Moderator: 0:01

Welcome to the Empowering Healthy Business podcast, THE podcast for small business owners. Your host, Cal Wilder, has built and sold businesses of his own and he has helped hundreds of other small businesses. Whether it is improving sales, profitability and cash flow; building a sustainable, scalable and saleable business; reducing your stress level, achieving work life balance, or improving physical and emotional fitness, Cal and his guests are here to help you run a healthier business, and in turn, have a healthier life.

Cal Wilder: 0:34

Welcome. This podcast, as you know, is dedicated to empowering small business owners to run healthy businesses. And so often we're talking about things like measuring profitability setting targets, how do we grow revenue and profit, you know, a lot of positive aspects of owning and running businesses. But at the same time, business is hard. And the data tells us that the majority of businesses go out of business within five to 10 years. And even big public companies face similar pressures, right? If we look at some of the largest public companies from decade to decade, over time, we'd see a lot of big names drop off the board, you know, companies like Polaroid and Sears and Blockbuster Video, etc. And so, a lot of risks in business. There are a lot of things that are not under our control. Markets change. Sometimes we make a decision that in hindsight turns out to be the wrong decision. And we can find ourselves in trouble. And so in today's episode, we're going to talk about how to manage a business that is in financial distress or financial trouble, whatever you want to call it. And we're going to talk about what does that mean, how businesses may get there. What are kind of the processes and potential outcomes for companies that are in financial distress. And what are some things that owners and executives may need to consider when they find themselves owning or managing a business that's in financial distress. Today, I'm joined by Charlie Goodrich. I first met Charlie about 20 years ago, when we were both members of Financial Executives International. I remember being fascinated by the fact he worked with companies that were in financial trouble. I continue to read his newsletters to this day. I find them to be very informative. And even if you're listening to this podcast, and you've got a business that's not in financial distress, which is good, please don't tune out. Because I think some of the insights Charlie's going to present are very relevant about how to manage relationships with lenders, or equity investors, or anybody who's invested capital in your business with some kind of an expectation of return on their investment. So stay tuned. And welcome to the show, Charlie.

Charlie Goodrich: 2:49

Great, Calvin, thanks for having me. And delighted to be here. Let's get started.

Cal Wilder: 2:55

All right. So before we dig into financial distress and the work you do for clients, could you give us a brief background on your career? I think you started working in financial planning and analysis at some big companies. And what did you do earlier in your career and kind of what drew you or led you to doing the kind of work you're doing now?

Charlie Goodrich: 3:14

Sure. So, you know, I was kind of a typical economics undergrad, went straight to business school and got an MBA in finance, and then worked in reasonably large companies in various financial management positions. So a combination of financial planning, analysis, business, unit controller, and CFO, corporate strategy, things like that. And I had a career aberration in the late 90s, which was I joined a bank in Boston. Was brought in by the CFO to help them change. They were clearly not going to change. So we parted ways. My kids were in middle school, in high school, so I didn't want to move. And everybody said, gee, you know, since business school on you know, consulting was always an option. Calvin, remember back then, you know, the internet boom was hot. And everybody was telling me Gee, Charlie, you gotta, you know, get in on this internet thing be a part-time CFO for startups. And I could tell that, you know, a lot of people had gotten into it before me. And the last thing you wanted to be was the last guy into something and, who knows what happens? My timing was pretty good. In January, one of my early leads, and my second engagement, a CFO, call me up, said Gee, Charlie, we need your help, but we have to restructure through bankruptcy. So we did a Delaware bankruptcy from the beginning to the end. And then if you recall, everything blew up in the.com world. So I was busy with restructurings and bankruptcies and all sorts of things and became a restructuring guy before I found out I was it was a very cyclical business. So 25 years later, I'm still doing it and having lots of fun.

Cal Wilder: 4:58

Great. So there's some vernacular in this niche that you practice in. You know, we talk about distressed businesses, bankruptcy, restructuring, workouts, etc. Are there any particular terms of art that the audience should know?

