Chapter 15: Financially Troubled Ventures: Turnaround Opportunities? 244
Chapter 15
FINANCIALLY TROUBLED VENTURES:
TURNAROUND OPPORTUNITIES?
FOCUS
We direct attention in this chapter toward recognizing and managing financial distress.
An inability to pay creditor obligations as they come due typically poses a major financial
threat and certainly distracts the venture from its primary mission. A successful
entrepreneur copes with such financial distress and finds a way to turn the situation
around. The alternative to a successful turnaround is venture liquidation.
LEARNING OBJECTIVES
1. Explain financial distress faced by troubled ventures
2. Define and describe insolvency
3. Describe how troubled ventures emerge from financial distress
4. Describe how private reorganizations and liquidations take place
5. Describe reorganization under Chapter 11 of the U.S. bankruptcy laws
6. Describe liquidation under Chapter 7 of the U.S. bankruptcy laws
CHAPTER OUTLINE
15.1 VENTURE OPERATING AND FINANCING OVERVIEW
15.2 THE TROUBLED VENTURE AND FINANCIAL DISTRESS
A. Balance Sheet Insolvency
B. Cash Flow Insolvency
C. Temporary Versus Permanent Cash Flow Problems
15.3 RESOLVING FINANCIAL DISTRESS SITUATIONS
A. Operations Restructuring
B. Asset Restructuring
C. Financial Restructuring
15.4 PRIVATE WORKOUTS AND LIQUIDATIONS
A. Private Workouts
B. Private Liquidations
15.5 FEDERAL BANKRUPTCY LAW
A. Bankruptcy Reorganizations
B. Reasons for Legal Reorganizations
C. Legal Reorganization Process
D. Bankruptcy Liquidations
SUMMARY
,245 Chapter 15: Financially Troubled Ventures: Turnaround Opportunities?
DISCUSSION QUESTIONS AND ANSWERS
1. What are the three types or methods of restructuring available when trying to
turn around financially troubled ventures?
The three basic types/methods are: (a) operations restructuring, (b) asset restructuring,
and (c) financial restructuring
2. Identify major factors that cause ventures to get into financial trouble.
Ventures get into trouble by mishandling strategic issues, failing to unite management
on key initiatives, and having poor finance and accounting practices and controls.
Since we are primarily examining entrepreneurial finance, we concentrate on the
finance and accounting origins of vent5ure troubles, including overextension of
credit, excessive use of financial leverage (borrowed funds), and lack of adequate
cash planning and financial forecasting.
Factors that cause ventures to get into financial trouble are very similar to those that
bring about venture failure. The U.S. Business Administration found that two-thirds
of business failures are due to either economic factors (inadequate sales, insufficient
profits, etc.) or financial factors (excessive debt, insufficient financial capital, etc.).
3. What is meant by financial distress?
Financial distress refers to when cash flow is insufficient to meet current debt
obligations.
4. What is meant by loan default? Also, describe (a) an acceleration provision
and (b) a cross-default provision.
A loan default is when there is a failure to meet interest or principal payments when
due on the loan. (a) An acceleration provision makes all future obligations of the loan
due immediately upon default, and (b) a cross-default provision provides that if one
loan defaults, it places all loans of the firm in default. (A “technical default” typically
refers to the violation of a loan covenant other than a failure to make a payment that
is due.)
5. What do we mean when we say a venture is insolvent?
An insolvent venture is one where equity is negative and/or the cash flow of the firm
is unable to meet debt obligations.
6. Compare and contrast (a) balance sheet insolvency and (b) cash flow
insolvency.
, Chapter 15: Financially Troubled Ventures: Turnaround Opportunities? 246
Balance sheet insolvency is when the firm has negative equity (or the debt is greater
than the assets) and is usually attributable to multiple years of operating losses. Cash
flow insolvency is when a venture’s cash flow is insufficient to meet its current
contractual debt obligations.
7. Use the concept of cash flow insolvency over time and describe what would
happen if the problem is temporary rather than permanent.
Continued cash flow insolvency over time relates to a sustained inability for cash
flow to meet debt obligations. A temporary insolvency is transient in the sense that
nearby future cash flows, sufficient to meet debt obligations, are expected (and
arrive). See Figure 15.1 for a graphical depiction of the two.
8. What are some of the basic requirements of a successful turnaround plan?
A successful turnaround plan should provide immediate remedial actions (once
serious financial problems are recognized) and detail the financial ramifications
expected given the remedial actions.
Often the immediate goal of a turnaround plan is raising survival cash quickly and
beginning to restore creditor confidence. Components of the plan may involve
employee unpaid leaves or layoffs, the sale of receivables at deep discounts, and the
liquidation of finished goods inventories. The turnaround plan needs to explain
credibly how both short-term survival and long-term financial health will result for
such actions.
9. Define operations restructuring and describe how it can be implemented to
escape financial distress.
Operations restructuring is either growing the firm’s revenues relative to cost or
cutting the firms costs relative to revenue. See Figure 15.2 for this and other ways to
address financial distress.
