lessons of bankruptcy
By Tom Richman
Interviews with four entrepreneurs, focusing on their bankruptcy experiences.
Inc. Roundtable participants:
JOHN KOSS - Age 60; in 1953 founded Koss
Corp., in Milwaukee, which became a leading maker of stereo headphones.
Koss filed Chapter 11 bankruptcy in December 1984; reorganized and reemerged
in December 1985. Last year's sales: $27 million.
BILL LEWIS - Age 48; has started eight
companies. Lewis filed personal bankruptcy twice, in 1977 and in 1986;
now founder and CEO of Federal Refunds Inc., Jacksonville, Fla., which
assists purchasers of petroleum products in recovering funds on overbilled
accounts. Last year's sales: $1 million.
PAUL E. PERKINS - Age 51; in 1978 founded
Voyages International Travel Co., in Highwood, Ill., to disseminate
travel information using optical disk storage and computers. Filed personal
bankruptcy in 1989; currently driving school bus while beginning a new
MICHAEL E. SALVATI - Age 38; in 1985 joined
Virtual Network Services Corp., in Oak Brook, Ill., a long-distance
telephone-service provider, as a vice-president. Company filed Chapter
11 bankruptcy in 1986 and was sold three months later. Partner and bankruptcy
specialist at KPMG Peat Marwick, Chicago.
In the minds of many entrepreneurs, bankruptcy means failure. But four
small-company executives who have been through it contend that, although
it's not a goal anyone is likely to aim for, it can be a tool: a painful
but effective way to learn how to look at your company and your goals
differently. And, they say, the lessons of bankruptcy are there even
for -- maybe especially for - those who have not gone through it.
Given the shape of today's economy, we decided that now would
be a good time to take out of the closet and dust off a topic most Inc.
readers probably prefer not to think about. Senior writer Tom Richman
sat down recently in Chicago with three current or former chief executives
and one former chief financial officer who had been through bankruptcy
proceedings to discuss what it was like and what they had learned.
INC.: Each of you had to have done something somewhat unusual to be
invited here. Can you explain what that was?
PERKINS: I had six little companies that I dissolved, and I wound up
in personal bankruptcy. No, I didn't have condos, yachts, or a lot of
expensive clothes. Instead, I had signed for a lot of expensive electronic
equipment, so I took personal bankruptcy. We live on my wife's salary.
I drive a school bus every morning because it keeps me alive.
INC.: John, your experience?
KOSS: We tried to diversify, to go into other areas, and we stopped
paying attention to our core business, which was stereo headphones.
We started to get involved with the Walkman-type personal electronic
products. It didn't work, but we spent more and more time trying to
make it happen and less and less time on what we knew. Other people
took the opportunity to sneak into that market.
wound up with horrendous debt. In four years we went from practically
no debt to $14 million, and sales headed down, from $25 million at their
We tried to work with the banks, to get them to understand it was going
to take a while to turn this around, and they said, "To us, long term
is about a year." That wasn't going to be enough time. So we realized
we were going to have to call the guy with the black robe to hold them
off while we got this thing reworked.
LEWIS: I've had two sevens - Chapter 7s. That should be lucky, and in
a way it was. If I'd continued on the track I was on, I'd be dead. I've
recovered, like an alcoholic, I guess. The only problem I have with
it today is that I can buy a Porsche, but I can't rent a Ford. I can't
SALVATI: I was at Peat Marwick, and one of my start-up clients was a
long-distance phone company. It recruited me as vice-president for finance.
I thought it would be a good opportunity to get into a business on the
ground level and use my skills in a way I couldn't as a consultant.
We lasted two years. We grew from no sales to $15 million in 12 months
on an annualized basis. In fact, one of our problems was, we were growing
too quickly. We put in a new president and tried to restructure and
sell the company. We found a buyer, but on the day of the signing he
decided not to do the deal. We filed Chapter 11 bankruptcy instead,
and within a week there was a hostile takeover attempt; some people
wanted to come in and assume our position in bankruptcy, but I could
see that they had no more cash than we did. We had to hold them off
in court until we found another qualified buyer. The new owners offered
me a job as controller, but I decided to take some time to unwind. Now
I'm back at Peat, working with companies in bankruptcy.
INC.: You frequently hear the phrase, "sought protection under Chapter
11 of the bankruptcy code." Is that accurate: protection?
