The 363 Sale Playbook: How Distressed Startups Sell Through Bankruptcy — and Why It Differs From Every M&A Guide You've Read

Many startups funded in the 2020–2023 cycle are running out of runway. Down rounds are common. For some, the question is no longer whether to sell — it's whether the sale can happen at all when creditors are knocking, equity is underwater, and there's no leverage left. For those companies, the most common path is a Section 363 bankruptcy sale: a court-supervised auction process under the U.S. Bankruptcy Code that transfers assets free and clear of liens, extinguishes successor liability by court order, and operates under fundamentally different rules than any traditional M&A transaction.

A 363 sale is not "M&A in bankruptcy." It is a different transaction with different mechanics, different protections, different timelines, and different outcomes for founders and equity holders. Here's what every founder needs to understand before they face one.

What Is a Section 363 Sale?

Section 363 of the Bankruptcy Code, codified at 11 U.S.C. § 363, authorizes a bankruptcy trustee or a Chapter 11 debtor-in-possession (DIP) to sell property of the estate outside the ordinary course of business, after notice and a hearing. The sale can happen early in a bankruptcy case — sometimes within weeks of the filing — without waiting for the lengthy plan confirmation process that defines a traditional Chapter 11 reorganization.

As Troutman Pepper's bankruptcy sale primer explains, 363 sales typically take place at the outset of a bankruptcy case, so a buyer does not need to wait through the lengthy plan process to acquire a debtor's assets. This speed is one of the primary advantages: a company can sell its assets, satisfy creditors from the proceeds, and wind down — all within a compressed timeline that a Chapter 11 plan sale cannot match.

Critically, a 363 sale is a public process. The debtor files a motion seeking court approval of bidding procedures, qualified bidders are given access to a data room, and if more than one qualified bid is received, an auction is held. The winning bid is then presented to the bankruptcy court for approval at a sale hearing. This is fundamentally different from the private, bilateral negotiation that characterizes a traditional M&A transaction.

The Stalking Horse and Bid Protections

Because a bankruptcy sale is public and the debtor has limited leverage, most 363 sales begin with a stalking-horse bidder — a buyer who negotiates a purchase agreement with the debtor before or shortly after the bankruptcy filing and agrees to serve as the baseline bid at auction. The stalking horse sets the floor price and the deal terms that competing bidders must improve upon.

In exchange for setting that floor, the stalking horse receives bid protections that compensate it if a higher bidder wins the auction. According to Goodwin's analysis of stalking-horse bid protections, these typically include:

• Break-up fee: Usually 1–3% of the stalking horse's purchase price, payable if the debtor sells to a higher bidder.
• Expense reimbursement: Reimbursement of the stalking horse's reasonable and documented due diligence and legal expenses, often capped at a specific dollar amount.
• Topping thresholds: Minimum overbid increments that competing bidders must exceed, designed to ensure that a rival bid meaningfully exceeds the stalking horse's offer rather than marginally topping it.

These bid protections must be approved by the bankruptcy court, which evaluates whether they are reasonable and designed to maximize value for the estate. As the Goodwin analysis notes, recent cases in the Delaware Bankruptcy Court — including In re Ideanomics and In re First Mode Holdings — demonstrate that courts value stalking-horse bids and generally approve customary bid protections, even when the stalking horse is also a secured lender or has insider connections. However, courts have pushed back on requests for "superpriority" status for bid protection claims, limiting them to administrative expense priority instead.

For founders, the stalking-horse dynamic is important to understand: the debtor (your company) negotiates the initial deal terms with the stalking horse, and those terms — including which assets are included, which contracts are assumed and assigned, and what representations the debtor will make — become the baseline that the auction builds on. You don't get to negotiate separately with each bidder. You negotiate once, and then the market sets the price.

Free-and-Clear Asset Transfers Under § 363(f)

The most powerful feature of a 363 sale is the ability to transfer assets free and clear of all liens, claims, interests, and encumbrances. Section 363(f) of the Bankruptcy Code, codified at 11 U.S.C. § 363(f), permits the trustee or DIP to sell property free and clear of any interest in such property of an entity other than the estate if any one of five conditions is met:

1. Applicable nonbankruptcy law permits the sale free and clear of such interest;
2. The entity with the interest consents;
3. The interest is a lien and the sale price exceeds the aggregate value of all liens on the property;
4. The interest is in bona fide dispute; or
5. The entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of its interest.

