What happens when personal guarantee is removed from c-corp credit?

[ExplorerZ]

I have a 30% share in a 7-year-old tech c-corp that I co-founded and which pays my entire household income. The corp had to cut my salary by nearly half and at the same time I had a kid and my wife stopped working, so I'm looking at Chapter 7 (I'm just at the phase of looking for a lawyer and researching the issues, greatly aided by this forum!). I'm the key worker in the company and of a dozen friends-and-family bootstrap shareholders the only one full-time; without me the company would almost certainly fold.

The board required the action to focus on sales and marketing, rather than new feature development, to try to reverse slower growth (but still growth!), so I expect the situation to change once the economy corrects itself or the marketing focus actually yields results. So I want to protect it as much as possible, as well as my shares in it. Right now it has yet to show a profit on a single annual federal return with over 20k in NOL carry-forward, but that's simply because it maxes out payroll (mostly mine).

So I have two questions:

1) How nervous should I be about my shares? The share certificates all include a clause basically saying the company has the right of first refusal on buying back the shares, which I think would further limit the value considering the limited cashflow of the company, no? The company has only ever paid for perhaps $5k in assets (at purchase, they'd probably fetch $1.5k at best at auction).

2) The biz credit cards with personal guarantee... what should I expect to happen when my personal guarantee dies? Will they likely close the accounts and demand it? Or would they jump straight to suing the company for it immediately? I couldn't find any post in the biz forum about what tends to happen to guaranteed biz cards upon entering personal chapter 7. Even more so, if the guaranteed card is with a bank such as BofA and which the biz has active checking accounts (funded by third-party merchant accounts) and payroll services.

Thank you for any thoughts on these questions!

[tobee43]

first welcome to the forum.

usually with a c- corp, business your liability depends in part on which debts you guaranteed, as a shareholder you don't usually or generally have any liability. if you are an officer, that's another story. you will be filing florida.... my general understanding, which is limited, on this type of situation, (really this is a tax issue as well so you need to look into that also), and hopefully one of our resident atty's will chime in, is while both the florida LLC and the florida c-corporation offer protection of the owners' individual assets from liabilities of the business entity, only the florida limited liability company can protect the business ownership or stock in the c-corp from creditors of the owners, shareholders. these protections are only available with the florida LLC when it is properly structured to take advantage of the florida charging order for its members.

that would mean, you would be responsible for any and all debt that were actually and personally guaranteed by you. i would list them all as personal on my petition although they were used for business if that is the way you are going to go. your 30% share may also be up for grabs from the trustee. whereas, you may be required to give up your ownership. although, the board should and would have first option of purchase of your percentage. however, they will really need to consult an atty and see if maybe they can buy you out first to protect their interests. otherwise, if they have any value they will most likely be fair game for the trustee.

[HHM]

It's a bit much to explain fully here, but number 1 is a much bigger problem for you than number 2.

As to the personal guarantees. So long as the payments are being made, the banks generally don't care. The worst case scenario is that the banks will close any open line of credit but they don't generally demand full payment, nor can they in most cases. The company is the primary debtor.The guarantor is only triggered if the company defaults, not the other way round.

As for number 1...a good attorney will ask to see the operating agreement and/or shareholder agreement. That document will help clarify the risk. The right of first refusal is not that much protection for you. If the trustee cannot do anything with the shares, (e.g. liquidate the company or sell the company outright because he doesn't have the voting majority) the trustee will approach the other shareholders and solicit offers from them to buy out your interest. The trustee doesn't need to collect much money, even a couple thousand is worth the trustees effort. If you have a 30% stake, I imagine that is one of the larger stakes, so the trustee can probably hold the company hostage from doing certain things until someone buys him out.

You mentioned this is some sort of "tech" company, and you are the main employee and sounds like you work on whatever product this company offers. As such, you need to be cognizant of who owns any intellectual property. Do you own it, does the company, etc.

So, the question you need to ask yourself is...are there any aggressive or unfriendly shareholders in the company that would be interested in buying you out? If yes, then you will most likely lose the shares in chapter 7 BK. If no, someone (you or someone else) will probably need to pay the trustee something to get him out of the picture.

[despritfreya]

The moment you file bk your shares become an asset of the bk estate. If you cannot find a way to exempt the shares a Chapter 7 Trustee will have the right to sell them. He will offer them to the other shareholders and, if no offer materializes, he may try to auction them. If you are worried about what a Chapter 7 Trustee might do and/or are worried that if sold to the other shareholders you cannot cut a deal with them to recover your shares, after consulting with a competent attny, you may decide that a Chapter 7 is not the way to go and may elect for a Chapter 13 (if you are under the debt limit) or a Chapter 11 (if you are over the 13 debt limit). If you feel there is no market for the shares (including selling them to the other shareholders) then you may want the 7 and wait for the Trustee to realize they have no value.

