A lot of owners reach the point where the choice seems simple: settle what the business owes, or shut it down and walk away. It is tempting to “walk away” when a business fails because there is a cost to resolving the debts that may seem onerous. But closing a business doesn’t make its debts disappear. In many ways it makes things worse, not better. Both debt settlement and closing the business entail negotiation. There are not always easy answers. Even if you were to only close your business down and not try to negotiate debts, a business closure can be tricky to set up. There are legal requirements to follow and notifications that need to be sent out. Here is what closing actually involves, and where settlement comes into it.
Advance Notice
Start with the people you have to tell. People don’t like being blindsided, so give employees as much advance notice as you can, perhaps telling senior staff first. And make sure your employees are paid and receive their benefits (such as insurance) until the wind-down is over. State law typically requires final paychecks within a certain number of days after the business closes; pay your employees, because it affects your personal reputation, especially if you plan to start other businesses.
Banks and lenders are different. Once you tell them you’re closing, they’ll likely shut down the accounts and cancel any lines of credit. If the business owes them money, they may offset that debt against money on deposit. Some may consider the notice a technical default under the loan documents and sue you for the debt plus interest, fees and costs. If you signed a personal guarantee, they may include you in the lawsuit along with the business. Be sure to look at the loan documents before you give notice to see if you’ll be held personally responsible. So, the key is to understand what your liabilities are and how they’re structured.
The landlord (and any storage units) can catch you when you least expect it. If you have months or years left on the lease, you could owe all of it. Technically the landlord may be required to mitigate damages by trying to re-rent the space. If the landlord is understanding, he or she may even let you off the hook. You may also be able to let the landlord keep the security deposit to cover part of the unpaid rent. If you can’t reach an agreement, the landlord may be able to sue you in a landlord-tenant lawsuit. The landlord may also try to place a lien on business property still in the rented space. If you signed a personal guarantee on the lease or storage unit, don’t be surprised if the landlord sues you too.
You should contact your vendors and service providers as soon as possible, both to make sure the business isn’t picking up new debt and to give them a chance to plan. You might consider sending back goods you will no longer need. Make sure they know when and if you will be paying their invoices. Some vendors will act immediately: trying to reclaim their goods, closing open credit, requiring future orders to be cash on delivery (COD). As for customers, it’s always best to collect the receivables to use to fund the wind-down. If you’re holding deposits or prepaid orders or mid-project, you can use the receivables to make them whole or to arrange for another business to take over the accounts. Otherwise litigation may follow.
The Debts Themselves
Then come the debts themselves, and the tax debts first. Sales tax and payroll tax can be the traps that separate a successful closure from a disaster. Sales tax is treated as money held in trust for the taxing authority, so if you don’t pay it, both the business and you personally can face serious penalties. And payroll tax on your employees’ wages is also subject to personal liability by federal and state authorities. An accountant or tax attorney can help you get current and tackle any personal liability issues. Be sure to file a final state and federal tax return through the date you close. And if you’re going to sell your assets and inventory, look out for bulk sales law, which may require you to give notice to your creditors.
This is where settling versus closing stops being an either-or choice. Think about your unsecured debts, like internet and phone bills, credit cards, and overdraft fees. If the business doesn’t have enough cash to pay them, reach out to each creditor and try to work out a resolution. That process is called business debt settlement, and it’ll need to happen regardless of whether the business is open or closed. Find out which of those accounts you are personally liable for, and prioritize those first. That way, you’ll end up in the least amount of debt possible. Then move on to secured debts, like auto loans. If the business doesn’t have the money to pay, you may need to return the property. Otherwise, the creditor can repossess and sell it at auction, and then they can try to get the balance between the property value and the debt owed from the business.
Dissolve the Entity
Even after that, the business may still exist on paper. If you want to wind up the business, dissolve the entity. For an LLC or corporation that means more than just shutting down the doors. You’ve got to formally dissolve the company, usually by filing documents with the state where you formed it. You’ll have to list what the business owes and own and make sure all the owners sign off on it. Some states require the business to show it doesn’t owe taxes or other specified debts, though. And of course you’ll have to follow the procedure in your articles of incorporation. Don’t forget to file the documents that show you’ve cancelled any licenses, permits and trade names the business might have. It’s not a huge hassle, but it’s a hassle nonetheless, and it adds up with everything else you have to do.
Sometimes the best alternative to winding down a business yourself is to assign it to a person known as an “assignee” in what’s called an assignment for the benefit of creditors (ABC). The assignee takes over the business and its assets and winds it down for you. The assignee hires accountants, auctioneers and attorneys and does all the work. It’s a state court-supervised process. An assignee earns a commission on any assets the assignee is able to recover and liquidate. Assignees will often agree to do the job even if there are apparently no assets.
So which is better, settling or closing? It is rarely one or the other. Even a business that closes down with debts will still have to negotiate the ones it can’t pay. Don’t ignore them and hope they go away. You will have to handle them. Small business owners could be held personally liable for business debts if they signed personal guarantees. Closing ends the business; settlement is how you deal with what it owes, whether the doors stay open or not. There are pros and cons to both scenarios, and each can work under the right circumstances. What matters is knowing, before you give anyone notice, which debts can follow you personally and how each creditor is likely to react.
