Bankruptcy is never a “fun” topic to discuss. But if your small business is failing financially and you can’t pay your creditors, it is critical that you understand what bankruptcy is and how it works, and determine what bankruptcy options are available and helpful for your business model.
Choosing the right option can not only have a significant impact on your ability to retain your small business assets and avoid costly legal action, it can also affect any plans you may have to reorganize and rebuild your business in the future.
Bankruptcy may not, in fact, be the right option. Be sure to consult a lawyer and get good advice before contemplating bankruptcy. You can also refer to this online Bankruptcy Guide for Small Business Owners.
Here is some basic information about bankruptcy law and what to expect under the chapters available to small businesses.
Types of Bankruptcy
There are several types of bankruptcy that your business may file for and each is closely tied to how your business is structured.
- Chapter 7 – More commonly referred to as liquidation, this bankruptcy route is appropriate when a business has no future and lacks substantial assets. Because of this, it is often suited to sole proprietorships and small businesses, when the company is essentially an extension of its particular owner’s skills. Under Chapter 7, the bankruptcy trustee will sell assets to satisfy outstanding debts and discharge debts that can’t be satisfied with the available assets. More.
- Chapter 11 – If your business has a plan for future recovery, Chapter 11 supports the continuation of a business under a reorganization plan. Although it can be a very complex process, Chapter 11 applies to sole proprietorships, corporations and partnerships. If you choose this option you can expect to operate under increased scrutiny from a court-appointed trustee. More.
- Chapter 13 – Under Chapter 13, you file a repayment plan with the bankruptcy court detailing how you are going to repay your debts. Chapter 13 bankruptcy is a reorganization bankruptcy typically reserved for consumers, though it can be used for sole proprietorships. If your personal assets are tied in with your business assets, as in a sole proprietorship, you can avoid the risk of losing your house if you file Chapter 13 versus Chapter 7. More.
- Chapter 12 – Chapter 12 is designed for “family farmers” or “family fishermen” with “regular annual income”. Under Chapter 12, debtors propose a repayment plan to make installments to creditors over three to five years.
To help you determine which option – if any – is right for your business, Lawyers.com has some great resources that address common questions about bankruptcy and the small business, including:
- Should the business be reorganized or liquidated?
- How much of the business debt is “secured”?
- Does management have the resources and desire to engage in the reorganization process?
- Is the business one that you could start up again after a liquidation of the current business?
There are also services that can assist small business owners with staying out of bankruptcy and repairing their credit rating after declaring bankruptcy. SCORE also has formed an alliance with Corporate Turnaround (formerly known as Commercial Credit Counseling Services, Inc.) to reach out to small businesses experiencing financial difficulties.
- How to Keep Your Business Out of Bankruptcy – If your small business is facing financial difficulties, there are steps you can take to try to stay out of bankruptcy court. Rosemary Peavler of About.com has five tips.
- Bankruptcy Survival Guide for Business – Here are some tips to help small businesses stay afloat while they reorganize and, hopefully, rise from the ashes of bankruptcy, by Diana Ransom of SmartMoney’s Small Business Site.
- Bankruptcy Guide for Small Business Owners – Learn more about bankruptcy law and tax considerations.
- IRS Bankruptcy Tax Guide – Debt cancellation, tax procedures, and considerations for different types of business structures are explained.