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Debtor-in-Possession Financing: A Lifeline for Small Businesses

6/1/2023

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​Sometimes even the most well-managed small businesses have financial trouble. Reasons why can vary from unexpected circumstances and economic downturns to poor financial management, but the outcome is often the same: bankruptcy. 

Bankruptcy does not always spell the end for a business, especially if it is a viable business with a viable future. Instead, bankruptcy filing can allow the business to reorganize its finances under bankruptcy protection. The business can continue to operate and emerge from bankruptcy financially stronger. 

Ensuring continued access to working capital, though, can be challenging for businesses in bankruptcy. Obtaining traditional financing is often not possible, especially for small businesses facing stress. Without financing, businesses can struggle to fund operations, negotiate favorable terms with vendors, and land new opportunities—all of which can make emerging from bankruptcy more difficult. 

There is another option, though: debtor-in-possession financing. This article explores debtor-in-possession financing and how it can be a lifeline for small businesses in bankruptcy. 

What is debtor in possession?

In the United States, there are three main types of business bankruptcy filings: 
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  • Chapter 7: In what is also known as a liquidation bankruptcy, a business is shut down and its assets are used to pay off creditors. Chapter 7 is typically used when a business is not viable and cannot restructure. 
 
  • Chapter 11: Also known as a reorganization bankruptcy, Chapter 11 filing allows a business to continue operations while it restructures its finances under a plan approved by the bankruptcy court and the business’s creditors. 
 
  • Chapter 13: Similar to Chapter 11, this type of filing is for individuals or sole proprietors. Debts are repaid typically over a period of three to five years. 

A business might file for Chapter 11 bankruptcy because it is a viable business, but it is unable to repay multiple creditors at once. During Chapter 11 bankruptcy, the company is known as “debtor in possession” (DIP) because it continues to operate as the debtor under court control. The company/debtor retains control of its assets and business operations, subject to court approval under bankruptcy protection. 

The goal of debtor in possession is to enable the company to restructure its finances to service its debts to creditors and turn a profit, eventually emerging from bankruptcy financially viable. 

Debtor in possession financing

Repaying creditors and turning a profit, though, requires the ability to capture new sales and grow, even during the bankruptcy process. This is where many small businesses meet obstacles, because obtaining financing by traditional means can be difficult if not impossible. 

Debtor-in-possession financing can provide much-needed capital for businesses that would not qualify for bank financing. Debtor-in-possession financing is often secured by the assets of the business—and like any financing obtained during bankruptcy, would be subject to approval by the bankruptcy court. 

According to data from the United States Courts, more than 13,000 small businesses filed for bankruptcy in 2022. These small businesses are facing a particularly fraught path to obtaining financing, as small business lending approvals at banks and credit unions continue to decline. According to recent data, recent instability in the banking system and rising capital costs are contributing to the declining approvals. And the smaller the business, the more difficult it is to obtain bank financing, especially when a business has filed for bankruptcy. Other tools businesses rely on for cash flow relief, such as extended payment terms from vendors, may also not be available while operating in bankruptcy. 

These businesses, though, do have another path to financing: invoice factoring, which can be used for debtor in possession financing. Invoice factoring is a financing method in which a business converts its unpaid invoices into immediate cash by working with a factoring company. 

Invoice factoring can give businesses working to emerge from bankruptcy access to the capital they need to continue to operate as well as to secure new business. Invoice factoring can help these firms: 

  • Negotiate favorable pricing and payment terms with vendors and suppliers Service new business and grow existing accounts to improve profitability
 
  • Service new business  and grow existing accounts to improve profitability
 
  • ​Access cash to fund operations without having to wait for extended payment terms from current customers and more

Interested in exploring debtor-in-possession financing? We can help. Prairie Business Credit is a national working capital provider to young, growing, or recovering businesses. We offer accounts receivable financing, purchase order financing, and equipment financing. Our company serves both as a trusted financial resource and consultant to entrepreneurs dedicated to building their businesses and ensuring their success.  
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