SALVATI: That's the reason we filed. We were under tremendous pressure
from our creditors because we owed them about $8 million. We were on
a 24-hour disconnect notice from our long-distance carriers. By the
time you decide to file for bankruptcy, you've got so many people ganging
up on you, and it takes only one to ruin the business.
INC.: You believe, most of you, that you got a fair shake from the bankruptcy
SALVATI: Yes, but remember that the protection is just from the creditors.
You're still out there competing in the marketplace with a weak capital
structure, and your customers are getting phone calls from your competition.
One thing you learn in bankruptcy is that you no longer control your
company. The court does. All the interested parties in the world are
in there talking to the judge, and you're not out calling on customers.
You're spending your time in court.
INC.: Nobody forced your company into bankruptcy.
SALVATI: No, we made the decision ourselves, and that's one of the hardest
things an entrepreneur can come to: deciding to file. If we had waited
another two weeks, we would have been shut down, and nobody would have
bought us. A lot of companies moving toward bankruptcy have opportunities
to file early, but they're reluctant. They keep looking for those little
incremental successes to keep them going.
INC.: You mean people aren't willing to admit to themselves that they'd
better get out while they can?
SALVATI: Not so much getting out but giving up control of the company.
The entrepreneur's drive to succeed is so strong, but he can see success
in only one way: in meeting the goal he originally had in mind. Maybe
success to him was going public. I viewed success differently; I viewed
it incrementally. Success was going public if we got the $6 million
in equity, but we didn't. So then success became getting to profitability,
selling the business, and getting our money out. We came up short there,
too, so you keep working your way back. But entrepreneurs typically
hesitate to lower their goals, and they end up losing more control.
LEWIS: Let me say something about the difference between personal bankruptcy
and company bankruptcy.
KOSS: Different world.
LEWIS: Yeah, and it's difficult to separate the entrepreneur from his
business. If you're a ground-start entrepreneur, you put everything
you've got into the company. You've got to pay the employees, so you
sell the house. You do whatever you've got to do. I didn't do anything
illegal, but my point is you do anything you can. And when it finally
collapses all around you, like my long-distance company did, everything
goes down the tubes, and you go with it. You don't make plans to go
Chapter 11; you just say, The hell with it, close the door, and file
a Chapter 7. They take your Rolex and your limousine and everything
anyway. In Chapter 11, don't the guys starting the company keep their
own personal money?
SALVATI: Not really. I was probably one of the company's largest creditors.
Besides, I had 160 people looking to me to make sure that they got paid,
so it was somewhat personal.
LEWIS: You can rent a Ford, right?
SALVATI: Yeah. But it's exactly what you said. You're so wrapped up
in it. I see it all the time in my work now. Companies have opportunities
where they could probably have done a restructuring outside of bankruptcy
if they had started three months earlier, but you just don't want to
give up. You think, If I change this or change that, it'll work. I've
had these incremental successes; I can do it again. Everybody is behind
me. Well, what happens is, you go from there right up to the brink of
bankruptcy. When you're short of cash, you have all those balls in the
PERKINS: Employees turn on you.
SALVATI: And if one of them falls -
PERKINS: But in an entrepreneurial company, you say you're going to
get it done no matter what. When you're an entrepreneurial start-up,
you're living with your suppliers because you're always behind in your
bills. You're living with a Chapter 11 every day. You've always got
those people who could close you down in a minute if they pulled the
plug. I get a big kick out of people talking about timing. That's a
crock. Timing is an after-the-fact analysis. I want to hear somebody
tell me about how they planned it up front and knew exactly what day
this was going to happen.
LEWIS: Yeah, that's bullshit.
PERKINS: Where you hit my hot button, Bill, is when you said, "Is it
personal, or is it corporate?" When you're an entrepreneur, it's all
LEWIS: You've got a lot of pain. I can feel it.
PERKINS: I've got a lot of anger.
LEWIS: Anger, pain. You've got a lot of it. I finally got over it when
I quit saying, "If I only would have . . . " or "I could have . . .
" I was brokering long-distance service through another company's switch,
the first in the country to put multilevel marketing into long-distance
service. We were growing so damn fast they couldn't handle our business.
All of a sudden, the company in Memphis that I had contracted with was
sold, and the new owner wrote me to say they would no longer provide
the service. They gave me two weeks to move my customers. We tried to
get an injunction, and my screwy lawyer didn't know what he was doing.
