Available at: What Start-Up Lawyers Should Know About Bankruptcy
Abstract:
Bankruptcy has long been regarded as a gloomy area of law, one that fits uneasily with the heady optimism usually associated with start-ups. At the same time, start-up lawyers need to understand how downside scenarios will play out, both inside and outside bankruptcy court, in order to advise their clients appropriately. That is especially true for social enterprises – where the decisions throughout a company’s life affect its ability to stick to its mission during times of financial distress. In a forthcoming book chapter, I map out the various elements that start-up lawyers need to consider.
Bankruptcy has a reputation problem.
For many attorneys outside our field, bankruptcy is viewed as something that happens only after a business has failed—a specialty to call only after all other options have been exhausted. Christopher D. Hampson's thoughtful article, What Start-Up Lawyers Should Know About Bankruptcy, makes a compelling case that this view is exactly backwards. Bankruptcy law should inform legal advice from the very beginning of a company's existence, not merely after it finds itself in financial distress.
Summary:
Hampson argues that start-up lawyers need to understand how today's corporate decisions affect tomorrow's restructuring options. That is particularly true for social enterprises—companies that seek both profits and a broader social mission—because the choices they make regarding corporate structure, financing, governance, and growth may determine whether that mission survives financial distress.
The article explores the ongoing debate over whether Chapter 11 adequately protects the missions of social enterprises. While Hampson believes the law may offer more flexibility than many commentators assume, he cautions that attorneys should never simply presume bankruptcy will preserve a company's founding purpose. Planning must occur long before any bankruptcy filing becomes necessary.
To help practitioners think through these issues, Hampson proposes a straightforward framework:
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Mission – What is the enterprise trying to accomplish?
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Form – Which legal entity best supports that mission?
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Fundraising – What obligations accompany outside investment?
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Growth – How will expansion affect future restructuring options?
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Downturn – What happens if the company encounters financial distress?
The article illustrates these concepts through companies such as Dave's Killer Bread, Bombas, Warby Parker, and Allbirds, demonstrating how different business models integrate their social missions to varying degrees. It also discusses the tradeoffs among nonprofit corporations, benefit corporations, and traditional business entities.
Perhaps the article's most practical warning concerns secured lending. Businesses that grant blanket liens on virtually all of their assets before distress often enter bankruptcy with very little room to maneuver. Once a secured creditor controls nearly every meaningful asset, the debtor has far fewer options to preserve either its business or its mission.
Hampson closes with an observation that deserves to be repeated: bankruptcy law is not merely something lawyers encounter during a downturn. Insolvency rules quietly influence negotiations, governance decisions, financing arrangements, and corporate strategy throughout a company's entire life cycle.
Commentary:
Although Professor Hampson writes primarily for start-up lawyers, his message should resonate with virtually every attorney who advises businesses.
One of the biggest misconceptions about bankruptcy is that it begins with the filing of a petition. In reality, bankruptcy often begins years earlier when a lawyer drafts loan documents, negotiates security interests, prepares an operating agreement, structures ownership, or advises a client on raising capital. Those early decisions frequently determine whether a business will have meaningful restructuring options later—or whether those options have already been surrendered.
Consumer bankruptcy attorneys have long understood this reality. Every blanket lien, every personal guaranty, every restrictive covenant, and every financing arrangement affects what may be possible if the business eventually encounters financial difficulty. By the time a company walks into a bankruptcy lawyer's office, many of the most important decisions have already been made.
The article also highlights something transactional lawyers sometimes overlook: entity selection is not simply a tax question or a governance question. It is also a bankruptcy question. Whether a business chooses to operate as a traditional corporation, LLC, benefit corporation, or nonprofit can have profound consequences if financial distress occurs.
The same is true for financing decisions. Every dollar of additional leverage may fuel growth today, but every additional lien may eliminate flexibility tomorrow. Bankruptcy lawyers see these consequences every day, often wishing they could go back five years and help structure the deal differently.
For those of us who practice bankruptcy law, this article is also an important reminder that we should do a better job sharing our perspective with the broader legal community. Bankruptcy attorneys are not simply litigators who appear after a crisis develops. We are counselors who understand risk, leverage, restructuring, and preserving options. Those insights can add value long before a bankruptcy case is ever filed.
Finally, I'd encourage my readers to do me one favor. If you found this article—and this blog post—helpful, please share it with attorneys who practice outside the bankruptcy field. Send it to your corporate lawyers, real estate lawyers, estate planners, business litigators, in-house counsel, and anyone who advises entrepreneurs or closely held businesses. Bankruptcy law is not a niche that exists apart from the rest of the legal profession. It is woven into nearly every significant business decision, whether lawyers recognize it or not.
The more our colleagues understand that reality, the better advice their clients will receive—and perhaps a few more businesses will avoid becoming "bankruptcy cases" in the first place.
To read a copy of the transcript, please see:
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