- Celsius’ Chapter 11 is uncommon in a startup world where companies quietly flame out.
- Startups typically burn through cash rather than racking up long-term debt or an army of creditors.
- They tend to favor private, out-of-court liquidations to avoid scrutiny, lawyers told Insider.
When Celsius filed for Chapter 11 in July, it acknowledged to a bankruptcy court in Manhattan that it owes answers to its massive base of 1.7 million users who’d held various crypto assets that represent most of its $5.5 billion in liabilities.
But the crypto lender’s high-profile bankruptcy marks the relatively uncommon instance of a startup that has run out of cash and is seeking to restructure in bankruptcy court. According to five corporate lawyers Insider spoke to, many startups more often simply liquidate and wind down operations privately.
“Many startups don’t have long-term liabilities or debt other than venture debt and trade payables,” Ronald Fleming, a partner at Pillsbury Winthrop Shaw Pittman LLP — where he leads its emerging-companies practice — said.
“They’re burning cash to operate,” he said. “Bankruptcy tends to be a solution for solving balance-sheet issues, which is not really the problem for startups that can’t raise cash to fund operating losses in a tougher financing environment.”
As share prices of public-tech companies have plummeted and venture capitalists have pulled back on funding in the downturn, venture investors have put pressure on portfolio companies to cut costs, which for many has meant reducing staff. Companies like Coinbase, Gopuff, Better, and Noom have all laid off staff.
Others, like Fast, a one-click checkout-software company, have shut down completely and dissolved. Some startups try to restructure their operations through a Chapter 11 filing to deal with their liabilities and emerge a leaner enterprise, while others at the end of the road dissolve and offload their assets in out-of-court proceedings.
As the economic downturn hits startups, dissolutions become more likely. According to data from PitchBook, some 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 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 declined to 37 in 2021, according to PitchBook data.
The cost factor
In short filings, Celsius outlined the substantial physical hardware it used to run its online business, including tens of thousands of bitcoin-mining rigs among its $4.3 billion in assets. The crypto lender also said it owes millions to vendors helping it build a new mining center in Texas.
A formal Chapter 11 restructuring would help the company, valued at roughly $3 billion in December, by creating a regimented and transparent process to repay a large creditor base, leverage its physical assets, and emerge with a business on the other side.
But the costs and rigors of a court-monitored process for Chapter 11 bankruptcy make it a less appealing option for many startups and emerging tech companies strapped for cash, attorneys said.
The problem for startups is that they’ve burned through their cash, Fleming said.
“Many people don’t understand this, but you need cash or financing to avail oneself of a 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 financing, is to seek out some kind of business combination,” he said. “If that process fails, the choices are either to shut down and wind up, or, more frequently, to orchestrate a ‘soft landing,’ or an ‘acquihire,’ often at a very low, nominal purchase price, with another startup. ”
Companies restructuring in federal court must keep paying their bills while they close down stores or offices and tee up asset sales under the supervision of a bankruptcy judge. Companies in bankruptcy must also get the court’s permission to pay various business expenses, or to 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 companies, as the bankrupt company must pay the army of professionals involved — bankers, consultants, and top lawyers billing upwards of $1,500 an hour — out of its debtor’s assets.
A quick wind down
For many emerging tech startups, the problem is also less that they have major liabilities like long-term debt to carefully slash by restructuring, or large numbers of physical stores to wind down, or major assets like equipment to sell off, attorneys said.
When the one-click checkout startup Fast burned through some $120 million in funding, it simply laid off employees and ended its operations in April.
“Startups fail for many reasons, of which Fast obviously was not immune. But decisions made that lead to this outcome which I take responsibility for,” Domm Holland, the startup’s CEO, wrote in social-media posts at the time.
Startups can can shut things down quickly and liquidate their remaining assets — often whatever cash is left — and parcel it out to any remaining creditors, Ed Zimmerman, a partner at Lowenstein Sandler who chairs the firm’s tech group, said.
“It’s harder to do some sort of reorganization or work out when the assets are as … I don’t want to call it nebulous, but intangible, and perhaps unusable without team members,” Zimmerman said. “It’s not like we have a lot of printing presses that can be sold.”
“Startups that are prioritizing growth over profitability run out of cash because they go from funding to funding,” he said.
That can become a problem when VCs pull back. Deal activity among VCs in the US has declined significantly since record investments last year hit $342 billion, according to PitchBook and the National Venture Capital Association’s Q2 2022 report. According to the report, as of June 30, this year, deal activity stood at $144 billion.
The ‘ABC’ process
One approach that startups more commonly use to quietly wind down operations is a combination of asset sales and liquidations that they can operate under the radar with a process known as an assignment for the benefit of creditors, restructuring attorneys said.
The process, which the industry often refers to with the shorthand ‘ABC,’ follows state laws to unwind a company. States have different rules governing the process, and some states like Massachusetts and California — where many Silicon Valley tech companies have their bases — allow startups to handle their dissolution out of court, shielding them from negative press and scrutiny.
After Optimus Ride, an autonomous-vehicle company, sold off valuable assets like its intellectual property to Magna International, a Canadian auto-parts manufacturer, in January, it undertook the ABC process in Massachusetts to pay off creditors, Brad Sandler, a partner at the restructuring firm Pachulski Stang Ziehl & Jones, told Insider. Sandler represents the entity that was winding down Optimus Ride’s remaining assets through the process, which is taking place out of court.
“Because bankruptcies are expensive, an ABC is, generally speaking, a less expensive process, and more efficient process,” he said.
The Chapter 7 option
Another option is a Chapter 7 liquidation, a court-monitored proceeding in which a bankruptcy trustee oversees the distribution of liquidated assets to creditors. Unlike in a Chapter 11, the board and management of a company don’t play a role in the process. Electric Last Mile Solutions, an electric-truck company, filed for Chapter 7 in Delaware bankruptcy court last month after its CEO and founder both left the company.
As with most restructuring and unwinding processes, it’s creditors who get priority to recover their losses based on how much their loans were secured by the company’s assets. In the context of startups, venture lenders like Silicon Valley Bank, which provide loans backed by collateral, could fall in the category of secured lenders.
Investors and stockholders frequently see their equity wiped out unless a deal can be reached otherwise, attorneys said.
“When companies fail, the liquidation value of a failed startup tends to be remarkably low, notwithstanding how much money they raised, or what they think the value of their technology is,” Fleming said.