Charlie Goodrich: 5:13

The real thing is, the core thing is, to really understand is what is bankruptcy and think of that not as a legal tool, but as a financial condition. And that's if you take the enterprise value of your company, you know, if you could sell it as an ongoing concern. And if you sold it, and you couldn't pay off all your debts, that's bankrupt. That's what's called being bankrupt. And you may well be solvent and be able to pay your bills and keep going on until at some point, something happens. You can be not bankrupt but insolvent, and insolvency is when you can't pay your current bills. So all of a sudden things, you know, you can't pay your vendors, you can't pay payroll, you know, the end is near even if there's substantial value in the company. And that's what insolvency is. And insolvency is often the condition that drives things in my world to start happening. So that's really the key thing. Some of the other terminology to keep in mind is secured lender, you know, i.e., they have liens on your assets. And it's important to understand who's got liens on what. And the rest of the terminology that you often hear is really around various legal tools, as opposed to what you do in the process itself. You had mentioned workout. Workout is really, you know, it's get me out, as the bank has charged with getting them out of loans they no longer want to be in. So they "work them out." These days, if it's a large company, it's pretty easy to sell them and get paid, or even refinance them to get paid. Not everybody might get paid, but the secured lender will get paid. Smaller companies, it's a lot harder, and that's the world that I've been focused on for the last 8-10-12 years.

Cal Wilder: 7:09

You know, one other term I want to ask you about we sometimes hear, and usually it's in the context of larger businesses, but debtor in possession financing. What is that?

Charlie Goodrich: 7:18

OK, so if you use the bankruptcy tool, and file for bankruptcy, which is a federal process-- the Constitution says it will be a federal process-- there is the concept that you become the trustee of the assets. And so debtor in possession means you are the debtor, the company that you can't pay your bills, and you are the in possession of your own assets and operating the business. So that's what debtor in possession means, often shortened to DIP. DIP financing is if you need financing when you file for bankruptcy, you go through a process called DIP financing. And if you're a lender, there can be various reasons why you want to be a DIP lender. So for example, DIP lenders can jump ahead in terms of collateral in priority. So an existing lender will often want to be the DIP lender and get certain powers. That's what a DIP lender is.

Cal Wilder: 8:27

So you mentioned separating legal from finance processes. Could you walk us through, you know, more of the finance side of you know, what's the process? How do businesses become distressed? What are some financial metrics that indicate distress? How does that process play out?

Charlie Goodrich: 8:46

Yeah. So businesses, there's a variety of reasons, you know, for businesses to become distressed. But there's really two common things that happen quite a bit. And one is basically arrogance or a lack of humility. And you think you can do everything when you can't. So you do things that, you know, stepping back, you would say why on earth, and I think that that could be anything from an investor, putting too much debt on the company, to thinking you can fix things. And the other is, you know, kind of repeated inability to execute. If you're just not the person to fix things, and make corrections, and you repeatedly can't do that. Well, eventually, you get into trouble. Those are the two most common reasons. And if you do all the things that you should do to be a normal, healthy business from a financial perspective, you should typically when I get there, every now and then there's you know, idiosyncratic things or as COVID. You know, the world can change a lot. You can be a startup and you run out of money because no one wants to invest in you anymore. But for the most part if you do what you should do, you won't be talking to me.

Cal Wilder: 10:03

So if if I'm a small business owner, and I don't have traditional debt, I don't have promissory notes, no bank lines of credit bank or term loans, if I don't have debt, how does the process differ for me if I just find myself unprofitable and not able to really stay in business?

Charlie Goodrich: 10:24

Sure. So if you have debt, you know, then it depends, right? So there's a couple things that you know, with debt. First of all, if it's secured, the secured lender has a right to those assets. So you have to pay that lender back before maybe your trade creditors. Also, if you have debt, particularly small business, there's often a personal guarantee, maybe a mortgage on your house, something like that. So those are things that you have to worry about. But other than managing, we can talk about this later, kind of first potential personal liability when you go through the process, you know, if you just want to close the doors, and you can pay all your remaining bills is a pretty simple process.

Cal Wilder: 11:43

Okay, let's talk through that process a little bit, because we have some clients at SmartBooks that this unfortunately happens to somebody every year. They ask us, How does this work? And it sounds simple, but it's very stressful at the time. And it might not be easy, although it sounds simple, right? So how does that really play out? If you just find yourself short on cash, you may or may not be able to make your last payroll, and you certainly can't pay a bunch of your bills? How does that actually play out? Assuming you don't have you know, personal guarantees on bank debt, things like that?