10. Define asset restructuring and describe how it can be implemented to escape
from financial distress.
Asset restructuring involves either selling off assets and/or improving the firm’s
working capital. See Figure 15.2 for this and other ways to address financial distress.
11. Define financial restructuring and describe what is meant by (a) debt
payments extension and (b) debt composition change.
Financial restructuring involves changing the contractual terms or composition of the
firm’s debt obligations to help the firm meet those obligations. Debt payment
extension is allowing the firm to pay their interest or principal payments at a later
, 247 Chapter 15: Financially Troubled Ventures: Turnaround Opportunities?
date. Debt composition change is when the creditor reduces its claim (typically
interest or principal) against the firm.
See Figure 15.2 for the use of financial restructuring and other ways to address
financial distress.
12. What is a private workout? Also, describe some of the characteristics of
ventures that are likely to engage in private workouts.
A private workout is a voluntary restructuring of the firm in lieu of declaring
bankruptcy. Ventures engaging in private workouts typically have few creditors
and/or are early stage ventures. They also rarely have public bonds outstanding.
13. What is a private liquidation? What does the process of assignment mean?
A private liquidation is selling the pieces of a venture. The process of assignment is
the distribution of assets to a third party to liquidate them and distribute the proceeds
to the creditors.
14. What is Chapter 11 bankruptcy and how is it used by ventures?
Chapter 11 bankruptcy is an attempt by the firm to receive protection from creditors
as it tries to reorganize itself.
15. Describe a venture bankruptcy. Also, indicate the difference between (a) a
voluntary bankruptcy petition and (b) an involuntary bankruptcy petition.
A venture is bankrupt when a petition for bankruptcy is filed with a federal court.
Voluntary bankruptcy is a petition filed by the venture’s management. An
involuntary bankruptcy is one where the petition is filed by the venture’s creditors.
16. Briefly describe the common pool and holdout problems that often make it
necessary for a venture to enter into a court-supervised reorganization.
A common pool problem exists because individual creditors have an incentive to
foreclose on the venture even though it is worth more as a going concern. The
holdout problem exists when one or more of the creditors refuse to agree to the
reorganization terms because of the potential for a larger individual recovery.
17. Briefly define the following terms: (a) “cram down procedure,” (b) “debtor-
in-possession financing,” and (c) “prepackaged bankruptcy.”
A cram down procedure is when a bankruptcy court accepts a reorganization plan for
all creditors including dissenting creditor classes. Debtor-in-possession financing is
short-term financing to help meet liquidity needs during the reorganization process.
A prepackaged bankruptcy is an initial private attempt to convince a majority of the
Chapter 15
FINANCIALLY TROUBLED VENTURES:
TURNAROUND OPPORTUNITIES?
FOCUS
We direct attention in this chapter toward recognizing and managing financial distress.
An inability to pay creditor obligations as they come due typically poses a major financial
threat and certainly distracts the venture from its primary mission. A successful
entrepreneur copes with such financial distress and finds a way to turn the situation
around. The alternative to a successful turnaround is venture liquidation.
LEARNING OBJECTIVES
1. Explain financial distress faced by troubled ventures
2. Define and describe insolvency
3. Describe how troubled ventures emerge from financial distress
4. Describe how private reorganizations and liquidations take place
5. Describe reorganization under Chapter 11 of the U.S. bankruptcy laws
6. Describe liquidation under Chapter 7 of the U.S. bankruptcy laws
CHAPTER OUTLINE
15.1 VENTURE OPERATING AND FINANCING OVERVIEW
15.2 THE TROUBLED VENTURE AND FINANCIAL DISTRESS
A. Balance Sheet Insolvency
B. Cash Flow Insolvency
C. Temporary Versus Permanent Cash Flow Problems
15.3 RESOLVING FINANCIAL DISTRESS SITUATIONS
A. Operations Restructuring
B. Asset Restructuring
C. Financial Restructuring
15.4 PRIVATE WORKOUTS AND LIQUIDATIONS
A. Private Workouts
B. Private Liquidations
15.5 FEDERAL BANKRUPTCY LAW
A. Bankruptcy Reorganizations
B. Reasons for Legal Reorganizations
C. Legal Reorganization Process
D. Bankruptcy Liquidations
SUMMARY
,245 Chapter 15: Financially Troubled Ventures: Turnaround Opportunities?
DISCUSSION QUESTIONS AND ANSWERS
1. What are the three types or methods of restructuring available when trying to
turn around financially troubled ventures?
The three basic types/methods are: (a) operations restructuring, (b) asset restructuring,
and (c) financial restructuring
2. Identify major factors that cause ventures to get into financial trouble.
Ventures get into trouble by mishandling strategic issues, failing to unite management
on key initiatives, and having poor finance and accounting practices and controls.
Since we are primarily examining entrepreneurial finance, we concentrate on the
finance and accounting origins of vent5ure troubles, including overextension of
credit, excessive use of financial leverage (borrowed funds), and lack of adequate
cash planning and financial forecasting.