As Jones Day's analysis of free-and-clear sales explains, the purpose of this provision is to allow the debtor to obtain the maximum recovery on its assets in the marketplace. A prospective buyer would discount its offer significantly if it faced the prospect of protracted litigation to obtain clear title. The free-and-clear mechanism eliminates that discount by washing the assets clean — liens attach to the sale proceeds instead of the assets themselves, and the buyer takes title unencumbered.

For startups, this is a double-edged sword. On the one hand, it makes the assets more attractive to buyers who would otherwise be deterred by the company's debt, pending litigation, or contractual obligations. On the other hand, it means that the sale proceeds — not the assets — are what's left for creditors and equity holders to fight over. And in most distressed startup sales, those proceeds are insufficient to cover even the secured debt, let alone unsecured creditors or common equity.

Extinguishing Successor Liability

One of the most significant differences between a 363 sale and a traditional asset purchase is the treatment of successor liability. In a non-bankruptcy asset sale, a buyer may inherit the seller's product liability, employment law, and regulatory obligations under various state-law successor liability doctrines. In a 363 sale, the bankruptcy court's sale order can extinguish those claims.

As the Jones Day analysis notes, the majority of courts have concluded that successor liability claims fall within the scope of "interests" that can be sold free and clear under § 363(f). Cases from the Second, Third, Fourth, and Ninth Circuits have all upheld sales that transferred assets free and clear of successor liability claims — including product defect claims, employment discrimination claims, and ERISA withdrawal liability. The sale order itself contains an express finding that the assets are transferred free and clear, and that finding provides finality that helps fend off post-closing challenges.

However, there are limits. The Second Circuit's decision in In re Motors Liquidation Co. (the GM bankruptcy) held that certain successor liability claims were not barred because they had not yet arisen at the time of the sale and the claimants received inadequate notice. The lesson for buyers: the free-and-clear protection is powerful but not absolute, and proper notice to all potential claimants is essential.

Credit Bidding and Secured Creditors

Section 363(k) of the Bankruptcy Code gives secured creditors a powerful tool: the right to credit bid at the auction. Under 11 U.S.C. § 363(k), a holder of a claim secured by a lien on property being sold may bid at the sale by offsetting its claim against the purchase price — effectively "paying" with the debt it is owed rather than cash.

For distressed startups, this means that a venture debt lender or other secured creditor can acquire the company's assets by credit bidding its secured claim, even if no cash buyer emerges. This dynamic — sometimes called "loan-to-own" — is common in startup distress cases. The secured lender provides debtor-in-possession (DIP) financing during the bankruptcy case, positions itself as the stalking-horse bidder, and then credit bids its debt at the auction. If no higher cash bidder materializes, the lender takes the assets.

For founders and equity holders, credit bidding is often the mechanism by which a company is sold to its lender for less than the equity holders believe it's worth. There is no negotiation leverage: the secured creditor has a statutory right to credit bid, and the bankruptcy court generally will not deny that right absent cause.

363 Sales vs. ABCs vs. Chapter 11 Plan Sales

Founders facing distress should understand that a 363 sale is not the only option — and comparing it to alternatives helps clarify why it's chosen.

Assignment for the Benefit of Creditors (ABCs)

An ABC is a state-law liquidation procedure in which the debtor voluntarily assigns its assets to a assignee who liquidates them for the benefit of creditors. As Manatt's analysis of ABCs as an alternative to 363 sales notes, an ABC can be more expedient, efficient, cost-effective, and flexible than a bankruptcy sale. It avoids the bankruptcy court process, the public auction, and much of the cost associated with Chapter 11.

However, an ABC lacks the key advantages of a 363 sale: there is no court order transferring assets free and clear of liens, no judicial extinguishment of successor liability, and no automatic stay protecting the debtor from creditor actions. For startups with significant secured debt, pending litigation, or complex contract assignment issues, these limitations often make a 363 sale the more practical path — the court's involvement provides finality that an ABC cannot.

Chapter 11 Plan Sales

Alternatively, a debtor can sell assets through a confirmed Chapter 11 plan. As Goodwin's primer on bankruptcy sales explains, a 363 sale happens at the outset of the case, while a plan sale requires the debtor to negotiate a plan of reorganization with creditor classes, obtain creditor votes, and secure court confirmation — a process that can take many months or even years.