Charlie Goodrich: 12:15

Right. So let's say there's no debt. First of all, hopefully, you've made sure that you can make payroll and pay your final payroll. Because that, you know, there's typically personal liability for that. You want to make sure you can always pay your payroll and any so called fiduciary tax, which is the withholding portion of payroll taxes, not the not the employer part. Any sales tax has been collected, conceivably sales tax that's owed. That's generally considered fiduciary, and you want to make sure that you can, you can pay that once you pay that. There's all types of things you can do. For something small, you know, generally, what I recommend is trying to prepay some burial expenses. And then just distributing the funds on a pro rata basis, dissolve the company, send the letter out saying you're gone, and be done with it. Hopefully, you're setting it up in some legal structure. So you're not personally liable. You know, if you're Schedule C, if you've never set up an LLC or corporation, well, then you got a real problem. And there's not really much you can do to overcome that at this point. But if that's not the case, you do that, you send a letter out saying, Sorry, this is what's happened. And if they don't like it, they have to undo everything they did on their own nickel. And that's rarely very appealing. I've actually done something like this several times and much larger cases. There is something a legal tool that's available if you're a legal Delaware entity called a Delaware statutory liquidation. And basically what that says is that if you distribute funds on a pro rata basis, you're indemnified as whoever's distributing the funds. You also have the Delaware business judgment rule to let's say, pay payroll taxes and things like that, first. You're not required to notify anybody. There's no claims process. Send out the money, say we did this, and then dissolve yourself with the Secretary of State in Delaware, then you're done. I did this for a large kind of Flash Boy broker dealer. You know, the real estate broker that thought he was going to get a large commission for, you know, settling the lease was rather upset but, you know, his attorney said, No, you're out of luck. And so, you can do that. And outside of that kind of process. I've got a small client right now that I'm wrapping up a liquidation. Basically, the owner threw in the towel. They tried to sell it, they couldn't, so we just shut everything down that way.

Cal Wilder: 15:04

And so if the creditors don't have a security interest claim on any collateral, it's like they're going after an empty-- dissolved business that has nothing they can go after, which is the point you're making, right?

Charlie Goodrich: 15:16

Correct.

Cal Wilder: 15:17

Okay. Well, let's take a case where I'm I've got some bank debt that I had to personally guarantee. What does that process look like then?

Charlie Goodrich: 15:28

Well first of all, the bank has as you know, in the loan agreement, various powers that you agree to, which usually means they can, you know, take all your cash, et cetera, et cetera. When you're working with a lender, what you want to do is be proactive, and work with the lender, so that they can get paid. You cooperate with them, and life is better. In a situation like that, you know, first is you should really bring on somebody like me as a financial adviser. You know, the process is very different. CPAs and accountants dabble in it. But you know, if they haven't done it, they really don't know how to do it. And the other is to get good outside legal counsel, that is familiar with these types of situations in laws. Your regular counsel might think they are, but they're not. And for some lenders, the first sign that you don't know what you're doing is you don't have an attorney that knows what they're doing. Some of them will use that to just take advantage, charge all kinds of things and fees that maybe you don't have to pay. So that's step one. And then typically, what I do if I were to come in, in a situation like that is the first thing you want to get your arms around is liquidity. You can have all kinds of great plans, but if you're not going to make payroll at the end of the week, that's no good. So I develop something called a 13 week rolling cash flow forecast. Typically includes anything that is secured by the bank. So typically, receivables, could be inventory. You also project that out, because lenders want to see that one, they want to, you know, they want to be able to look at your sales level and track it through. So it's not just, Hey, I think this is gonna come in next next week. You make sure there aren't any problems. Usually they are, so that gives you a chance to plan ahead and say, okay, you know, I've got quarterly sales tax is due two weeks from now. And I better cut back on vendor payments now. So I have the cash to make that payment two weeks from now. So that's kind of the first step. And then typically, I quickly look at the assets and liabilities of the business from a perspective of what are the assets and what can you get for them. What are the liabilities. So you can count, you know-- and then I start looking at the loan agreements to understand what those conditions are. And often what I'm doing is looking for unencumbered collateral that maybe you can borrow against to fund a sale process, something like that. So you kind of assess everything. A key is reading loan documents, and then you develop a plan that looks feasible. You talk about it with your lender, so that they have their buy in, they get a sense of understanding of how they're going to get paid when they're gonna get paid. And then you implement it. And when you implement it, that's when you step back and decide, Okay, do I need a special legal process or not?

Cal Wilder: 18:41

In your experience, you know, although banks have some pretty scary looking terms in their loan agreements, where in theory, they can come take your house, right? In reality, does that happen? What determines how aggressive the bank is in coming after you personally.

