When the money runs out, and obligations outweigh assets, most companies, failing to locate an “angel” to save the business, will face liquidation and most likely settle for peanuts with the sale of any IP and activity to the highest bidder.
It is however our experience this does not necessarily have to be the case.
Financial distress is an inventible phase that almost every early stage company goes through. But don’t take my word for it, read Ben Horowitz’s book The Hard Thing About Hard Things.
And when it does happens the company in most cases loses its founders – the driving spirit behind the technology, in addition to its going concern value.
But remember: peanuts are for monkeys and this doesn’t have to be the case, as our judicial system offers companies in general, startups included, a better alternative to winding-up, one that protects the company’s personnel and its going concern value while working on a recovery plan.
This alternative is called “stay of proceedings” and the legal arrangement is set forth in Section 350 of the Companies Law.
The financial markets give a lot of attention to the major companies going through debt restructuring or reorganization, as evidenced by the amount of media coverage they are getting from the financial papers.
The reason these companies are not going into liquidation is because they are worth much more as a going concern, and have good prospects for rehabilitation.
Startups, however, employing just a handful of people and valued at only several millions, are not that interesting to the financial markets and their stories rarely make the press.
But startups, as any other company big or small, are entitled to petition the court for a stay of proceedings order, and when any of our clients reaches the point of financial distress we cannot underemphasize the benefits of corporate recovery over liquidation.
Section 350, our equivalent to Chapter 11 in the US, provides distressed companies the protection of the court from legal claims for a certain period of time while the company works on a recovery plan.
A stay of proceedings order affords the company time to locate an investor or work on reorganization for turning the company around and getting it back on track.
Entrepreneurs, founders and executives need to know winding-up is not the only option to deal with insolvency, and VCs and investors should know there could be significant money to be made in investing in distressed companies.
If you fancy, pick up the book by Tony Hsieh, Zappos CEO, describing how his company, which was acquired by Amazon for $1.2 billion, was more than once on the verge of going under.
Achiad’s dispute resolution practice is focused on conflicts concerning shareholders, securities, technology, intellectual property and labor law issues, and is also an expert on bankruptcy and restructuring.
DISCLAIMER: Blog posts are not designed to provide legal advice or create a lawyer-client relationship. You should not take action based on this content.