Some Things About Business

creditors are less willing to work with insolvent businesses to return the business to long-term health, and more eager to liquidate and recover whatever they can on their debts immediately.

The evidence for this is anecdotal, to be sure. But most of the people I interviewed said that between the prolonged recession and slim chances of successful workouts for small companies, lenders have ever less patience for turnaround plans.

Here’s one more reason why creditors prefer liquidation: They’re often not the ones who originated your loan. I just came across this data from the a survey of 395 turnaround professionals by the Turnaround Management Association:

Half the respondents said distressed debt trading in bankruptcy or in out-of-court restructurings is stalling negotiations and 40 percent said quicker liquidations and sales result. …

“Buyers of secured distressed debt may be more interested in obtaining the assets of the borrower and turning a quick profit,” [Scott Opincar, an attorney with McDonald Hopkins LLC in Cleveland] said. “On the other hand, a traditional secured lender may be interested in a more conventional workout that leads to a greater recovery over a longer period of time.”

Last year BusinessWeek’s Amy Barrett explored this in a story about what happens when the original lenders sell to third parties. From her story:

Dealing with a hedge fund or other private firm is very different from working with a bank. While some creditors will be willing to work out a deal for companies that seem healthy, others are likely to move quickly to foreclose if a company seems vulnerable. The third option is “loan to own,” in which the loan holder typically agrees to some concessions in return for a sizable chunk of equity.

The world of trading in distressed loans is invisible to most entrepreneurs. Smaller loans are sold in pools; larger ones (usually with unpaid balances of at least $1 million) sell individually. The buyers study each borrower’s file and usually acquire the debt for a fraction of its face value. A loan to a borrower in decent financial health or one that is well collateralize may sell for 90¢ on the dollar, while others may fetch only 10¢. The borrower learns of the transaction via a “goodbye” letter from the bank, which says the loan has been sold. The new holder then sends a “hello” letter announcing the acquisition.

And that was before the financial crisis last fall. I don’t know if there’s any way to find out, but I wonder how much of the increase in business bankruptcies is a result of this trend. Your local banker might be willing to give you the benefit of the doubt and agree to a turnaround plan, if your business has a strong long-term outlook but faces a short-term cash crunch. But if that banker sold your note to a hedge fund investor for 30 cents on the dollar? Probably not so much.