Charlie Goodrich: 18:58

Whether they get paid or not. You know, that's really the key. They have an obligation, you know-- they can't just pass, say, you know, give a pass, because they don't want to collect. Within that, you have to start breaking down, you know, banks will typically typically start charging all kinds of fees and penalties, high default interest rates. If through that process, "you haven't paid everything back," but they've recovered their principal, well, now you've got a chance to maybe negotiate a settlement. But you know, you need to be, you know, back to coming up with a plan how you're going to do as, hey, we may not be covered, you're gonna get your principal back, you might not get all your fees and charges. If they can get their principal and out of pocket expenses, they'll probably work with you. And that can be you know, a condition of, Hey, otherwise, maybe I won't work with you, and you know, yeah, you're gonna have to fight to get my house and that's gonna be a long fight.

Cal Wilder: 19:55

Right, right. So let's take it a step further. Say you've got your secured bank debt, but let's say you've got some friends and family loans, and maybe you got some angel investors who put some money into the business. So you've got different kinds of creditors. What determines the pecking order and how do you navigate that?

Charlie Goodrich: 20:16

Well, you know, when you do something like this, one of the things I'll start projecting is what I call the waterfall. And you know, if you think of a startup going public, you might have a waterfall, you've got the waterfall when all the options kick in at cetera, et cetera, et cetera. Here when things are not so nice, you're basically saying, okay, based on the collateral, this lender gets this because it's secure, this lender gets that because it's unsecured. You might have a difference if you've got a building and you got a separate mortgage on the building. And you basically, you know, say, Okay, we got to pay the employees, we got to pay the taxes, because the tax people will come back and the banks know that. You develop a waterfall. Then you have to pay all your unsecured creditors, if you can pay all the unsecured creditors in default. Which might mean, you know, if you have a lease, you have to, you know, reach a settlement with the landlord. If there's anything after that, you know, then it would come down to subordinated unsecured, subordinated creditors, which is maybe where the a friends and family fault. And then down the equity, you know, down the pecking order on the capital chart.

Cal Wilder: 21:27

So, we hear about restructuring in a chapter 11 type, bankruptcy or liquidation and chapter 7 type bankruptcy. What determines whether you can restructure and stay in business, or if you end up in a liquidation?

Charlie Goodrich: 21:42

Well, here's where you have to kind of look at the distinction of the legal process. So a lot of larger liquidations happen in chapter 11. And basically, the argument to the judge and the creditors is, we know the business better than an outside trustee. And we can liquidate it and get a better outcome than a trustee can, who's going to have to spend a lot of time getting up to speed on everything that we've done, and he gets to collect a percentage of the assets. So most times a liquidation for something larger will be done as a --in a Chapter 11 context. Chapter Seven is typically when it's smaller, and there's nothing there. So maybe, you know, for a lot of small businesses, you know, they might just file as a chapter seven. But they have to have a reason to want to use the bankruptcy code to want to do that.

Cal Wilder: 22:42

Okay. And then I've heard about chapter 22, or occasionally 33. What is that?

Charlie Goodrich: 22:48

Oh, that's just repeat bankruptcy filings for the same fundamental business. And basically, the reason that happens is typically larger companies. And what you know what happens in a larger you know, bankruptcy restructuring, is you playing the games with the upper part of the balance sheet, right? So secured lenders say, Well, I want to get paid in full. But the junior creditors, maybe they're subordinated note holders, maybe they have liens on some assets. They say, well, rather than a straight liquidation, let's we think a new CEO can fix this business. And we're better off. And we'll take the equity. So now they emerge as the new equity, maybe with some bank debt. But often, the problems fundamentally aren't fixable. So they file again, a lot of times, there's some reasons, the management of some of those creditors might want to do this, because they know they're onto another assignment. And it looks like they save the day, even though they just put it off till the next guy is stuck with it. That's some of the internal dynamics that happens. But that's why that you see that you see that a lot with retailers.

Cal Wilder: 24:07

So I tend to play in the small business space with less than $10 or $20 million in annual revenue or assets. And then you've got the mid market, however you define that. And your big companies. So what's the difference in the process and outcomes for smaller businesses versus medium or larger businesses?

