Anyone looking at the statistic on small business failure would agree with the common idea that running a small business is difficult. The Small Business Administration claims nearly 50% of small businesses fail in their first five years. Lack of capital, bad credit terms, and too much debt can sink businesses. Knowing how much to borrow and when can be the difference between success and failure.
A lot of small business loans come with a personal guarantee of some kind, which is the lender’s way of making sure they are not throwing money away on a risky investment. If the business does not pay, the owner is on the hook for the difference. The lender has the option to go after the owner’s personal assets and income. If they are having problems, they can file for personal bankruptcy and it may be wiped out.
If you’re thinking of bankruptcy, you’ve probably done the list of impossible things. It is best for those who have tried all other options. Take a minute to make a list of the debts and check to see which ones you personally signed for. Here are the kinds of debt that weigh on small businesses.
Business credit cards are unsecured revolving lines of credit. They’re widely used. They can be used to keep personal and business spending separate for recordkeeping and tax purposes.
A business line of credit is more credit card than loan. The lender checks your credit first. A line of credit has to be renewed every year.
Traditional small-business loans can be fixed or floating rate. The payment schedule can be monthly or quarterly.
Merchant cash advances have become a lifeline to people who have no other way to get capital to work with. The lender advances money in exchange for an agreement to hold a certain percentage of the business’ debit and credit card sales until it has recouped its advance. The owner also grants the lender a UCC lien against the assets of the business, including any checking accounts. Lenders usually take money out of a small-business bank account daily or weekly. They often make the business owner sign a confession of judgment, allowing them to get a judgment against the owner if they fail to pay. Annual rates can be in the triple digits. Some 20 to 30 percent default on them. They are incredibly expensive, and they can chew up receivables and cash flow. They can trap an owner in a debt cycle.
Commercial leases cover everything from the space you use to the machines you use to the delivery van you drive. Owners can be asked to personally guarantee the debt.
SBA loans come in a few varieties: Economic Injury Disaster Loans, 7 (a)s, 504s, and Microloans. Any loan over $200,000 requires a personal guarantee from the owner that the business will repay it. Some smaller loans require a personal guarantee. Anyone who has a sole proprietorship is the business. The company and the owner are legally the same. So if it has a SBA debt, the owner owns it. Some SBA loans also require a UCC lien.
A business can file for bankruptcy. So can the owner. The corporation gets no discharge in its own bankruptcy. If the owner files personally, then they can get a discharge of the business debts they signed personally, including:
- Business credit card balances.
- Business loans or lines of credit.
- SBA loans.
- Leases and contracts the owner signed.
- Judgments from lawsuits.
If it is time, it is time. Closing down, or selling for pennies on the dollar, leaves the owner in trouble. They may have to file personal Chapter 7 bankruptcy or Chapter 13 depending on their circumstances. When they file, they usually get an automatic stay, which means all lawsuits, phone calls, frozen bank accounts, garnishments, and foreclosure sales are halted. Which Chapter fits depends on their income, assets and debts. The automatic stay gives the owner breathing room to figure out how much they have, what they owe, and which is the right way out of the mess. A Chapter 7 bankruptcy provides a quick discharge and a fresh start. A Chapter 13 means they repay some, or all, of the claims by a court-approved 60-month plan. Sometimes, the repayment is a tiny fraction of the total debt.
Some do better in Chapter 13 anyway. If they file Chapter 7, they will have to pass the means test, which will often kick them into Chapter 13 if they have a decent income. The means test does not apply if most of their debt is business debt. If they have charged business costs on personal credit cards, those do not count as business debt. Here is the tradeoff: A Chapter 7 can take your non-exempt assets. A Chapter 13 can leave you with them, as long as you pay their non-exempt value in your plan. A Chapter 13 also deals with any mortgage arrears or recent tax debt. That is why the owner may decide to file Chapter 13 bankruptcy instead, if they own a house and have gotten behind on the mortgage and taxes. However, even without the means test, if you have a large monthly surplus in household income, you may be limited to Chapter 13.
A bankruptcy is not necessarily the end of the road. A company that still has value and the potential to recover can opt for Chapter 11. Subchapter V of Chapter 11 of the Bankruptcy Code was designed to simplify the process and reduce the costs. The owner can restructure the debt and continue operating the business. To qualify, a small-business owner must be engaged in business. The main activity can’t be owning or running a single real estate property.
You may believe a Chapter 7 corporate bankruptcy for the business is the end of the rainbow. It is not. If you have a small business without many assets, a corporate Chapter 7 makes little sense. A corporate filing costs much more than a personal one. Often there are no assets to liquidate. You still remain personally liable for the guarantees you signed. Your lenders will turn to you when the company closes its doors. For most small-business owners whose businesses still have debts guaranteed personally, a personal bankruptcy makes sense.
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.