They had about 10 New York lawyers. Some lies were told. I knew the
courts were going to rule against me. I left and went straight to the
office. I called another company in Memphis and asked if they wanted
my customer base. I sold it to them, locked the door, and left. There
wasn't any reason to go through a bankruptcy. It was painful, man -
SALVATI: I think -
LEWIS: But let me finish. When I finally got over all that, that was
when I quit blaming other people. It wasn't the fault of the CEO of
the other company. It was my fault because I didn't plan far enough
ahead. It was as stupid as hell of me to sit there exposed like that.
INC.: Does it cost you anything in your head, your heart, or your gut
to file bankruptcy?
KOSS: It costs a lot. The guy who starts the business never thinks it's
going to fail. That is why most bankruptcies are too little, too late.
People wait too long, thinking something will happen at the last minute.
Somebody has to be objective for you in your organization. If you are
an entrepreneur, that person has to tell you, We've got to stop here,
or there will be nothing left. I don't think the fellows in Chicago
who became our lead bank realized that they weren't dealing with a man
and a business; they were dealing with a man and his life's work - not
only my life's work, but my wife's and the five kids'. What were we
going to do, take something we had spent all our lives developing and
just throw it away? Or were we going to fix it? It was never a question
of whether we were going to turn it around, just when.
INC.: So it was more than a business issue for you?
KOSS: Yes, it was the family, the lifestyle, the
whole thing. It wasn't just deciding with your wife that, gee, the
business has come to the end, so we'll let it go and do something else.
This was an exciting life's work. Most entrepreneurs are like that.
They get hung up on a product or concept or idea, and then they're not
doing it just to amass money.
LEWIS: It's a child.
KOSS: Yes, but you don't think about it that way until somebody threatens
to take it away from you. Signing those Chapter 11 papers was hard -
especially because of my age. I'm from a generation
where you never did that.
INC.: How did you reconcile this bias you had against bankruptcy in
light of having to file for one yourself?
KOSS: I talked to a lot of people, including some friends who had gone
through it. One friend gave me very good advice. He said: "When you
do this, you'll want to hole up at home. You won't want to talk to anybody
or see people. You're going to feel like a beaten animal. Don't do any
of that," he warned me. He said it would eat me up from the inside,
and I'd die from it.
LEWIS: You need to do it for a few days, though, don't you? You might
KOSS: The first night I stayed in and sat with my wife. It was on the
television, and of course, I had called a few friends to let them know
it was coming. The next day, though, I went charging into the office
with a very positive attitude because we were going to get through this
thing. We were sharing information about what was going on with our
employees and everybody else. Another friend told me that there's another
reason that you don't go into hiding. The reason is that a lot of people
out there want to help you.
LEWIS: Sure, if you're talking about Chapter 11. What about Chapter
KOSS: I don't know, but I bet there are still people who want to see
you, who want to help, but they don't know how to get to you. They're
not going to call you on the phone or ring your doorbell, but they can
get to you if you're out in the open.
INC.: Bill, was your family involved in your decisions?
LEWIS: Sure, just the first bankruptcy. I had a real estate firm, and
always one to do something different, I had bought a limousine and hired
a chauffeur so we could pick people up at the airport and show them
property. Then I came up with the idea of getting all these brokers
together under one roof with pictures of the subdivision lots, but it
didn't work. I lost everything, including the house, and my wife and
child had to move out because I couldn't feed them. But eventually they
came back, we bought a house, and - And we lived happily ever after?
No, I went bankrupt again. The guy who lent money to me for the long-distance
company really lent it to the corporation, but he came to me to get
it back. Then he got a lawyer, and I couldn't afford to fight it, so
I said, What the hell, and filed personal bankruptcy.
INC.: Would you do something different now if you had to do it again?
KOSS: Yes. I'd have filed earlier. I wouldn't have trusted the banks
that we were going to work this stuff out together and all that nice
stuff that they talk about before they turn you over to the workout
PERKINS: The idea of filing sooner assumes you've got money stashed
to hire competent attorneys. No good lawyer is going to take a bankruptcy
case on contingency - on the assumption that you're going to survive
and pay him later.
SALVATI: No, they'd be crazy to.
PERKINS: But no entrepreneur is going to take money from investors saying
it's to keep his company alive while he's really stashing it to hire
a bankruptcy lawyer. That would be wrong.
SALVATI: But it's not just stashing up money to go into bankruptcy.