Charlie Goodrich: 24:27

Well, larger businesses have a chance of surviving as an ongoing business-- the equity might get wiped out. That's much more of a challenge with smaller businesses. You know, a good outcome for a smaller business might be an example of a case that I had back in 2019. It was in Boston. It was a high end party rental company. And they had a lot of debt and mismanagement. And the buyer that bought them was the big kahuna in town that was owned by a private equity firm. They were the real buyer, because one, they they were big enough and established. So they could they could easily borrow, you know, had the funds to do the transaction. But they ended up walking away from the facilities. They cherry pick the inventory. They hired almost all the employees. And this was back when it was hard to get trucks. They paid Ryder Truck Rental all the unpaid rent on the trucks to be able to get those trucks. So that's a good outcome. Other times, for example, this one I just wrapping up now, it's a patio furniture store. And that market has become very niche. And, the founder passed away. It was kind of breakeven, but it was time to pull the plug. And so that was a pretty simple liquidation. You know, there's an auctioneer that came in, sold off the inventory, pay off the bank. And unfortunately, in this case, they had to put in some personal funds to pay off the bank, because they had a mortgage on the underlying building. But after that, that was it.

Cal Wilder: 26:06

How quickly do these things happen? I mean, we're talking about making payroll at the end of the week, but like, literally, how fast do you move in these situations?

Charlie Goodrich: 26:16

Well, you have to move fast. Depends on how much time you have and how much time you can buy. So for example, in the party rental company example, they were headed into their dead-- into January, and you know, nobody does parties in the first three or four months of the year. So no matter what they've got negative cash flow. It made sense to take the gamble on a good outcome with a sale process. They borrowed money against the underlying real estate that hadn't been mortgaged. And they use that to fund a sale process that led to a better outcome.

Cal Wilder: 26:51

How do valuations-- how are how are assets or businesses valued in this distressed situation versus a more efficient market?

Charlie Goodrich: 26:59

Well, you know, one of the first things I'll often do is do a liquidation analysis. And basically you want to say, Okay, if we just liquidate the assets, as is, kind of a force-sale liquidation, what can we get? If we collect the AR, maybe sell the real estate, what can you get. And that's kind of the underlying liquidation value. And then you're always looking for some type of outcome that can deliver a better value than that.

Cal Wilder: 27:30

Is there much of a going concern value attributed to going concern in these situations?

Charlie Goodrich: 27:38

In the larger stuff, there's-- you know, in some of the larger bankruptcies and even out of court restructurings, there can be some very heated expensive fights over valuation. So if you know, thinking back to that capital structure, if you're kind of in the middle of that capital structure, the guy above it might say, this thing isn't worth anything and you get nothing. And you might disagree on the value and say, No, it's worth more than that. I want something. Those types of issues come up typically in large complicated bankruptcies.

Cal Wilder: 28:13

So you mentioned bankruptcies are a federal matter. So logistically if you're thinking you're going down the road of bankruptcy filing, and you've never dealt with federal courts before, how does that work?

Charlie Goodrich: 28:26

Well, the first thing you should do is find, really be sure that you need bankruptcy, bankruptcy is a tool. It gives you a bunch of things that you may or may not need. That gives you something called the automatic state. So any lawsuits particularly with creditors stop. And creditors can't take any assets. If you have a plan, you can use you can sell so called executory contracts, and a loose definition of that as both parties have an obligation. So financing agreement isn't that a lease is a classic example. So let's say you have a lease and you haven't 20 years ago, and you still got 10 years left, that's a very valuable lease, you can sell that lease and generate some property. So if that's an issue you want to get out of it. That can be one thing that's valuable. If you have a buyer, and they want the protections of a bankruptcy court order, that might be a reason you want to do it. Or if you need a lender that's willing to finance the process, they may want the the protections that you can get from a bankruptcy from from DIP, froma DIP financing order. There's one other little piece which only applies to larger companies. If you have tradeable notes and securities, generally federal law to make any change in the loan agreement, you have to have 100% agreement. That's almost impossible. That's not needed in bankruptcy. So if you can get a say 70% to go along, you file for bankruptcy, they vote, they win. And you get, you can achieve that outcome. But in bankruptcy, the key to know is the first step is an unsecured creditors committees form. And they get to use the company's money to basically sue the company and its officers. So particularly for small businesses, you really need -- unless you do qualify for something called a sub five, which is within Chapter 11-- you want to avoid that if possible.

Cal Wilder: 30:31

Yeah, that sounds like it can be very expensive. It's very expensive to file bankruptcy, ironically, right? But how expensive is it? Like what's the range for different sized businesses?

