Dec. 29, 2006, was not a good day. That’s the day my distributor declared bankruptcy.
Like many small companies, my business depends on a distributor to get our products to market. In my case, I’m a book publisher. My distributor stored inventory, sold it to retailers, collected payment and then paid me.
When my distributor declared bankruptcy, it held most of my inventory, owed me a large amount of money and controlled access to many of my customers.
Since then, I’ve learned more about bankruptcy than I ever wanted. In the process, I’ve discovered ways for small companies to protect themselves before — and after — they find themselves in this unhappy situation.
In this week’s column, I’ll focus on steps to take now to insulate yourself against another’s bankruptcy, whether a customer, distributor, or supplier. Next week, I’ll discuss specific ways a company can react once a partner has declared bankruptcy.
Recognize The Possibility
“When a deal is being negotiated, it’s surprising how frequently no thought is given to the consequences if the other party goes bankrupt,” said my bankruptcy lawyer.
Check Finances
Before you go into business with a company, check their financial situation. “If it’s a public company, check their published financial records,” Coleman said. “If they have a history of operating losses or little liquidity, that’s a red flag. If it’s a private company, get a Dun & Bradstreet report.”
File UCC-1 Forms.
Any time you have your property in the hands of another when you haven’t actually sold it to them (or you’ve sold it to them on credit using the property as collateral), file a UCC-1 (Uniform Commercial Code) form with your state’s Secretary of State. This keeps other creditors of the bankrupt company from seizing your assets.
Get A Personal Guarantee
If you’re extending a significant amount of credit to a business customer, ask for a personal guarantee from the company’s owners. After all, you have to give a personal guarantee when you get a bank loan for your business.
Monitor Customers
“One red flag of potential trouble is when a company is slow to pay,” Coleman said. “Don’t let customers get too far out on what they owe you.”
Spread Your Inventory
You’re less likely to have a long-term business disruption if you can maintain access to inventory so you can still fill orders. Whether from bankruptcy, theft, fire, or a natural disaster, you’re vulnerable if all your stock is in one place.
Diversify
Being overly dependent on any one key partner — customer, supplier, or distributor — places you in jeopardy. If you receive more than 50 percent of your income from one channel, develop other sources of income.
Maintain Relations
Don’t allow a distributor to be the only one with contacts to your key customers. Try, as much as possible, to develop and maintain your own relationships with those who are critical to your company’s survival.
Establish Reserves
Another’s bankruptcy is going to cost you a lot — lost income and inventory, legal fees. You’ll need cash to see you through. Having an existing credit line and/or financial reserves can enable you to survive.
Fortunately, my company was in a good position to survive this crisis. Years ago, for instance, we made a commitment to diversify our income stream, which gave us significant cash flow and income from other sources. I have personal relationships with our most important customers — even when my distributor was the entity selling to those accounts. We have a good credit line and excellent relations with our suppliers.
I was able to come through this bankruptcy without major damage to my company. Not everyone can be so lucky.
Rhonda Abrams is the author of “Six-Week Start-Up” and “What Business Should I Start?”