The following article was written by Omar Aguilar and Robert Del Genio, senior managing directors from FTI Consulting, and Wharton accounting professor Christopher Ittner.
Bankruptcy is a formal process geared toward preserving stakeholder value, and the proceedings often include arduous negotiations between stakeholders that are time-consuming and expensive – with limited focus on enhancing future performance. As such, the main focus tends to be on completing the process, rather than positioning the bankrupt company for transformational growth upon emergence.
This limited focus is certainly understandable given all the pressures and constraints that accompany bankruptcy, especially as pre-packaged and pre-arranged bankruptcies become more common. (In many cases, pre-packaged and pre-arranged bankruptcies primarily focus on solving capital structure challenges, with minimal attention to operational changes to the business). However, some of the constraints that companies operate under during bankruptcy may be self-imposed or driven by conflicting priorities that restrict management’s options — limiting an emergent company’s ability to grow and thrive post-bankruptcy.
To shine a light on the critical need and opportunity for more effective emergence planning, we recently conducted an in-depth market survey of senior executives at companies that are currently in bankruptcy (or recently emerged). In conjunction with the survey, we also analyzed the overall bankruptcy landscape and developed a practical playbook to help companies design and execute successful emergence strategies that address all the key performance dimensions necessary to achieve profitable and sustainable growth after bankruptcy—not just capital structure fixes.
The data-driven and fact-based insights in this article are intended to inform all stakeholders about the emergence opportunities following bankruptcy. However, since the needs and available actions for different stakeholders are varied and nuanced — and sometimes conflicting — we offer relevant insights for the full range of stakeholders, including but not limited to affected companies and their management teams and boards; lawyers and other advisors; lenders and other creditors; and private equity and fund teams.
Bankruptcy Landscape Analysis
Based on our research, there were 665 Chapter 11 bankruptcies filed from January 2019 through May 2021. This analysis focuses on the 358 filings that involved liabilities of at least $50 million at filing. The liability threshold was chosen to provide insights about larger companies with more complex businesses, capital structures and scale.
Bankruptcies hit a 10-year peak in 2020. Chapter 11 bankruptcy filings for companies with liabilities greater than $50 million increased by 53% from 2019 to 2020 as COVID swept across the globe. However, as of August 2021, Chapter 11 filings were down 48% compared to the first eight months of 20202—likely due to buoyant credit markets and a national economic reopening tied to the COVID recovery and rising vaccination rates.
Some industries were hit especially hard by COVID. While not all bankruptcies were attributable to COVID, the pandemic did have a major disruptive impact on many businesses. The sectors most affected by the recent bankruptcy spike were energy (25%), retail & consumer (15%), healthcare & pharma (9%), telecom & media (5%) and hospitality & leisure (5%).
Pre-packaged bankruptcies increased as a filing strategy. Pre-packaged, pre-arranged and pre-negotiated bankruptcies (collectively referred to here as “pre-filings”) increased markedly from 2019 to 2020. Pre-filings accelerate the bankruptcy process and shorten timelines, making it especially important for companies to develop a pre-filing strategy and operating plan to achieve profitable and sustainable growth upon emergence.
The vast majority of businesses successfully emerged from bankruptcy, most as private companies. Of the 134 Chapter 11 cases that were confirmed or closed from January 2019 through May 2021, 88% of the underlying companies successfully emerged from bankruptcy. Among those companies, 75% emerged as private companies and 13% emerged as public companies with stock trading over the counter.
Energy and retail companies accounted for the majority of repeat bankruptcy filings. Between January 2019 and May 2021, 69 companies filed for a second, third or fourth Chapter 11 bankruptcy (based on a 10-year lookback period). The energy and retail industries made up 52% of the total repeat filings, reflecting the volatility of the oil & gas industry and the challenges that retailers face from online and technological disruption.
Emergence Market Survey
To gain real-world, quantifiable insights about the bankruptcy process — and how companies are planning to grow and thrive after they emerge from bankruptcy — we conducted a market survey of 50 business leaders from large companies with direct experience going through Chapter 11. Many of the survey questions focused on the five core business dimensions of capital, cost, growth, technology and talent — and how those dimensions related to the bankruptcy process. Our survey was representative of the market studied and is estimated to have a 13% margin of error at a 95% confidence interval, indicating that the results from the survey are statistically significant.
COVID-related factors were a major contributor to many bankruptcies. According to the survey, the three top reasons for Chapter 11 filings were debt maturities or interest payments (64%), sales and supply chain problems due to COVID (48%), and liquidity issues (32%) – all three of which had links to the global pandemic. That said, many bankruptcies were not directly attributable to COVID, with the global pandemic simply accelerating disruptive market trends and outcomes that were likely to occur anyway.
Capital was the primary focus during bankruptcy. Capital was the top priority for the majority of respondents (56%), followed by cost (34%).
Most respondents believe they were not fully prepared for post-bankruptcy success. According to the survey, respondents were least likely to be substantially prepared for post-bankruptcy success on the dimension of technology (14%). The other four dimensions scored higher: capital (32%), growth (28%), talent (26%) and cost (22%). The speed of the bankruptcy process likely hampers the ability to address these topics — all the more reason for the board and management to focus on these dimensions in a post-bankruptcy period to position the organization for accelerated transformational growth.