Charlie Goodrich: 30:45

You know, it'd be hard to do it for under 100 grand. In some of these larger bankruptcies, the professional fees have approached the billion dollar range.

Cal Wilder: 30:55

So you mentioned earlier of some alternatives to bankruptcy. Pragmatically, you mentioned just kind of winding down. If you don't have secured creditors, jus t being able to kind of wind down and dissolve, then there's one extreme. And then you've got the bankruptcy, which is probably not-- if you're filing bankruptcy, you may not have 100 grand to pay. Is there anything in between?

Charlie Goodrich: 31:19

There's a lot. First is really take a hard look to see, do you need anything other-- do you really need any type of legal mechanism. One of the things particularly if you have a secured lender, is a buyer may want to protections that's known as an Article Nine sale. And Article Nine refers to a provision in the uniform COC commerce code that covers secured interest in a business. And basically, you file a notice to all the creditors of the company that you're going to have a sale. And then you can sell the company. And they're basically restricted on going after the buyer and also the lender for the sale. Now the catch is you have to give notice. And so for example, in that party rental company I mentioned, the buyer first wanted the protections of a bankruptcy filing. We said, well, the business is going to die with that. Then they wanted the process with an Article Nine sale. The problem was, as soon as they filed an Article 9 sale-- they were so stressed with their lenders, at one point, they were three weeks behind on payroll-- they would have been forced into bankruptcy. So then they, you know, you're not able to achieve the results you want to do. But Article Nine is a way to do it. I had one client in the pandemic that lent subordinated debt to a virtual reality company that had retail presence. They tanked. He used the Article Nine sale to take possession of the intellectual property and assets. In two years later, he made a lot of money selling it to someone that finally was willing to step up and buy it. So that you know, you can do that. Another tool that you can use is something called a receivership. These are state law creations, and somebody becomes a receiver of the property. Typically, you're doing that in conjunction with a secured lender. And you know, then that receiver is given specific powers by the court. Sometimes they might be recognized in other states. And that prevents others from trying to grab the assets. And then you can liquidate under that. And that's done from time to time. It's often forced on a reluctant debtor by banks. I had that happened in one situation where you know, the CEO was just completely out of control and out to lunch. And so the lenders forced a trustee, a receivership. And then there's also something called an assignment for the benefit of creditors. Basically, the concept there is you transfer the assets to a trust, and an attorney works out a compromise and pays out the individual creditors. And there's a little bit of protection there. That said, I've been asked to do about 15 of them over the last 25 years and I've never done one because in the end the parties involved say, We really don't get much for this for this expense and

Cal Wilder: 34:24

So let's talk about personal liability hassle. considerations if I'm an owner or officer in this situation?

Charlie Goodrich: 34:37

Well, the first is obviously, you know, any personal guarantees that you've made. Even if you're a business, you may have pledged-- you might be-- if you're an entrepreneur, you may have pledged another piece of real estate, for example, as collateral. Maybe it's the real estate underneath the business. But you have to look at that because that's, you know, something, you want to make sure you can get that paid. And then the next big one is wages. Generally, just about every state holds directors and officers personally liable for unpaid wages. Traditional payroll is pretty straightforward. Where it gets complicated is when you have all types of sales, commissions things like that. Employment agreements that may stipulate various things. And that is all completely state law dependent. So I always recommend, at this point, having an employment law attorney in the state where that person is based, where the people are based, there might be multiple states. Really look at employment agreements, things like that. Sometimes if they were given stock in the company, in certain benefits is kind of a, you know, compensation package that also changes things a lot. So, for example, a little bit different aside, you may have heard about the FTC is trying to restrict restrictions on people going to work for a competitor. If you, you can still legally put those restrictions in if it's tied to a stock compensation plan. Okay, that's just, you know, one complication I had. So for example, I mentioned this flash boy broker dealer, they had employees in Hong Kong, and Hong Kong is very strict on employee liability. But their whole bonus system was based on being a"partner" in the firm, and that wasn't covered. So they didn't have to pay on their bonus.

Cal Wilder: 36:40

Okay, and then...