All of your personal guarantees will be discharged in your bk (assuming no problems with getting a discharge). Normally the creditor does not care so long as the entity is making the payments. There is probably a provision in the loan/credit agreement that the filing of bk by a guarantor is a default under the terms of the contact and the debt can be called due. My experience, however, is that such provisions are never used so long as payments are made.

Des.

[ExplorerZ]

Thanks for all the great answers!

Focusing on the c-corp shares... any idea how I would calculate a ballpark value the trustee might want?

The company makes a decent amount of revenue, but breaks even due to costs and payroll. I'm assuming the value is simply "what somebody might pay" but I have no idea how to determine that. The attorney I met with today thought they could simply say my 30% share in the company would be worth 30% of the annual revenues. I know none of the existing shareholders would pay that amount and I can't imagine anybody paying anything close to that at auction either.

I can't tell if they're just trying to scare me into a chapter 13 or if that's actually possible and I haven't found any stories of similar situations online to even get a feel for how it could go.

Thanks again!

[despritfreya]

... any idea how I would calculate a ballpark value the trustee might want? The company makes a decent amount of revenue, but breaks even due to costs and payroll. I'm assuming the value is simply "what somebody might pay" but I have no idea how to determine that. The attorney I met with today thought they could simply say my 30% share in the company would be worth 30% of the annual revenues. . .

30% of what revenues, gross or net? If “gross” that makes no sense because one must account for the cost of doing business which includes long and short term debt as well as cost of goods etc.

There probably is no right or wrong way to value your shares.

We typically want to minimize the value therefore I ask. . .

“If you were to shut the business down, liquidate all assets, collect all “collectable” receivables, would there be enough cash to pay all entity debt including the leased commercial space (if there is a long-term lease)?”

If the answer is “no”, we typically list the the shares of the entity with a notation “debts exceed assets” and a value of $0.00. If the answer is “yes” the next questions is. . .

“About how much would be left over?”

The answer to that question is how we determine value (of course, your value would be noted at 30% of total value).

The problem with this “liquidation” approach is that if there is a competitor out there that wants the shares, those shares will be worth substantially more than $0.00 or the net remaining after all debt is paid. While an “on-going concern” value may be too high, if someone really wants the shares then those shares are worth what someone is willing to pay and its up to the Trustee to do his due diligence in determining if the shares have value, regardless of what you list as the value.

Bottom line. . . I would use liquidation value and wait to see what happens next - but, I am not your attny and your attny may see things differently.

Des.

[helpmeout]

The company makes a decent amount of revenue, but breaks even due to costs and payroll. I'm assuming the value is simply "what somebody might pay" but I have no idea how to determine that. The attorney I met with today thought they could simply say my 30% share in the company would be worth 30% of the annual revenues. I know none of the existing shareholders would pay that amount and I can't imagine anybody paying anything close to that at auction either.

If the Trustee attempts to go that route, then your attorney will need to fight it. A company is not worth the annual revenue. What it is worth is the assets (net of depreciation) minus the debt owed.

The annual income is the Gross sales minus operating expenses (including depreciation).

[LadyInTheRed]

If the Trustee attempts to go that route, then your attorney will need to fight it. A company is not worth the annual revenue. What it is worth is the assets (net of depreciation) minus the debt owed.

It depends on the kind of business the company does and, as Des points out, what kind of market there is for selling the particular business. Some business are valued based on income, some based on liquidation value and some based on a combination of the two. In my experience in areas other than BK, liquidation value is most common and is a good default until somebody argues it is not a good valuation method. If the valuation is disputed, an appraisal by a professional business appraiser may be necessary. The appraiser would determine the best valuation method for a specific business and would explain why that method was used.

[helpmeout]

It depends on the kind of business the company does and, as Des points out, what kind of market there is for selling the particular business. Some business are valued based on income, some based on liquidation value and some based on a combination of the two. In my experience in areas other than BK, liquidation value is most common and is a good default until somebody argues it is not a good valuation method. If the valuation is disputed, an appraisal by a professional business appraiser may be necessary. The appraiser would determine the best valuation method for a specific business and would explain why that method was used.

That is true. But the income used to value the business is not the gross sales. It's the gross sales minus operating expenses (including depreciation). It's never just gross sales. And any forensic accountant (and that is really who should be valuing a business anyway) won't go with just gross sales.

[justbroke]

helpmeout, I don't know if that's a true assumption in determining "value" of a business. I say look at Amazon. Back in the mid-1990s into early 2000s... Amazon lost money every single day, every single month, every single year. However, the "value" of the business was worth more than merely looking at "gross revenue" less expenses (or net profit). The stock actually went up significantly causing a split at some point. Even with hundreds of millions of dollars in sales, they had an NOL which averaged $90-$100 million dollars.

