Running your own business is harder than ever. You’re up against the same brutal competition, unpredictable markets and economic forces as the big guys, but you have far fewer resources and less time to deal with it all, which can leave you racing to keep your head above water. It’s stressful to the point that outsiders can’t fathom it.
It’s easy to think about borrowing money as a sign of failure: You couldn’t get the job done on your own. But taking on loans is often a smart, strategic move, one that allows you to take advantage of opportunities you wouldn’t have otherwise. Most small businesses can’t even open their doors without borrowing.
When the wind is in your sails and sales are pouring in, repaying your loans feels like a breeze. But what happens if your business grows more slowly than you had planned? What if no one is buying or demand in your sector declines? Many small-business loans are personally guaranteed, meaning you’re personally on the hook for repayment even if the company closes or files bankruptcy.
Facing a pile of bills can be scary, and the natural impulse is to ignore the mail and hope the problem solves itself. It won’t. Whatever you do, don’t take out new loans to pay old ones. You’ll just be racking up more debt in the future. There are better options, including settling your debt and even filing for personal bankruptcy.
It’s impossible to generalize when it comes to debt. One owner may have borrowed money to launch a successful business, while another took out a line of credit just to keep their doors open. The truth is there isn’t a one-size answer. You have to weigh your options and find the best fit.
A Sole Proprietor Is Personally Liable
When you’re a sole proprietor, you and the business are legally the same, so any debts you take on in the company’s name are personal debts. Sole proprietors are often surprised to learn their personal and business assets aren’t separate in the eyes of the law. When you file personal bankruptcy, all your debts are listed, and the bankruptcy court typically discharges them all, regardless of whether they were incurred by you or your business.
If you’re the sole owner of your business and are personally on the hook for the debt, you essentially have three ways out: Chapter 7 bankruptcy, Chapter 13 bankruptcy and debt settlement. Each option has pros and cons, depending on your particular circumstances.
If you can’t afford your monthly bills anymore, debt settlement allows you to pay the lender a lump-sum payment that resolves the debt. When you start negotiating to settle unsecured debts like credit cards, they often settle for half the outstanding balance. But settling can be complicated. One key is gathering the money quickly. If you don’t have the savings, it may take you many months of disciplined saving. If you fall behind, a lender can take you to court.
Secured debts, by contrast, are ones backed by collateral. The lender extends you a loan to buy an asset and retains the right to seize that asset if you don’t make payments. Secured lenders typically repossess their collateral first, but small assets aren’t always worth the hassle of seizing. The reason is basic math: Small business assets don’t tend to have a lot of value.
If the lender is willing to settle, the best offers are for a lump sum or for payment within a few months. Paying an up-front lump sum allows you to settle for the largest discount, but how much cash can you realistically set aside? If your savings won’t cover it, think about other options. Lenders are typically unwilling to let you dribble out payments over time, so don’t go into settlement unless you can save up the payment. If you don’t pay, the creditors can sue you. If you lose, the court can let the creditor garnish your wages, levy your bank account, lien your home or all of the above.
Chapter 7 Bankruptcy
If you can’t settle your debts and haven’t saved enough to make a settlement payment, Chapter 7 bankruptcy may be the best option to discharge debt. Chapter 7 also wipes out both personal and business debts. It usually requires a means test that uses your income and expenses to determine your ability to repay your debts. The downside is that, when you have unprotected assets, the bankruptcy trustee can sell them off to raise cash to pay your creditors. It’s tricky to navigate, but many people who file for Chapter 7 don’t have any assets that can be taken.
If you make under the means test limit for your household size, you qualify. In Colorado, the limit changes twice a year, in November and April, but as of October 2023, a single filer whose income is under $75,710 or a household of two whose income is under $98,365 qualifies. These figures are revised periodically, so check the limits before you file.
If you make above the limit, the test looks at your expenses and decides how much discretionary income you have. If there’s enough, you may have to file Chapter 13 bankruptcy instead. High-income debtors whose debts are mostly not consumer debts, such as business loans and taxes, skip the means test. One note: If you have a mortgage, it’s considered consumer debt, not business debt. The non-consumer-debts exception can make a huge difference in your bankruptcy filing because it means you can file for Chapter 7 with higher income. But people sometimes miss the exception because their mortgages count as consumer debts.
Chapter 7 typically wipes out credit card debts, personal liability on business loans, and broken business leases. In Colorado, filers can keep up to $60,000 of business assets if the business is your primary income and $20,000 if it is secondary income.
Chapter 13 isn’t just for those who make too much to qualify for Chapter 7. It’s also a good fit for a lot of debtors who could choose Chapter 7 but don’t want to lose their assets. Chapter 13 bankruptcy sets up a court-ordered repayment plan that typically lasts three to five years. Once the plan is in place, the trustee never takes your property. That’s different from Chapter 7. There, the trustee can seize anything that’s not exempt under state or federal law and sell it off to raise cash to repay your creditors. You can use Chapter 13 to repay secured debt, such as a lien on a truck and trailer, at the asset’s current value, not what you owe, so you may pay back less than you owe.
Debts You Personally Guaranteed
At first glance, if you set up your company as an LLC or corporation, you might think there’s no problem taking on debt. The business is legally a separate entity, so it’s on the hook, not you, right? Maybe, but many lenders aren’t buying it. Lenders often insist on a personal guarantee before issuing business loans or leasing assets. If you signed one and miss a payment on a business loan, business credit card or line of credit, a business lease or a merchant cash advance, the lender can go after you personally, not just the business. If you signed a personal guarantee on any business debt, that debt becomes a personal debt, even if the entity files bankruptcy. That means you need personal debt relief, not just business debt relief.
If you’re still operating the company, you can settle your personal debt and the company’s debt separately, or both at once. If you don’t settle before dissolving the LLC, settling after dissolving it can be cheaper.
It’s tempting to separate business and personal debt, filing only for one, but debts you personally guaranteed have to be resolved for both you and your company, or they’ll follow you. If only the company files bankruptcy, you’re still responsible for debts, and if only you file bankruptcy, the company is still liable. It may be cheaper to just convert the business to a sole proprietorship and then file personal bankruptcy to erase the debts. Once you’re a sole proprietor, you and the business are the same legal entity, so you can wipe out both your debts by filing personal bankruptcy.
If you’re an individual who owns a business as a sole proprietor, it’s cheaper to file one bankruptcy than two, and business cases typically cost more. If your business is part of a corporation or LLC, the entity can file bankruptcy under Chapter 11 or subchapter 5. Only sole proprietors qualify for the tools-of-the-trade exemption. To avoid customers and employees getting spooked at the bankruptcy filing, dissolve the entity first, keep operating as a sole proprietor, then file your personal bankruptcy. Filing personal bankruptcy to wipe out business debt may cost less than company bankruptcy but it’s not automatic. You have to choose the right tool and properly structure your business. When done right, restructuring then filing once can protect assets while wiping out debt. But done wrong, it can backfire.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