Other important business issues were often not meaningfully addressed. Looking beyond the five core dimensions, nearly half of respondents (44%) did not feel they were able to meaningfully focus on other important business issues during the bankruptcy process, a fact that may limit their ability to thrive after emerging from bankruptcy.
Post-bankruptcy capital structures tended to be burdensome. Over seven of 10 respondents (72%) felt their post-bankruptcy capital structure was at least somewhat burdensome, and roughly one in four considered it to be onerous or an inhibitor to growth. Many companies remain highly leveraged on emergence despite having realigned their capital structures during the Chapter 11 process. As these companies continue to improve their financial performance, they can enhance their ability to pursue post-bankruptcy refinancing.
Cost reduction was not aggressively addressed — especially strategic cost reduction. The survey results show that during bankruptcy only 12% of respondents aggressively addressed structural cost issues – such as defining a new operating model – that could have helped them achieve a scalable and sustainable cost structure.
In bankruptcy, a company has unique opportunities to focus on the more profitable aspects of its business and create a stronger foundation for healthy, sustainable growth.
The top targets for full outsourcing were technology/IT and marketing/advertising. During or after bankruptcy, the business areas that were most often fully outsourced were technology/IT and marketing/advertising. Areas that were most often partially outsourced were marketing/advertising, sales/commercial support and customer service centers.
Technology enablement during bankruptcy or emergence was uncommon. Among the companies surveyed, roughly a third or less used technology such as enterprise resource planning (ERP), cloud and automation to enable their customer service centers (34%), technology/IT (32%), finance (32%) and/or supply chain functions (28%). Technology enablement in other parts of the business was even lower.
Technology implemented during bankruptcy was more for reporting and analytics than for transformation and modernization. The top focus area for technology implementation was financial reporting and analytics (58%), followed by reporting and analytics for risk (34%) and reporting and analytics for business/management(30%). Implementation levels were significantly lower for transformational technologies such as cloud (22%), IT modernization (22%) and enterprise data management (20%).
Most companies did not identify and rationalize their most and least profitable customers. The majority of respondents (56%) did not make substantial progress at identifying their most and least profitable customers, potentially leaving the business challenged for sustainable post-emergence profitability.
Growth actions in general were not common. Although various forms of profitability analysis did not receive much attention during bankruptcy or emergence, they were the most common growth-related actions (38%). Other growth actions received even less attention, particularly sales force incentives (8%), international growth (16%), marketing and advertising (16%) and commercial excellence programs (16%).
Most companies in bankruptcy did not adequately address talent issues. The survey results reinforce the theme that talent issues were generally not addressed very well or at all during bankruptcy. Only 16% of respondents felt they did very well at putting an effective executive team in place, likely given the inherent limitation of attracting new talent during bankruptcy. Human capital decisions are usually addressed post-emergence.
In a conventional bankruptcy, the preferred time to think about making a bankrupt business stronger is during the Chapter 11 process — not waiting until after it emerges. In bankruptcy, a company has unique opportunities to focus on the more profitable aspects of its business and create a stronger foundation for healthy, sustainable growth. And while there are certainly situations where consensus cannot be achieved on a company’s strategic plan – or even on the correct timing to bring in transformational advisors or initiate transformational change (given the uncertainty around the final bankruptcy outcome) – it’s essential to have an established playbook for post-bankruptcy planning and success.
The following practical emergence playbook can help bankrupt companies quickly develop effective strategies, plans and business/operating models that address all five core performance dimensions: capital, cost, growth, technology and talent. Of those five dimensions, the two that vary most widely, and therefore determine which playbook approach is applicable, are technology and capital.
- Technology: In some situations, profitable and sustainable growth can be achieved through traditional mechanisms such as organic growth, market expansion and acquisition (an “Emerge to Grow” model). In other situations, profitable and sustainable growth can only be achieved through longer-term technology transformation — using innovative technologies to dramatically improve a company’s performance and competitiveness (an “Emerge to Transform” model).
- Capital: Under either model, an emerging company might need to closely manage its liquidity and capital needs, particularly credit availability, before it can consider an aggressive growth or transformation strategy.
The resulting emergence playbook features four different approaches that increase in complexity, risk and duration depending on a company’s need for technology transformation and/or capital. (Figure 1).
Figure 1: Four approaches to successful emergence
Each of these approaches provides a valuable starting point for post-bankruptcy planning that fits a company’s unique needs and ultimately can help it emerge from bankruptcy positioned to achieve profitable and sustainable growth.
Conclusion: A new approach to bankruptcy
The bankruptcy process has many legal and practical limitations and may not position an emergent company to realize its full potential post-bankruptcy. However, since companies that undergo bankruptcy are taking the necessary and challenging steps to realign their businesses and to maximize value for stakeholders, it’s important for them to emerge stronger and healthier. The findings from this study can help stakeholders make more informed decisions and challenge commonly held assumptions and norms about bankruptcy that might not be relevant to their situations—using the insights and lessons learned to achieve the best possible outcomes during and after bankruptcy.