Yet, the company still enjoyed a $100+ stock price and a large market cap back then. (Of course, that was the .COM bubble which no one wanted to believe!)

So I think we are all right to say, that the valuation method can be anything from revenue, to gross profit, to net profit, to a balanced approach (balance sheet listing liabilities versus assets), versus some hybrid such as in the Amazon "amazing" story. (I like Amazon as an example because it dispelled all myths that a company must make money in 5 years or the business model was not viable. I used to imagine what it was like to borrow money and telling the lenders that you're going to lose $100M a year for 5 years with $300M from 2000-2002 alone.) Perhaps the revenue-based model is more appropriate for a consulting business, with no "product" costs, than a widget company. I for one, would not like to value a non-manufacturing "tech" company.

I don't think anyone was saying that "gross sales" was the way to measure a business' value. It can be tricky to value any business.

[helpmeout]

What you are talking about is a non-tangible asset. And those are extremely hard to sell. It's one thing to value a stock of a company that is losing money at $100 per share when it isn't for sale.

Chances are, that value would have taken a huge nosedive if Amazon had been put up for sale.

And when dealing with a BK, as an accountant, I would make the arguement that you have to go with the tangible. Because that's really the only thing that you can prove has any value at all. And a forensic accountant (which I am not) is the best person to determine value. Because they are going to take all factors into consideration while reviewing hard evidence of value.

[ExplorerZ]

A quick update on the personal guarantee and AmEx front...

Upon receiving notice of our BK, American Express closed the "OPEN" business credit card for my wife's LLC as well as the "OPEN" business credit card for my c-corp, as we were the guarantors for each respectively.

On the phone they said that any time a guarantor declares BK, the business card is closed (based on Google searches, it sounds like there was more discretion before the Great Recession).

They also now require personal guarantees on business charge cards, which also seems to be a new development in the past few years.

So unless you pass the $4M in annual revenue threshold to qualify for corporate cards, you're out of luck with American Express.

[alo]

It looks like you went ahead and filed Ch7. So what did you/your attorney decide to do regarding the 30% shares?

Here was a thought I had regarding your share...As a way of pre-planning for BK, I was going to ask if you could simply sell them to the stockholders with a stipulation that within a certain time frame, you cold re-purchase at the same price But I guess you pulled the trigger (congrats!)

Maybe others could chime in as to whether this is legal. I would assume it is like someone selling off their furniture and other assets to pay for living expenses and attorney fees or other allowable expenses.

Also, if you like your attorney, please PM me their name. I'm in your district and looking for recommendations. Thanks!!

[HHM]

Here was a thought I had regarding your share...As a way of pre-planning for BK, I was going to ask if you could simply sell them to the stockholders with a stipulation that within a certain time frame, you cold re-purchase at the same price But I guess you pulled the trigger (congrats!)

That scenario creates a host of issues. (1) the price paid has to be fair market value, (2) it must be a real transaction, cash must be exchanged, (3) then the debtor has to spend or otherwise exempt the cash (which could take a while). Nothing inherently illegal about it, but it would need to be done correctly and then you must deal with the practical and legal issues that arise from doing the transaction. This idea would probably be a last resort.

[ExplorerZ]

The lawyers all basically said the same thing, that unless you can wait a year, there isn't much to do beyond hope the trustee isn't interested or can't get any money for it. Two of three thought it wouldn't be an issue at all anyways, that no trustee would be interested in going after a minority share of such a small business with credit card debts, no profits, and few assets. We went with the lawyer who thought it would be a problem, or at least that we'd have a good chance of spending a day in deposition going through all the company finances before they would abandon the stock, even though I still think that's unlikely.

If you can wait a year, there do appear to be many more options. We didn't discuss it much since we couldn't wait that long. I imagine that if the company actually had profit, it probably could have bought back my shares (and then I'd put that money into qualified retirement plans) and issued me non-transferable options with a long vesting schedule. Changing anything with the stock seems like a way to beg for an adversarial proceeding though... heck, our trustee's standard non-asset intro letter included requests for 3 years of all sorts of documents (and photos of everything we own, without them lifting a finger or spending a dime, hah!), so I imagine they may have the same sort of interest in the company's books and records and I definitely wouldn't want it to come down to me having to convince a judge that it was indeed legit.

For me it was mostly a matter of imagining a worst case scenario of the common stock being sold at auction to a stranger. In that scenario, I realized it wouldn't even be all that bad because it would be minority stake, so they couldn't get on the board, which in turn means my job, income, and plans are safe and if we ever felt the need to issue dividends we could issue preferred stock that they wouldn't have access to. All that without diluting the shares at all. So I can't really imagine what anybody would want with it; I certainly wouldn't buy it. It helps that the remaining stock is held entirely by close family and no investors or competitors would benefit either (I wish that wasn't the case, hah!).