Bill decided he couldn't take his long-distance company any further
and sold it off. Is that failure? We sold a business to another company,
many people kept their jobs, and my customers did not get damaged by
picking up the phone and not getting a dial tone. I view that as a success.
INC.: You - all of you - had expectations. You had fantasies about where
this business was going to take you, dreams. What happened when reality
didn't match the dream?
LEWIS: It was devastating.
KOSS: You go into a survival mode. Remember, I'd been at it for more
than 30 years, and most of that time, even though it was my company,
I was subject to other people's control. Holy mackerel! It was 20 years
before the bank didn't make me sign everything over - family, dog, kids,
the whole deal - to use their money. Years! I knew what it was like
to wear a collar, and I didn't like it. Now I was wearing one again.
The answer is, there is no alternative. You dust yourself off . . .
There was a time, though, when I sat in my office and cried, and then
I put a gun to my head. The things that were going on in my life - I'd
lost my company, lost my home, lost everything.
couldn't handle it. Like the AA people, I turned it over to someone
or something stronger than me - to God - and that's the only thing I
could do. I begged the telephone company not to turn off my service.
It was so demeaning.
KOSS: Humbling, very humbling.
LEWIS: Yeah, and that was the good part. I was a peacock, man. I had
PERKINS: But see, I never had all that stuff. Don't look for my condos
in Brazil and bank accounts in Switzerland, because anybody who knew
me knew damn well there weren't any. What caused the problem was that
these lawyers think everybody else, including maybe themselves, would
do that kind of thing, so they think you did it.
INC.: What benefits come from this experience?
LEWIS: Listen, this lesson was extremely expensive. I paid dearly, my
family paid dearly, and I'm a no-good jerk if I don't come away learning
something from it. Yeah, I learned a lot. I'd be an incredible CEO for
some company. I'm the best.
INC.: You haven't chosen to do it for someone else, though.
LEWIS: No, well. . . .
INC.: You've started another company of your own. What lessons are you
LEWIS: I don't stay in hotels that cost $200. We had our first sales
meeting in Vegas two weeks ago, and the 20-something agents who came
paid their own way, their own hotel bills, everything. Back during the
Phone Company Inc. days I would have paid it all. I probably would have
hired some dancing girls, all that stuff. I've learned how to get more
for my dollar, not to throw money around. I've done one thing I feel
good about, though. I bought a Porsche a couple of weeks ago. I kept
thinking, I get up at 3:00 in the morning a lot of times and go to the
office, and then I go home and sleep; then I go back to the office and
home to sleep. What am I getting out of this? I want a toy, something
I can touch and feel, you know? So I bought a Porsche.
INC.: Does it ever go through your mind that this business might fall
LEWIS: Hell, yes, but you don't let that be a negative. You make it
a positive by keeping an eye on those cracks in the floor and making
sure that nothing falls through them.
KOSS: I learned about OPM - other people's money. Leverage was the way
to go, they told me: leverage, leverage, leverage. I tell you now, that's
not the way to go.
SALVATI: You know, when we filed bankruptcy, it was the first chance
I had to breathe in 15 months. We were practically insolvent the day
I walked into the company. We never had enough money. I went without
my paychecks. That's not the way you think it's going to work when you
come from a big, prestigious firm. With the bankruptcy, now all of a
sudden I knew there was a light at the end of the tunnel. Part of the
reason we had survived as long as we did was that we had always behaved
as if we were in bankruptcy, and now we actually had the court protecting
INC.: So, for John and Mike, bankruptcy was a help?
SALVATI: There's a lot of disappointment in seeing something go so far
but not as far as you'd hoped. We didn't reach our ultimate target,
and I felt bad because there were shareholders who believed in me, banks,
creditors, employees. Still, we built something from zero to a pretty
substantial company on a tremendous growth curve, and I took a few things
away from that experience that I use today.
INC.: Is failure - to the extent that bankruptcy
is seen as failure - a culturally acceptable event?
LEWIS: Oh, yes. It's as if you're in a stock-car race. You run out of
gas every once in a while, so you have to make a pit stop. Then you
get back in the race and keep gunning that sucker. I can't put it in
words too well, but that's the way I think of it.
KOSS: Failure is when you join the turf club. Anything else is an experience
that didn't work out too well. Bankruptcy
is a tool. If you try your best and you're an ethical and honest
businessman and circumstances work against you, the tool is there to
give you a chance to start over. We started over, and my God, look at
all the jobs and the families we saved.
