Employee-purchasers are well-positioned to buy firms out of bankruptcy
by Lucas Blower and Bridget Franklin
The coronavirus pandemic is predicted to set off a flood of bankruptcies. While many companies—if not entire sectors of the economy—may not survive, others will emerge from bankruptcy newly reinvigorated. Many will also be under new ownership. And at least some of those new owners should be the companies’ own employees.
Thus far, employee ownership advocates and advisors have sought to scale employee ownership by seeking out retiring business owners and convincing them of the benefits of selling to their employees. But another path may be to support employees in using the bankruptcy process to acquire their firms. Here’s how.
Bankruptcy Procedures: The Stalking Horse
Under Section 363 of the bankruptcy code, a company that declares bankruptcy can sell or auction its assets as a going concern substantially free and clear of all creditor claims. The auction typically opens with a bid from a “stalking horse,” a potential buyer who has performed due diligence and negotiated a deal with the seller during the bankruptcy. If the stalking horse bidder is outbid at the auction, the bidder often receives some break-up fees, compensating it for its efforts in investigating the company and setting the floor of the auction. But if there are no other bidders, the debtor’s assets go to the stalking horse bidder at the negotiated price.
The Employee Advantage
As the stalking horse bidder, the employees, represented by professional advisors, have a unique advantage. After all, the employees know the company best. As professional valuators pore over reams of financial information to set the right price, employees can scrutinize assumptions and provide a deeper understanding of the firm’s challenges and opportunities. Employees are better positioned than any other buyer to gut-check the valuation.
As the stalking horse bidder, the employees, represented by professional advisors, have a unique advantage.
To capitalize on this knowledge advantage, the advisors working with the employees would set up a bridge company to purchase the debtor company’s assets at auction. Then, if that bridge company were ultimately the successful bidder, it would immediately transfer its equity to an employee stock ownership plan (ESOP), or alternatively, the bridge firm could be structured as a worker cooperative. The company would reemerge as a new, employee-owned company.
The new company would reap the benefits of being employee-owned—namely, it would be more productive, more resilient, and more profitable than other companies. What’s more, employee-owned firms can take advantage of significant tax benefits. Finally, as a result of the bankruptcy, the new company would, by and large, have no prior claims against it, since a successful bidder in a Section 363 Sale purchases the assets free and clear of nearly all previous claims against the company. As a result, the employees will be in a strong position to successfully navigate a post-COVID-19 economy.
Financing a Bid from Employee Owners
But how would transition be financed? Employees don’t have deep pockets, nor should they risk their personal savings. Rather, the employee-purchasers—now organized as the bridge company—would use a few different layers of traditional and non-traditional financing options. To purchase the debtor company’s assets out of bankruptcy, for example, the bridge company could work with a traditional lender to purchase these assets using a collatoralized loan.
For additional funding to bring the business back to life, the new employee-owned firm could appeal to impact investors. The employee-ownership community has made a convincing case that investing in employee ownership provides the positive social outcomes and financial return that impact investors seek. In the bankruptcy context, these investments could be critical to saving jobs—and building a more equitable economy.
Yet another option would be private equity. Granted, employee-ownership would probably not be attractive to the sort of private equity funds that traditionally invest in distressed debt and extract maximum profit. But there are alternative private equity funds that are a better fit for employee-purchasers. Using a combination of debt and equity, they provide customized financing options to distressed companies but do not take a controlling stake in the companies.
One prominent example of such a fund is Apollo’s Hybrid Value fund, which raised $3.25 billion. To investors like these, employee-ownership should be a selling point—employee-owners provide the sort of good management and long-term thinking that ultimately protects investments.
Finally, the federal government should provide funding for employee-owners to purchase their companies out of bankruptcy. This would be an efficient, relatively low-cost way of preserving American jobs in the short term, but also an effective means of reducing inequality in the long run.
Unfortunately, but inevitably, some companies will go under as a result the pandemic. Others, though, will survive under new ownership. And, given what we know about the benefits of employee ownership, we should be doing all we can to ensure that some of those new owners are employees. That way, when the pandemic passes, we will be poised to rebuild an economy that is even stronger than before.
Lucas Blower and Bridget Franklin are partners in the law firm Brouse McDowell, located in Akron, Ohio. Bridget serves as Chair of the Business Restructuring, Bankruptcy and Commercial Law Group. Lucas practices in the area of complex litigation.