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Operations | By Robin Van Tan

Bankruptcy Guide
The B Word is not the end of the world for quick-service operators, but there are certain steps necessary to ensure it is as smooth a process as possible.
Its important for restaurant chains to be honest, not emotional, when filing for bankruptcy.

The length of time companies filing for bankruptcy are allotted to develop a plan of reorganization is 120 days. One false move during that period or the months leading up to it can drastically reduce the chances of making it through the ordeal.

QSR consulted lawyers, financial experts, and two quick serves going through the process and asked them to share the top bankruptcy mistakes restaurants make, and what to do differently. Their tips can help you come out of a bankruptcy better than before and even avoid bankruptcy altogether. Consider this your bankruptcy survival guide.

 

Don’t: Make business decisions based on emotional attachments.

Do: Stay focused on the fundamentals.

Several years ago, Alan Gallup, an asset recovery specialist, had a client who asked for advice about buying a group of about 10 Taco Bell stores.

“I said, ‘Why are you looking to buy these? You don’t have any stores in that market now. What are you after?’” Gallup says. “He said, ‘The numbers.’”

So Gallup looked at the numbers. He looked at the capital requirements and the coverage ratios and his client’s reserves. But the profitability just wasn’t good. So he asked again: Why did he want to invest in these stores?

The franchisee said, “If I buy these, I will then have 100 Taco Bells.”

“He was looking at the wrong number,” Gallup says. “It’s a common syndrome where multiunit operators who really are sharp business people, they know how to put together deals, they know how to put together restaurants, have a hard time saying, ‘This one doesn’t work for me.’”

Gallup, who is now working with Jack in the Box on the bankruptcy of several of its stores, says the multiunit operator in this case made the same mistake. He got emotionally attached to the idea of being the No. 2 Jack in the Box franchisee and expanded so quickly that he made unsound decisions, like taking over some stores that were on the other side of a coastal mountain range.

“When something like that happens, you just don’t get there,” Gallup says. “You don’t supervise them.”

Because the restaurants weren’t properly supervised, the operations, and bottom line, suffered.

Taco Del Mar was also a victim of rapid expansion. When president and CEO Larry Destro started with the company in June 2009, he visited more than 75 percent of the chain’s stores and found that the food quality, consistency, service, and overall customer experience all suffered from a reckless growth strategy.

“Getting the operations refocused on those fundamentals was critical,” Destro says. “We needed to get them back to where they could ensure a competitive consumer experience.”

 

Don’t: View bankruptcy as a death sentence or even a panacea.

Do: See bankruptcy for what it is—a tool that will buy you some time to pay off debts.

“A lot of franchisees and franchisors are afraid of what we call the B Word,” says Tom Mullaney, a founding partner of the real estate and financial restructuring firm Huntley, Mullaney, Spargo & Sullivan. “There’s no need to be afraid of bankruptcy. It’s simply a problem-solving tool to deal with your inability to pay your liabilities as they become due.”

Since Taco Del Mar accumulated more than $3.5 million in debt by the time Destro joined the company, bankruptcy was exactly what it needed to keep its head above water. It filed for Chapter 11 status in January.

“All these things were becoming due and payable at one time,” Destro says. “Bankruptcy was a defense tool and a very useful tool for us. … It afforded us the opportunity to develop a repayment plan for the creditors that was on terms and conditions that the cash flow of the business could handle.”

All that bankruptcy is going to do is buy you more time so you can fix the problems."

On the other end of the spectrum, some quick serves make the false assumption that bankruptcy will automatically end their problems.

“Bankruptcy is not a solution in and of itself,” says David Nolte, a financial expert at Fulcrum Inquiry Consulting Firm. “All that bankruptcy is going to do is buy you more time so you can fix the problems. … And there are times when bankruptcy won’t solve it at all.”

 

Don’t: Wait too long to declare bankruptcy.

Do: Have an exit strategy in mind before you file.