Charlie Goodrich: 36:43

Besides that, after that, you have to look at fiduciary taxes I mentioned. Now, the big one being the employee withholding. If you're really tight, you know, when you file your employee withholding taxes, make sure you say it's for the employee part, because the government will always play it against the employer part first, because they know they can get you on the other part. And then typically, sales tax that's collected, those are fiduciary taxes. There can be some unusual things if it's, if you're buying and selling produce and agricultural products, but that's pretty unique. And then you want to, you know, ideally, if you have money, I recommend, particularly if you've got multiple owners, buying-- you hopefully have directors liability insurance. You can still buy it if you're in default, it won't cover past sins. But that will cover you through the process. You buy something called a tail policy, which basically is you're covered for three to six years, for any claims that are filed. If you've got the money to do that, I always recommend that. I'll never come in in a position where I'm either controlling cash and disbursements, or an officer or director of the company, without it. And then the other exposure is basically state law claims for something called fraudulent conveyance. So let's say you're paying yourself large salaries, dividends, etc. You know, the argument basically, is if they can prove you are bankrupt, at that time, then they can claw the money back, often three to seven years back, based on the state law. That's an expensive process for creditors. So for small change, they're probably not going to do it. But you know, some creditors also get just get irked and have vendettas against the debtor because they've been so badly mistreated.

Cal Wilder: 38:31

So we're talking mostly about disputes over money, which in my mind, is a civil proceeding, but when do things cross the line, do they cross the line, into criminal type proceedings?

Charlie Goodrich: 38:46

Oh yeah. A client of mine, two months ago, was recently sentenced to 20 months in jail in federal prison. I won't say a lot about the details, but google 20 months in prison and Boston, you'll find out who the person is. And basically, this person was under investigation by the Department of Justice for some other issues. And they started watching, you know, they always look at your checking account. And they noticed that starting in 2022, well after COVID was winding down, Oh, I'm not gonna pay payroll taxes. Oh, there's ERC, there's ERC. So he had when I got there about $3.4 million of unpaid payroll taxes. And meanwhile, he was taking money to put into another one of his businesses. The 60% owner was getting all kinds of padded expenses. That was underwater trust. So they were paying expensive property taxes on some huge spread in Vermont, etc. And he pled guilty and was sentenced to 20 months and I think $3.8 or$4.2 million of restitution. So don't mess with the IRS and payroll taxes. That's the easiest way to get into criminal trouble.

Cal Wilder: 40:06

Okay. Let's say you can see the business is going toward distress but it's still solvent. You still think the assets exceed the liability. But things are going south or have gone south to some extent. How do you manage banking and investor relationships in that kind of a situation like. I have a client I work with that unfortunately, they didn't raise prices. They're largely a services business and they didn't raise any prices in the years between 2020 and 2022 when we got hit with huge inflation. They went from being very nicely profitable to being unprofitable and in violation of bank covenants over the course of about 12 to 18 months. So how should in theory, you communicate and manage your, especially banking and lending, relationships when things are not looking so good.

Charlie Goodrich: 40:57

The first step is have good financials. And timely financials. Which to me means accrual based. They can be converted to GAAP, most people should look at something different that's more management focused. And usually your books should be closed within the first week or two, and you look at it and can react. And then the second is you should be periodically doing financial projections. And if you do that, in a company like that, they should be able to project that, okay, we are declining, things are bad. And at this point, we're going to start defaulting on our covenants. So ideally, you come up with a plan before that happens, and you tell the bank, hey, here's where we're headed, we know we're going to be in default this quarter, here's what we're doing to fix that. You have a concrete plan to do that. You know, if it's not really horrible and ugly, banks will typically work with you. You gotta remember, they spent a lot of money trying to get your business. And if they can save the credit, that's a lot easier than trying to replace it. But the key is you got to get in front, and you got to be proactive, and you got to keep them abreast and you have to be transparent. The ones I get, they have poor financial records. They can't see what they're doing. They are not able to project. They think they can wing it. And they don't react to the bank properly.

Cal Wilder: 42:31

So, good business practices. And then communicate, communicate, communicate. Make sense. You could talk to an attorney, talk to your accountant, talk to consultant like you, if you think you're in financial trouble, who's the first person that you generally want to want to start working with?

