Choosing a Small Business Bankruptcy
In the small business world, financial challenges can arise unexpectedly, leading entrepreneurs to consider bankruptcy a potential solution. Navigating a business bankruptcy can be daunting, and the decision will matter as the choice can significantly impact not only the future of the business but also personal finances and credit ratings. Making an informed decision can help you protect your assets and emerge stronger.
The USA has approximately 33.2 million businesses in 2024. 99.9% (31.7 million) of all businesses are small businesses. [1]
Types of Bankruptcy for Small Businesses
Each type of bankruptcy serves different needs and circumstances. Think carefully about which bankruptcy type is most appropriate for your company.
Chapter 7 Bankruptcy For Small Business Bankruptcy
Chapter 7 bankruptcy, often referred to as “liquidation bankruptcy,” involves the sale of a business’s non-exempt assets to pay off creditors. Once the assets are liquidated and the proceeds distributed, most remaining debts are discharged, allowing the business owner to start fresh. There were 261,277 Chapter 7 bankruptcies filed in the US in 2023 alone. [2]
Pros
- Quick process (typically a few months)
- Discharge of most unsecured debts, providing a clean slate
- Allows the owner to walk away without ongoing financial obligations
Cons
- Business assets may be sold off, leading to the end of the business
- Certain debts (e.g., taxes, student loans) may not be dischargeable
- A significant impact on personal credit if the owner is a sole proprietor
Ideal Scenarios for Small Businesses
Chapter 7 best suits small businesses with limited assets and significant unsecured debts, particularly when the owner has no viable path to continue operations or if the business is no longer sustainable.
Chapter 11 Bankruptcy For a Small Business Bankruptcy
Chapter 11 bankruptcy is designed for businesses seeking to reorganize their debts while continuing operations. It allows the business to propose a reorganization plan to repay creditors over time while maintaining control of the business.
Pros
- Opportunity to restructure debts and potentially emerge stronger
- The business can continue operating during the bankruptcy process
- Flexibility in negotiating terms with creditors
Cons
- It is a lengthy and expensive process, often taking years to complete
- Requires detailed financial reporting and oversight from the court
- No guarantee of successful reorganization; some businesses may still fail
When to Consider Chapter 11 Bankruptcy
Chapter 11 Bankruptcy is a good option for small businesses with viable operations but overwhelming debt. It is suitable for businesses seeking to negotiate with creditors and restructure their financial obligations while retaining control.
Did you know there were 7,456 Chapter 11 bankruptcies filed in the US in 2023 alone? [2]
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is primarily for individuals but can apply to sole proprietorships. It allows business owners to keep their assets while developing a repayment plan to pay back creditors over three to five years.
Pros
- Retains control of the business and its assets
- Allows for a structured repayment plan that can make debt management more manageable
- Discharge remaining unsecured debts after completion of the repayment plan
Cons
- Limited to businesses with a certain amount of secured and unsecured debt
- Monthly payments can be burdensome
- Requires adherence to a court-approved repayment plan
Best Use Cases for Chapter 13
Chapter 13 is ideal for sole proprietors who have a steady income and want to maintain their business while addressing personal and business debts. It suits those who can commit to a repayment plan but need relief from creditor pressures.
There were 183,956 Chapter 13 bankruptcies filed in 2023. [2]
Factors to Consider When Choosing Bankruptcy
Deciding to file for bankruptcy is a significant step for any small business, and choosing the right type involves consideration of several key factors. Each business is unique, and understanding these elements can help you make the best decision for your specific situation. Here are the primary factors to consider:
Business Structure
The legal structure of your business can impact which bankruptcy options are available and how they affect personal liabilities. For example, a sole proprietorship may face different consequences in a Chapter 7 filing compared to an LLC.
Amount of Debt
Assessing the total amount of secured and unsecured debt is essential. Some bankruptcy options, like Chapter 13, have limits on the amount of debt that qualifies.
Future Business Prospects
Consider whether there’s a realistic chance of recovery and profitability. If the business has the potential to succeed with restructured debt, Chapter 11 might be a better fit. If not, Chapter 7 may be more appropriate for a fresh start.