Factors that cause ventures to get into financial trouble are very similar to those that
bring about venture failure. The U.S. Business Administration found that two-thirds
of business failures are due to either economic factors (inadequate sales, insufficient
profits, etc.) or financial factors (excessive debt, insufficient financial capital, etc.).
3. What is meant by financial distress?
Financial distress refers to when cash flow is insufficient to meet current debt
obligations.
4. What is meant by loan default? Also, describe (a) an acceleration provision
and (b) a cross-default provision.
A loan default is when there is a failure to meet interest or principal payments when
due on the loan. (a) An acceleration provision makes all future obligations of the loan
due immediately upon default, and (b) a cross-default provision provides that if one
loan defaults, it places all loans of the firm in default. (A “technical default” typically
refers to the violation of a loan covenant other than a failure to make a payment that
is due.)
5. What do we mean when we say a venture is insolvent?
An insolvent venture is one where equity is negative and/or the cash flow of the firm
is unable to meet debt obligations.
6. Compare and contrast (a) balance sheet insolvency and (b) cash flow
insolvency.
, Chapter 15: Financially Troubled Ventures: Turnaround Opportunities? 246
Balance sheet insolvency is when the firm has negative equity (or the debt is greater
than the assets) and is usually attributable to multiple years of operating losses. Cash
flow insolvency is when a venture’s cash flow is insufficient to meet its current
contractual debt obligations.
7. Use the concept of cash flow insolvency over time and describe what would
happen if the problem is temporary rather than permanent.
Continued cash flow insolvency over time relates to a sustained inability for cash
flow to meet debt obligations. A temporary insolvency is transient in the sense that
nearby future cash flows, sufficient to meet debt obligations, are expected (and
arrive). See Figure 15.1 for a graphical depiction of the two.
8. What are some of the basic requirements of a successful turnaround plan?
A successful turnaround plan should provide immediate remedial actions (once
serious financial problems are recognized) and detail the financial ramifications
expected given the remedial actions.
Often the immediate goal of a turnaround plan is raising survival cash quickly and
beginning to restore creditor confidence. Components of the plan may involve
employee unpaid leaves or layoffs, the sale of receivables at deep discounts, and the
liquidation of finished goods inventories. The turnaround plan needs to explain
credibly how both short-term survival and long-term financial health will result for
such actions.
9. Define operations restructuring and describe how it can be implemented to
escape financial distress.
Operations restructuring is either growing the firm’s revenues relative to cost or
cutting the firms costs relative to revenue. See Figure 15.2 for this and other ways to
address financial distress.
10. Define asset restructuring and describe how it can be implemented to escape
from financial distress.
Asset restructuring involves either selling off assets and/or improving the firm’s
working capital. See Figure 15.2 for this and other ways to address financial distress.
11. Define financial restructuring and describe what is meant by (a) debt
payments extension and (b) debt composition change.
Financial restructuring involves changing the contractual terms or composition of the
firm’s debt obligations to help the firm meet those obligations. Debt payment
extension is allowing the firm to pay their interest or principal payments at a later
, 247 Chapter 15: Financially Troubled Ventures: Turnaround Opportunities?
date. Debt composition change is when the creditor reduces its claim (typically
interest or principal) against the firm.
See Figure 15.2 for the use of financial restructuring and other ways to address
financial distress.
12. What is a private workout? Also, describe some of the characteristics of
ventures that are likely to engage in private workouts.
A private workout is a voluntary restructuring of the firm in lieu of declaring
bankruptcy. Ventures engaging in private workouts typically have few creditors
and/or are early stage ventures. They also rarely have public bonds outstanding.
13. What is a private liquidation? What does the process of assignment mean?
A private liquidation is selling the pieces of a venture. The process of assignment is
the distribution of assets to a third party to liquidate them and distribute the proceeds
to the creditors.
14. What is Chapter 11 bankruptcy and how is it used by ventures?
Chapter 11 bankruptcy is an attempt by the firm to receive protection from creditors
as it tries to reorganize itself.
15. Describe a venture bankruptcy. Also, indicate the difference between (a) a
voluntary bankruptcy petition and (b) an involuntary bankruptcy petition.
A venture is bankrupt when a petition for bankruptcy is filed with a federal court.
Voluntary bankruptcy is a petition filed by the venture’s management. An
involuntary bankruptcy is one where the petition is filed by the venture’s creditors.
16. Briefly describe the common pool and holdout problems that often make it
necessary for a venture to enter into a court-supervised reorganization.
A common pool problem exists because individual creditors have an incentive to
foreclose on the venture even though it is worth more as a going concern. The
holdout problem exists when one or more of the creditors refuse to agree to the
reorganization terms because of the potential for a larger individual recovery.
17. Briefly define the following terms: (a) “cram down procedure,” (b) “debtor-
in-possession financing,” and (c) “prepackaged bankruptcy.”
A cram down procedure is when a bankruptcy court accepts a reorganization plan for
all creditors including dissenting creditor classes. Debtor-in-possession financing is
short-term financing to help meet liquidity needs during the reorganization process.
A prepackaged bankruptcy is an initial private attempt to convince a majority of the