© 1999 Goldhirsh Group, Inc.
Issue of Inc.!
Because so many people going through divorce are under financial stress,
they often think about the possibility of bankruptcy as a way to get
control of everything.
If you're thinking about bankruptcy, or more importantly, if your spouse
is thinking about it, you're smart to pay attention to this information,
because the way you word your divorce settlement can have a lot to do
with how the bankruptcy affects your divorce, and vice versa.
There's lots of information here on DivorceInfo on how bankruptcy and
divorce affect each other. I don't do bankruptcies. I think bankruptcy,
like divorce, is an area that you can't do well unless that's about
all you do, so I leave that to others.
What I've concentrated on is understanding how bankruptcy and divorce
The first thing you need to understand, if you haven't already thought
it through, is that there are several different kinds of bankruptcy.
Beyond that, here are the way the issues settle out:
you're not alone
Most of us know that bankruptcy filings are up. Most of us don't know
how much. Here's how the U.S. non-business bankruptcy filings have increased
over time. This doesn't mean bankruptcy is a great idea.
It does mean, though, that if you become involved in bankruptcy, you'll
have more company than you would have had a few years ago. More women
than men are filing bankruptcy these days, which is a significant change
the automatic stay
The first and perhaps most important consequence of a person's filing
for bankruptcy is the automatic stay. When you or your spouse files
for bankruptcy, the automatic stay kicks in to stop all efforts to enforce
the collection of debt.
It is the exceptions to the automatic stay that are important in divorce.
A great deal of the material on this page deals with a bankruptcy term
called "discharge." You'll also hear about "discharging" a debt, whether
a debt is "dischargeable," and whether an action affects the "dischargeability"
of a debt.
Simply put, we're talking about whether the debtor can get rid of the
debt - can get free of it. Obligations from a divorce to pay support
are not dischargeable in bankruptcy. Period. This includes payments
to support a former spouse or minor children.
The support obligations that are nondischargeable include child support,
alimony or spousal support, and lawyer's fees from a divorce or to modify
support. A person (in bankruptcy terms, the "debtor") can file bankruptcy
and can complete the bankruptcy process even while owing support. It's
just that when the case is finished, the debtor will owe the support
obligation with no change.
The bankruptcy code section that governs this is 11 U.S.C. §523(a)(5).
If an obligation from divorce is in the nature of property settlement,
whether it gets discharged is a good bit less certain. They're presumed
to be nondischargeable, but the debtor may be able to overcome the presumption
and have them discharged.
Overcoming the presumption requires a showing that the debtor cannot
pay the debt and still take care of himself, his dependents, and his
business, or that discharging the debt would result in a benefit to
the debtor that outweighs the harm that would be caused to the former
spouse or child by non-payment.
The bankruptcy code section that governs this is 11 U.S.C. §523(a)(15).
what doesn't get discharged
Here are the debts that don't get discharged in bankruptcy:
1. Alimony and child support;
2. Some obligations for property settlement in divorce;
3. Student loans;
4. Debts arising from fraud or theft; and
5. Criminal restitution.
what you can do
If your spouse owes obligations to you after divorce, and if there
appears to be a good chance the spouse will file bankruptcy, the implication
is clear: Support is good. Property settlement is bad.
What you need to do is to characterize as much of the obligation as
possible in ways that makes it clear that it's intended for support,
not property settlement.
Note that the bankruptcy court will not be bound by what you call
the obligation, but if you clearly call it support and it behaves
like support, there's a good likelihood the court will find it to
be support and will not allow discharge.
If there's no question that a portion of the obligation due to you
is property settlement, though, no amount of verbal window-dressing
will change it. So what can you do then? Think security.
What you want to do is take a lien on one or more assets of value
- preferably assets that are important to your spouse. Then if your
spouse proposes later in bankruptcy to have the debt discharged, you
can seize the property to pay the debt.
It's messy, and you may get far less from the property than it's worth,
but depending on how much equity the debtor has, the leverage of the
lien should help to get the debtor's attention in bankruptcy.
One last thought: if both of you are thinking about bankruptcy, you
may want to file before you get your divorce. That way, you'll know
when you divorce which obligations will be discharged, and you can
each negotiate with full knowledge.
In addition, filing before divorce will save you some money, because
you'll pay for only one bankruptcy filing instead of two, and your
divorce will be a good bit less complicated.
© 2002 Divorceinfo.com