 11, a company’s board and management play no role in the process. Electric Last Mile Solutions, an electric truck company, filed for Chapter 7 in Delaware bankruptcy court last month after its CEO and founder both left the company.
As with most restructuring and unwinding processes, creditors have priority in recovering their losses based on the amount of their loans secured by the company’s assets. In the context of startups, subprime lenders like Silicon Valley Bank, which provide loans secured by collateral, could fall into the category of secured lenders.
Investors and shareholders often see their equity wiped out unless a deal can be reached otherwise, the lawyers said.
“When businesses fail, a failing startup’s liquidation value tends to be remarkably low, regardless of how much money it raised or what it thinks its technology is worth,” Fleming said.