The trade-off: a plan sale allows for more complex distributions to creditor classes and can incorporate negotiated outcomes that a 363 sale cannot. But for a startup with limited liquidity and no realistic path to reorganization, the delay and cost of a plan process is usually prohibitive. The 363 sale exists precisely for companies that need to sell quickly.

What Founders Should Expect: No Indemnification, No RWI, No Leverage

The deal terms in a 363 sale look nothing like the M&A transactions this blog has covered. Here's what disappears:

• No representations and warranties insurance (RWI). The concept doesn't exist in a 363 sale. Assets are sold "as-is, where-is" with only limited representations from the debtor. As Goodwin's primer notes, a winning bidder will almost always be required to purchase assets on an as-is basis with no post-closing indemnification or other recourse against the debtor.
• No indemnification escrows. There is no escrow holdback, no survival period, no basket or deductible. The sale order is final.
• No earnouts. The purchase price is fixed at the auction. There is no contingent consideration tied to post-closing performance.
• No shareholder representative. There is no selling stockholder representative to manage post-closing obligations, because there are no post-closing obligations to manage.
• No purchase price negotiation leverage. The debtor sets the process, the stalking horse sets the floor, and the auction sets the price. Founders do not negotiate the purchase price — the market does, under court supervision.

What replaces these traditional M&A protections is the court order itself. The bankruptcy court's sale order finding that the purchaser acted in good faith, that the consideration was fair and reasonable, and that the sale was conducted at arm's length provides a form of finality that no private M&A agreement can match. Section 363(m) of the Bankruptcy Code further protects the purchaser by providing that the reversal or modification of a sale authorization on appeal does not affect the validity of a sale to a good-faith purchaser — meaning that once the sale closes, it is extraordinarily difficult to unwind.

But this finality comes at a cost to founders and equity holders: the sale proceeds are distributed according to the absolute priority rule of the Bankruptcy Code, which places secured creditors first, then administrative expenses, then unsecured creditors, and only then equity. In most distressed startup sales, the proceeds are exhausted long before they reach the equity layer — meaning founders and employees receive nothing.

Actionable Next Steps

If your startup is running low on runway and a distressed sale is becoming a realistic possibility, here's what we recommend doing before you reach the courthouse steps:

1. Assess whether a 363 sale is the right path. Compare a 363 sale against an ABC and a negotiated out-of-court sale. The right choice depends on your secured debt structure, the complexity of your contracts, pending litigation exposure, and the willingness of your secured creditor to cooperate. A 363 sale provides finality and free-and-clear transfers that an ABC cannot — but it also involves more cost and court oversight.
2. Identify a stalking-horse bidder before filing. The pre-filing marketing process is where most of the value is created. A stalking horse who has signed a purchase agreement and conducted due diligence before the bankruptcy filing signals to the market that your assets have real value and sets a credible floor for the auction.
3. Understand your secured creditor's credit-bid position. If your venture debt lender or another secured creditor can credit bid, they effectively control the floor price. Model the credit-bid scenario and understand whether any cash bidder is likely to exceed it. If not, the secured creditor will likely acquire your assets — and the question becomes whether you can negotiate any value for equity holders in that scenario.
4. Engage bankruptcy counsel early — not after the default. The decisions made in the weeks before a bankruptcy filing — including which assets to market, which contracts to assume and assign, and how to structure DIP financing — determine the outcome of the 363 sale process. Engaging counsel after the lender has already filed a UCC foreclosure notice or pushed the company into an involuntary petition dramatically limits your options.
5. Prepare for the reality of the priority waterfall. In most distressed startup sales, equity holders receive nothing. The absolute priority rule of the Bankruptcy Code ensures that secured and unsecured creditors are paid in full before any distribution to equity. If your investors and employees are expecting a return, managing those expectations before the sale process begins is essential — both for credibility and for avoiding post-sale disputes.
6. Consider whether key employee retention can be negotiated. In a 363 sale, the buyer may want certain key employees to remain. Retention agreements negotiated through the bankruptcy process (with court approval) can provide a soft landing for founders and critical staff — but only if they are structured before the sale closes, not after.

A 363 sale is not a failure. For many startups, it is the most efficient way to preserve the value of what was built — the technology, the team, the customer relationships — when the financial structure that supported it can no longer survive. But it operates under rules that bear no resemblance to the M&A playbooks most founders have studied. Understanding those rules before you need them is the difference between a controlled exit and a fire sale.