- Chapter 11 of Celsius is uncommon in the startup world where companies are quietly exploding.
- Typically, startups burn money instead of accumulating long-term debt or an army of creditors.
- Lawyers told Insider they tend to favor private liquidations out of court to avoid scrutiny.
When Celsius filed for Chapter 11 in July, it admitted to Manhattan bankruptcy court that it owed answers to its massive base of 1.7 million users who own various crypto assets that account for most of its $5.5 billion in liabilities.
But the high profile bankruptcy of a cryptocurrency lender is a relatively uncommon example of a startup that has run out of cash and is seeking restructuring in bankruptcy court. According to five corporate lawyers Insider spoke with, many startups often simply liquidate and liquidate operations privately.
“Many start-ups have no long-term obligations or debt other than project debt and trade payables,” said Ronald Fleming, partner at Pillsbury Winthrop Shaw Pittman LLP – where he leads the startup practice.
“They burn money to work,” he said. “Bankruptcy tends to be a solution to balance sheet problems, and it’s not really a problem for startups that can’t raise cash to fund operating losses in a tighter financing environment.”
With public tech stock prices plummeting and venture capitalists slashing funding in an economic downturn, enterprising investors have put pressure on portfolio companies to cut costs, which for many means fewer employees. Companies such as Coinbase, Gopuff, Better, and Noom have laid off employees.
Other companies, such as Fast, a one-click checkout software company, have shut down completely and are disbanded. Some startups are trying to restructure their operations through a Chapter 11 filing to deal with their liabilities and the emergence of a smaller venture, while others are eventually dissolving their assets and offloading them in out-of-court proceedings.
When an economic downturn hits startups, a solution becomes more likely. According to data from PitchBook, about 684 US startups went out of business or filed for bankruptcy in 2020, and that number rose to 804 last year. As of July 28 this year, 356 startups have already closed or have filed for bankruptcy, according to PitchBook. The number of bankruptcies in those groups is relatively small — just 60 US startups filed for bankruptcy in 2020, which dropped to 37 in 2021, according to PitchBook data.
In court filings, Celsius identified the large physical hardware it uses to run its online business, including tens of thousands of bitcoin mining rigs among its $4.3 billion in assets. The cryptocurrency lender also said it owes millions to sellers who are helping it build a new mining hub in Texas.
A formal Chapter 11 restructuring would help the company, valued at $3 billion in December, by creating an orderly and transparent process for paying off a large creditor base, leveraging its physical assets, and emerging with a company on the other side.
Lawyers said the costs and difficulty of the court-watched process for Chapter 11 bankruptcy make it a less attractive option for many cash-strapped startups and technology companies.
The problem with startups, Fleming said, is that they have run out of money.
“Many people don’t understand this, but you need cash or financing to take advantage of the bankruptcy restructuring process,” he added.
“Bankruptcy is expensive — the reality for many startups that can’t raise a round of venture capital or other bridge funding, is to look for some kind of business combination,” he said. “If this process fails, the options are either to close and expire, or more often, to organize a ‘soft landing,’ or ‘possessing’, often at a very low token purchase price, with another startup.”
Corporate restructuring must continue to pay its bills in federal court while stores or offices close and asset sales begin under the supervision of a bankruptcy judge. Companies in bankruptcy must also obtain court permission to pay various business expenses, or even access any financing they negotiated with lenders and investors during the process.
Other costs of filing for Chapter 11 can be prohibitive for small businesses, as a bankrupt company has to pay the army of professionals involved — bankers, consultants, and senior attorneys who earn upwards of $1,500 an hour — out of the debtor’s assets.
For many tech startups, the problem is also that they do not have large liabilities such as long-term debt that must be carefully reduced through restructuring, or the disposal of a large number of physical stores, or major assets such as equipment to be sold, as well as Lawyers said.
When the one-click payment startup Fast drained nearly $120 million in funding, it simply laid off employees and ended operations in April.
Dom Holland, the startup’s CEO, wrote in social media posts at the time: “Startups fail for many reasons, Fast was clearly not immune. But the decisions that were made led to this outcome for which I am responsible.”
Ed Zimmerman, a partner at Lowenstein Sandler who heads the company’s technology group, said start-ups can quickly close things down and liquidate their remaining assets — often what’s left of cash — and distribute them to any remaining creditors.
“It’s hard to do some sort of reorganization or work when the assets are like this… I don’t want to call it murky, but it’s intangible, and probably unusable without team members,” Zimmerman said. “It’s not like we have a lot of presses to sell.”
“Startups that prioritize growth over profitability are running out of cash as they move from finance to finance,” he said.
This can become a problem when the investment capital declines. Deal activity among VCs in the United States has fallen dramatically since record investments last year reached $342 billion, according to PitchBook and Q2 2022 report from the National Venture Capital Association. According to the report, as of June 30 of this year, deal activity amounted to $144 billion.
Restructuring lawyers said one of the techniques startups more commonly used to quietly wind down operations is a combination of asset sales and liquidation that could go under the radar in a process known as a creditor waiver.
The process, which the industry often refers to by the acronym “ABC,” follows state laws to break up a corporation. States have different rules governing the process, and some states like Massachusetts and California — where many tech companies have bases in Silicon Valley — allow startups to process their dissolution out of court, protecting them from negative press and scrutiny.
After Optimus Ride, an independent car company, sold valuable assets such as its intellectual property to Magna International, a Canadian auto parts maker, in January it undertook ABC’s operation in Massachusetts to pay off creditors, Brad Sandler, a partner in restructuring firm Pachulski said. Stang Ziehl & Jones, for Insider. Sandler represents the entity that has been working to terminate the remaining assets of the Optimus Ride through the process, which takes place out of court.
“Because bankruptcies are expensive, ABC is generally a less expensive and more efficient process,” he said.
Chapter 7 Option
Another option is Chapter VII liquidation, a court-controlled procedure in which a bankruptcy trustee oversees the distribution of liquidated assets to creditors. Unlike Chapter 11, the board of directors and company management do not play a role in this process. Electric Last Mile Solutions, an electric truck company, filed for Chapter 7 bankruptcy in Delaware last month after its CEO and founder left the company.
As with most restructurings and breakups, creditors are the ones who get priority to recover their losses based on how much their loans are secured with the company’s assets. In the context of startups, project lenders such as Silicon Valley Bank, which offers loans backed by collateral, could fall into the category of secured lenders.
Lawyers said investors and shareholders often saw their equity eroding unless an agreement was reached otherwise.
“When companies fail, the liquidation value of a failing startup tends to drop significantly, no matter how much money they raise, or what they think the value of their technology is,” Fleming said.