The 70-unit franchisee for Jack in the Box waited to file until September 2009, just after the state shut down about half of his restaurants for a day and a half because of unpaid sales tax. When he finally did file, the judge appointed a trustee to protect the estate, who later determined that he had waited too long to seek bankruptcy protection and that reorganization was no longer a viable option.

“Franchisees will wait until they’ve lost so much blood that when they file for bankruptcy, they can’t lift their head off the gurney,” Mullaney says.

Franchisors dealing with bankruptcy can run into the same problem.

“If you wait too long, there may not be a solution on the other side that you’ll find acceptable,” Destro says.

Low liquidity, trouble making payroll, difficulty paying bills, and increasing debt are all hallmark signs that bankruptcy should be considered. If that route is taken, filing while there’s still enough capital to both operate and pay bankruptcy attorneys is key, especially since such limited financing is available now.

“Bankruptcy won’t provide new cash,” Nolte says. “It will provide an opportunity to conserve cash, but you’re going to need cash to keep your operation open.”

Beyond filing while there is still enough capital, franchisees can also increase the odds of successfully emerging from bankruptcy by coming up with an exit strategy before they ever declare it.

Destro says Taco Del Mar didn’t file for bankruptcy until it determined it had the support staff, skills, and cash necessary to move the company forward.

“We started preparing for that months in advance to make sure we understood what the process would look like,” he says.

 

Don’t: Try to handle bankruptcy on your own.

Do: Seek advice from outside advisers.

Self-evaluation tools such as benchmarking, where one compares its operations to those of a similar chain or franchisee, and trying to determine why they’ve been underperforming can be helpful in the prebankruptcy stages. But, should a company decide to declare bankruptcy, seeking advice from an attorney or financial adviser is essential.

“This is like kitten surgery,” Mullaney says. “It’s very specialized.”

One of the first moves Taco Del Mar made when it knew it was going to declare bankruptcy was to speak to a lawyer.

“Experienced attorneys will cost you far less in the long run than if you try to do this yourself,” Destro says. “Plus, they’ll tell you if this is even a process you should consider in the first place.”

Even if a professional has already been consulted, getting an outside opinion is wise.

“The guys who were telling you what to do when you got into this situation aren’t likely to be the ones who will help you out of it,” Gallup says. “It doesn’t mean you have to throw out the baby with the bath water, but you do need to reach out and get people who will come in with a fresh objective to look at it.”

To find the best advisers, those going into bankruptcy should ask for a list of previous bankruptcies advisers have handled and then look at both their approach and results.

“They shouldn’t tell you what they’re going to do for you, they should tell you what they’ve already done for someone else,” Gallup says.

 

Don’t: Try to hide the realities of the situation.

Do: Be as open as possible with all parties.

Even if creditors seem like the bad guys, the urge to sugarcoat fledgling finances should be resisted after bankruptcy is declared. Instead, creditors should be contacted early and communicated with honestly and unemotionally.

“Give them all of the facts, all of the truth, and nothing but facts or truth,” Gallup says. “With that, reasonable people should be able to draw similar conclusions.”

That strategy got several landlords in the Jack in the Box case to lower their rent. Once they realized the stores simply weren’t generating enough revenue to pay the asking price, they decided that lowering the rent was better than forcing Jack in the Box to vacate and earning nothing on the space.

Being honest and open with other parties is equally important.

Taco Del Mar carefully scripted messages to franchisees, shareholders, and customers following its decision to file for bankruptcy. The company also answered any and all media requests.

“We were telling everyone the same factual information,” Destro says.

He says Taco Del Mar’s transparency helped assuage each group’s bankruptcy concerns quickly.

“There was probably some chatter about this for the first seven to 10 days, but after 10 days that died down,” he says.

It meant that Taco Del Mar could go back to focusing on what it was supposed to: serving tacos.

That’s exactly how it should work, Gallup says.

“A lot of brands have gone bankrupt, and the consumers never knew the difference,” he says. “There was never a cold burger.”