Bankruptcy. There’s probably no scarier word out there for a small business owner. When you think of bankruptcy, you may think of financial ruin—losing your business and maybe even the home, car, or whatever other guarantee you’ve put down to secure your financing.
You might also think that you’ll be unable to ever get a second shot at entrepreneurship, or even another chance at any kind of small business loan.
Why File for Bankruptcy?
The truth is, if your business is consistently unable to keep up with your debts and expenses, it’s already bankrupt—or on a very short trajectory towards it. Filing for bankruptcy protection is meant to help you get out of this untenable situation and keep many of your personal assets. You may be able to keep your business open while you pay off debt by reorganizing, consolidating, and/or negotiating terms.
And while filing for bankruptcy does take recovery time, it isn’t the all-time credit-wrecker you may think. Typically, after ten years, it is removed from your credit history, and you’ll likely be able to get financing several years before that.
Depending on your situation, filing for bankruptcy may be a smart next step for your struggling business. It might even save your business. Filing for bankruptcy can protect your business from creditors who might attempt to liquidate your business. You will, of course, eventually have to pay them some or all of what you owe, but the reduction or delay in payment offered through some types of bankruptcy protection may be exactly what your business needs to get back on its feet.
Three Types of Bankruptcy Protection
Below are examples of three types of business bankruptcy protection: Chapter 7, Chapter 11, and Chapter 13. Each grants you a temporary “stay” protecting you from creditors while the logistics of your filing are finalized. These logistics depend on which type of bankruptcy you file.
- Chapter 7: In business Chapter 7 bankruptcy, the business is closed and liquidated to cover debts. Sole proprietors must file a personal Chapter 7, which covers both personal and business debts.
- Chapter 11: In Chapter 11 business bankruptcy, the business makes a plan to reorganize and repay its debt. This plan must be approved by creditors, but typically gives a business years to pay its debts, while remaining open and keeping assets.
- Chapter 13: In a Chapter 13 bankruptcy, you create a payment plan to personally repay debt with a portion of reliable future income over three to five years—but you are allowed to keep your assets. Companies and corporations are ineligible for Chapter 13.
A sole proprietor business may file under any of the three, whereas corporations and partnerships are only eligible to file for Chapter 7 and Chapter 11. Depending on the size of your debts and the viability of your business, you may not be eligible for some options.
Here’s when you should consider filing for bankruptcy:
Your Personal Assets Are on the Line. If you are the sole proprietor or a general partner of your business, you are personally liable for the business’s debts. Your personal assets are also your business’s assets–that means that your personal assets are fair game for business creditors to seize to satisfy debt.
The good news here is that if you are the sole proprietor, you may file personal bankruptcy under Chapter 7, which can eliminate both personal and business debts. Some of your business assets may be protected by exemptions, meaning that you could potentially continue to operate after filing bankruptcy. Additionally, if you are a partner in a business or corporation that is going under, you may want to consider filing a personal Chapter 7, as it will eliminate your own liability for business debts.
Your Business Is Still Viable. If your business has a future despite its debt, you may be able to keep running it while reorganizing and repaying your debt. (If you’re a sole proprietor, this would mean a personal Chapter 7 with exemptions protecting enough of your business assets. Otherwise, this would mean a Chapter 11 filing.) This is the best-case bankruptcy scenario: you keep your personal and business assets and keep your business open.
Your Business Is Definitely Not Viable. If there’s no saving your business, filing for bankruptcy protection can minimize the damage associated with closing your doors.
If your business is an LLC (limited liability company) or corporation, or if you are a limited partner, it is considered a separate entity from you and your personal finances. Filing under Chapter 7 for your business means that the business must be liquidated to settle debts; however, your personal assets will not be seized.
Bankruptcy certainly shouldn’t be undertaken lightly—but it isn’t the end of the world, either. Depending on your business’s circumstances, it just might be your best move.