Impact on Personal Finances
For sole proprietors, business debts may directly affect personal finances. Understanding how bankruptcy will impact personal credit and assets is vital, especially when choosing between different types.
Time and Cost
The time and cost associated with filing for bankruptcy can vary significantly. Chapter 11, for example, is often more complex and expensive than Chapter 7.
Relationship with Creditors
If you have a good relationship with creditors, negotiating payment plans outside of bankruptcy might be feasible. However, if negotiations have failed or creditors are unwilling to cooperate, bankruptcy might be the necessary route.
Steps to File for a Business Bankruptcy
Filing for bankruptcy is a structured process that requires careful preparation and understanding. For small business owners considering this route, following the necessary steps can help ensure a smoother experience. Here’s a breakdown of the steps involved in filing for bankruptcy:
1. Assess Your Financial Situation
- Evaluate Debts and Assets: Start by conducting a thorough assessment of your business's financial health. List all debts, including secured and unsecured loans, and evaluate your assets to understand what you may lose or retain during the bankruptcy process.
- Cash Flow Analysis: Review your cash flow to determine your ability to continue operations and whether restructuring is feasible.
2. Consult with A Bankruptcy Attorney
- Seek Professional Guidance: Consult with a business bankruptcy attorney as they can help you understand your options, and the implications of each bankruptcy type, and guide you through the legal process.
- Review Alternatives: Discuss potential alternatives to bankruptcy, such as debt negotiation or restructuring, to see if they may be viable options before proceeding.
3. Prepare Necessary Documentation
- Gather Financial Records: Compile essential documents, including financial statements, tax returns, a list of creditors, and any contracts related to your business.
- Complete Required Forms: Fill out the necessary bankruptcy forms specific to the type of bankruptcy you are filing (Chapter 7, 11, or 13). This includes detailed schedules of assets and liabilities, income, expenses, and a statement of financial affairs.
4. File the Bankruptcy Petition
- Submit the Petition: Once all documentation is prepared, your attorney will file the bankruptcy petition with the appropriate bankruptcy court. This marks the official start of the bankruptcy process.
- Automatic Stay: Upon filing, an automatic stay goes into effect, temporarily halting most collection actions by creditors, allowing you to focus on the bankruptcy proceedings.
5. Attend the Meeting of Creditors
- 341 Meeting: After filing, you will attend a meeting of creditors (also known as a 341 meeting), where you will answer questions about your financial situation. Creditors may attend, but it’s usually a straightforward process.
- Prepare for Questions: Be ready to explain your financial circumstances and the reasons for seeking bankruptcy. Your attorney will help you prepare for this meeting.
6. Follow the Business Bankruptcy Plan
- For Chapters 11 and 13: If you’re filing under Chapter 11 or 13, you’ll need to adhere to the repayment plan established during the bankruptcy process. This plan outlines how you’ll pay creditors over time.
- Stay Compliant: Make all required payments on time and comply with any court orders or obligations throughout the bankruptcy period.
7. Complete Financial Management Courses
Most bankruptcy filings require debtors to complete financial management courses before debts can be discharged. These courses aim to help you manage your finances better in the future.
8. Receive Discharge
After completing the bankruptcy process and fulfilling all obligations, you’ll receive a discharge of eligible debts. This finalizes the bankruptcy and allows you to move forward financially.
Bankruptcy can be challenging, but it also provides an opportunity for renewal and growth. By understanding your options and taking proactive steps afterward, you can set your business on a path to recovery.
Have questions or need insights on bankruptcy options?
Book a free consultation with the bankruptcy attorneys at Frego Law.
Sources:
[1] Radage, K. (2024, October 8). The Number of Businesses in the USA and Statistics for 2024. Credit Card Processing and Merchant Account. https://www.clearlypayments.com/blog/the-number-of-businesses-in-the-usa-and-statistics-for-2024/
[2] Bankruptcy Filings Rise 16.8 Percent. (2024b, January 26). United States Courts. https://www.uscourts.gov/news/2024/01/26/bankruptcy-filings-rise-168-percent
