Small companies can survive Chapter 11

March 1, 2003

In the last few years, the telecommunications industry has seen more than its share of bankruptcy filings, including some national and international networking giants. Many of these telecom companies worked with lawyers, bankers, and investors to restructure and reenter the marketplace with some semblance of the former company intact. But what happens when things suddenly "turn south" for the small, privately owned firm in the optical communications space? Although the stories may differ from company to company, all have some "lessons learned" to pass on—and a few, like Metrobility Optical Systems (Merrimack, NH), are fortunate enough to prove there can be life for small companies after Chapter 11.

In 1990, Metrobility (then called Lancast) was founded with a focus on Ethernet solutions for LANs. The company eventually branched into media converters, first developing a good reputation for "dumb" media converters and in 1997 migrating to more managed media conversion products.

By 1999, the company had grown to about $24 million and, with new leadership, developed a strategic plan for growing the business—basically to leverage its experience in Ethernet connectivity and optical-electrical conversion to provide connectivity access and concentration solutions for the network.

Three years ago at SuperComm, discussions began with venture capitalists (VCs) about getting $20 million to fund the company's new direction and have products to market in less than two years; several VCs were interested. It was during these discussions that Alex Saunders, president and chief executive at Metrobility, thinks the company made a fundamental mistake.

"One of the VCs told us it would be awfully smart if we didn't have multiple VCs in the deal," recalls Saunders. "They said we were giving up too much of the company, and with all the multiples and valuations going up, up, up, the smart thing to do would be to take half the money, $11 million, and have only one VC involved. We could always do another round—there's more money where this came from—in six months or a year, and we'd get a higher valuation on it."

The company agreed because it was obvious that the whole optical space was going through the roof and the market was hot in every analyst's view. Metrobility thus forgot its basic plan and accelerated everything, from hiring people to research and development. Between December 2000 and the summer of 2001, the bottom began to fall out. VCs shut down funding—just when companies like Metrobility were becoming aware that another round of financing was critical.

"While all of this is going on, we're also hearing that we shouldn't cut back on R&D spending," says Saunders, "because if you do that, the value of why any company might acquire you is diminished. So we were caught in a catch-22 situation."

Another big problem Metrobility encountered was trying to do business in China. Although $2.4 million of equipment was accepted, shipped, and installed in two different Chinese provincial telecoms, Saunders says payment was not received. The cash crunch Metrobility was experiencing would not have been so bad had the company been getting regular payments out of those two accounts.

Another $1 million in orders were placed by the Chinese telecoms, but after negotiations with resellers, the company had to take a "no cash, no equipment" approach. They've since collected $1.6 million and are still trying to collect $400,000 more.

Metrobility declared Chapter 11 in September 2001—just one day before the events of Sept. 11, which would ground everything to a halt for more than a month. Now began the negotiations to overcome Chapter 11 and successfully reemerge.

Metrobility had less then $300,000 when it filed for Chapter 11 protection and began grinding out a plan to get the company back on its feet. There were two main reasons the company succeeded: loyal customers and vendor trust. "The biggest reason this company can ever say it came out of Chapter 11 is loyal resellers and loyal customers that liked and wanted our products," says Saunders. "They were willing to take a chance that our management team could still provide those products. The other reason is vendors that trusted us and were willing to give us another chance to go forward."

Every six weeks, Metrobility was required to file a debtor-in-possession plan with the courts that described in excruciating detail the company's status. After each six weeks, if the judge was convinced of improved cash position and customer willingness to place orders, another six weeks was granted.

By June 2002, Metrobility had increased its $300,000 to $3 million.

After clawing its way nearly out of bankruptcy—meaning creditors were being paid back at least some of the money owed—Saunders and his management team approached the VCs again with their story. "It turned out that two VCs [Sierra Ventures and CEI Ventures], led by North Atlantic Capital, liked our story and wanted to hear more," says Saunders. "They pawed over our projections and financial reports and made an offer to put money in the bucket."

Today, the company has scaled back its appetite and slimmed its product line, signed up 85 new customers, and overcome the "digs" by its competitors. Metrobility officially emerged from Chapter 11 last July.

Saunders has some advice for anyone approaching a Chapter 11 decision. First, avoid Chapter 11 if possible. But if a company does file, its subsequent plan must be adhered to and controlled—hour-by-hour—to ensure the goals are met. Companies also must be realistic when compiling the plan. "The last lesson is that the only thing that really counts is cash—and customer," says Saunders. "So work with your customers as closely as you can and conserve every penny you can, because it's very, very painful to fall."