Charlie Goodrich: 42:56

Depends on how early you are in the process. You know, if you're early on, like the clients you described, I would recommend getting a financial consultant to help them out. And, you know, particularly if they're not able to do projections at cetera, I would invest in getting the books closed quickly. So you can start reacting to that. And at least start make sure you're in compliance with the basic reporting. And also, don't be late on financials. If you're required to have a review or an audit at the end of the year, make sure that's on a timely basis. When lenders can't see into your company, and things are bad, they get very scared and nervous. And so you want to avoid that, that's kind of the key. And then just be transparent with them and have a plan. If they want you out, find another lender that can come in and replace it. They're not gonna be the same cost. But there's lots of lenders and avoid merchant cash advances, because those typically spiral and come out of control and they're often, you know, rarely you could do that.

Cal Wilder: 44:11

Right. It's kind of a vicious circle once you start that it's hard to stop, right?

Charlie Goodrich: 44:16

Yeah.

Cal Wilder: 44:18

Well, this has all been great. Are there other topics or insights that you want to share while we're chatting Charlie?

Charlie Goodrich: 44:24

I think we've covered you know, quite a bit. I guess the other side I'll talk about briefly is when your when your customers become insolvent, what to do. A couple key things: If they do fall for bankruptcy, you've got to cease collection efforts. If you don't have a credit department that knows what to do, I recommend getting some outside advice. And if they are in financial trouble, you got to manage the risk. You have to make some hard decisions and have a good credit department.

Cal Wilder: 45:02

I understand that certain vendors can continue to do support and get paid by a company when they're in bankruptcy while others cannot. How do you continue to work and get paid?

Charlie Goodrich: 45:13

The're a concept called a critical vendor that you need, and you get court approval to pay them and their old bills. There's nothing in the bankruptcy code that says Okay. But you could be in a situation where maybe you can you can do that. It's kind of made up bankruptcy law and there are a couple sections that say they have those powers. So not all courts will do that. But if you have, if you have truly a critical vendor, yes, it's viable that the business is going to continue, you may be able to get approval to pay them. get paid for future work that you do, but you may have to write off some prior invoices? Yep, yeah. If it's something where they have the ability to shut you down completely, they might. I've also seen it done for critical vendor orders to solve a problem. So for example, this was some time ago, it was a much larger company. They were in Alabama, they had a manufacturing plant. They were the largest-- and there was a municipal gas company-- they were the largest user of gas. They would have shut down the entire gas system for this little town in Alabama if they did become a critical vendor. The judge said, okay, we can do that.

Cal Wilder: 46:37

Okay. Another question that comes to mind. So, on the persinal bankruptcy side, I hear there's certain kinds of debt, specifically, student loan debt that is not dischargeable in a personal bankruptcy. Are there some kinds of debt that's not dischargeable in a corporate bankruptcy?

Charlie Goodrich: 46:56

That's not dischargeable? Well, basically, no, as a practical matter, no. Because there was a restructuring plan. Basically, no. There are a few things, let me take that back. You have to be careful, if you have a multi employer pension plan, and there's a deficiency, oftentimes, that deficiency will either follow who buys it, or go back upstream. So for example, back to this case in Alabama, there was an unfunded pension plan and many years later, the PBGC, the benefit Pension Benefit Guaranty Corporation of the government, was chasing the owner. I was involved in another one where there was a large claim from the pension plan against for the PBGC. It was owned by a private equity firm, they ended up agreeing to keep the pension plan and fund it because they said we're just gonna go after your portfolio companies because we can do that.

Cal Wilder: 48:00

That reminds me of Carl Icahn's misstep with TWA in the 1980's, somehow he got himself-- he already owned the majority of the business-- but he got himself over 80%. And then somehow his assets became liable for the pension obligations of TWA. Well, this has all been great. This is kind of a different kind of podcast. A lot of unique knowledge that hopefully listeners will not need to put to use, but inevitably, some of them will. And if they need help, Charlie, what's the best way for them to reach out to you?

Charlie Goodrich: 48:40

My phone or an email? My phone number is 781-863-5019. My email is Charlie with an IE at Goodrich hyphen associates.com(charlie@goodrich-associates.com).

Cal Wilder: 48:53

Well, great, we'll get that into the show notes. Thank you very much for sharing with the audience, Charlie, appreciate it.

Charlie Goodrich: 48:59

Great. It's been fun.

Cal Wilder: 49:02

Reference show notes and find other episodes on EmpoweringHealthyBusiness.com. If you would like to have a one-on-one discussion with me, or possibly engage SmartBooks to help with your business, you can reach me at Cal@EmpoweringHealthyBusiness.com or message me on LinkedIn where I am easy to find. Until next time, this is Empowering Healthy Business, the podcast for small business owners, signing off.