Seeing Through Common Misconceptions Associated With Bankruptcy
Bankruptcy is a term that makes some cringe, but it was actually designed to provide businesses protection and offer debtors a “fresh-start.” Conversations are taking place in many board rooms of healthcare & life science companies between executives previously accustomed to large revenue growth and high valuations. Rapid changes in consumer behavior, a shift in customer needs and the regulatory and reimbursement strain has been difficult to navigate. Consumer behaviors and needs are well publicized. We have all seen and read how COVID-19 has halted consumer decisions to proceed with elective surgeries and hospitals have had the need to re-purpose surgery space for COVID-19 patients. Quarterly earnings calls have confirmed the billions in lost revenue to date from elective surgeries.
While these metrics are staggering, they do not include the impact to other segments within the industry such as pharmaceutical, biotechnology, medical device manufacturing and more. Many medical device manufacturers are directly impacted by the number of elective surgeries. Pharmaceutical companies racing out to find a COVID-19 vaccine dominate the headlines, but in general, pharmaceutical companies face unprecedented regulatory and reimbursement challenges and significant litigation. Moreover, who would have thought biotechnology and bankruptcy would be used in the same sentence?
The federal government acted swiftly to provide assistance to healthcare providers (as seen in the Accounting Considerations for Healthcare & Life Sciences article). For many providers, this was only a brief sigh of relief, while other industries received no benefit. Reality is beginning to set in making bankruptcy a more viable long-term option.
Not All Industries Are Created Equal
Healthcare and life science companies face unique issues with bankruptcy proceedings. In other industries, the creditors and shareholders are the primary drivers behind bankruptcy filings regardless of whether it’s involuntary or voluntary, or it’s Chapter 7 (Liquidation) or Chapter 11 (Reorganization). Healthcare and life science companies generally have more complex equity structures and equity-linked financing. These companies must evaluate the impact of selling assets with significant regulations, larger customer relationships, Medicare and other payer agreements, Medicare/Medicaid recoupments, and a much broader scale of equity holders than a typical business.
Pharmaceutical and Biotechnology Companies
Pharmaceutical and biotechnology growth companies are generally structured to be able to avoid bankruptcy regardless of bottom-line and macro-economic conditions. These pre-revenue company’s valuations are typically based on intangible assets (ideas and vision) rather than tangible assets or profitability like most companies. Investors are drawn to the idea of the solution and can see significant future profitability if the company executes according to plan. The vast majority of these companies are pre-revenue companies still undergoing clinical trials and because of the significant investor activity, there’s typically little to no debt to restructure if the investor pipeline dries out.
While many of these pre-revenue companies may be structured to avoid bankruptcy, 2020 has come calling. As these companies’ medications make it to the latter phases of clinical trials, it becomes more and more difficult for management to guarantee the correct revenue trajectory for its investors — which is a crucial time in a pharma company’s life. Food and Drug Administration (“FDA”) approval, while a significant accomplishment for a company, does not necessarily mean the product is going to sell, or sell at projected profits, due to the structure of arrangements with Medicare/Medicaid, regulatory requirements, and some companies are hit with a harsh new reality.
For more mature pharmaceutical companies, the litigious environment surrounding opioid medications is a good example of companies that have been thriving for years are now under attack with lawsuits from both state and local governments. These lawsuits could create significant liabilities to these companies and eventually force bankruptcy discussions. In these bankruptcy proceedings, the intangible assets become a significant factor at this point for the current stakeholders wanting to exit as these help generate prospective buyers through the courts where the stakeholders could receive a portion of their initial investment, and potentially a large portion or profit, once sold.
Medical Device Manufacturers
The capital structure of medical device manufacturers is generally more in-line with other industries, where debt financing is prevalent. With recent increases in canceled services throughout hospitals, as mentioned above, many medical device companies stopped production or have incurred significant costs to pivot to products aligned with current COVID-19 needs. While the historical structure of these companies generally creates additional risk of a bankruptcy filing, reorganizations offer opportunities to restructure quickly and put a stop to continued losses. This has become a very practical option for manufacturers hit with this reality as they are given the opportunity to achieve economic feasibility and a “fresh-start” once the company emerges.
Executing a Sound Plan
Bankruptcy filings come with a significant demand on senior management, financing and accounting, well beyond the normal day-to-day activities. Financial reporting, regulatory compliance, and court proceedings are highly complex, once a reorganization (Chapter 11) plan is approved by the bankruptcy court making it critical that management understand the process, the company’s current capacity to execute the plan, and the regulatory and financial reporting requirements necessary during the planning process. Companies in healthcare and life science that have successfully emerged after filing for protection under Chapter 11 apply these key planning principles to execute a reorganization plan that enables future growth when possible.
While the planning and expertise necessary can be daunting, bankruptcy is a viable option to help restructure a business and create opportunities for future growth. The following considerations could indicate bankruptcy is an alternative business decision to progress your company forward:
- Has the business incurred significant operating losses in recent history or a significant downturn due to recent market conditions?
- Does the business have significant debts to various lenders stalling the growth of the business?
- Are identifiable segments of the business relying on the profitability of others to maintain operations?
- Are current shareholders reviewing options to liquidate quickly and cut their losses?
If you answered ‘yes’ to any of these questions, bankruptcy is a possible alternative for your business and Cherry Bekaert is here to help.
How Cherry Bekaert Healthcare & Life Science Experts Can Help You Navigate These Complexities
Cherry Bekaert and our leading professionals in healthcare and life sciences can help organizations navigate complex accounting issues brought on by bankruptcy and adapt to the regulatory environment while continuing to run a business. Please contact Chris Rux or Chase Wright to discuss these and related topics further. You can also check out the COVID-19 Guidance Center for more topics that might interest you.
