Not all financial distress is equivalent. Bankruptcy is one of the most extreme forms of debt restructuring. In legal terms, a business bankruptcy is a declaration that the company cannot pay its obligations to creditors. The company, by applying to the court, is granted protection from collection activities while it restructures or sells assets. It is slow and expensive, and it leaves a black mark on your credit. But if you truly cannot pay what you owe, it can take the biggest debts off your shoulders so you can start over. Here is what you should know before filing your small business bankruptcy.
The Filing Process
Step one is to get advice. You don’t want to go through bankruptcy alone. The two professionals you need are a financial advisor and a bankruptcy attorney. A financial advisor will have an idea whether there is a way to avoid bankruptcy, like refinancing debt to get a lower interest rate and monthly payment; asking the creditor to defer payment; or loan modifications. The advisor will also be a second set of eyes on your finances and help you understand what to expect once you’re out of bankruptcy.
A bankruptcy attorney is the next key player. The bankruptcy process is complicated, and the specific steps and paperwork differ depending on your industry, circumstances, and jurisdiction. They may be able to work out negotiations with creditors for repayment depending on the chapter. They will also ensure you meet deadlines and complete all paperwork correctly.
Step two is choosing a chapter. There are three main chapters, and your choice depends on your business type and goals. Chapter 7 is for sole proprietors who wish to liquidate and close the business. Your assets will be sold to pay creditors, and then you get a clean slate. Because a sole proprietorship has unlimited liability, your personal assets can be liquidated, though state laws may protect certain items like your home and vehicle.
Chapter 11 is open to any business that wants to continue operating under a modified repayment plan. You will restructure your debt by negotiating a new agreement with your creditors. You will agree to a new amount, frequency, and term. Your creditors and the court have to approve. Negotiations are expensive and time-consuming. Your creditors already don’t trust you, so it will take a lot to convince them to change the terms. You will have to prove to the court that your plan is feasible and that you can bring in enough revenue to pay it.
Chapter 13 is available for sole proprietors with smaller debt who want to keep operating. There is a debt cap on combined debts, so ask your attorney what the current limit is. It relies on your personal income. This chapter is faster and cheaper than chapter 11 because it is less complex. Your business structure also influences which chapter you can file under.
Step three is gathering records. The next steps involve credit counseling and filing the petition, so this step involves gathering all the financial documents you will need to provide them. Collect all personal and business tax returns over the last three years. Gather current financial statements - balance sheets, income statements, cash flow statements and profit and loss statements. List out all current assets and liabilities, including appraisals, loan agreements and lease agreements. Collect copies of all existing contracts. Note all payroll obligations such as employee benefits and insurance.
Step four is credit counseling. Find out if you have to take credit counseling before filing for formal bankruptcy. This step is required by the U.S. bankruptcy court for all individual filers. To find the list of approved credit counseling providers in your area, visit the U.S. bankruptcy court’s website.
Step five is the filing itself. You can get the list of bankruptcy forms at the court’s website. Depending on the complexity of your case, the paperwork can be extensive, but an attorney can help you figure out what is needed and fill out the forms correctly. If you are an individual, fill out the voluntary petition form B 101, schedules of assets, exempt property, secured and unsecured creditors, contracts and leases, codebtors, income, expenses, statement of financial affairs (B 107), and all the chapter-specific income forms. Non-individuals, or businesses, must file the voluntary petition form B 201, summary of assets and liabilities B 206Sum, schedules D, E/F, G, H, statement of financial affairs B 207. Chapter 11 filers also must list their 20 largest unsecured creditors, excluding insiders (form B 104).
Step six is approval. If you have filed for restructuring (chapter 11 or 13), you will have to get creditors to approve your repayment plan. This might take some time, because your credibility has already been damaged. You will need to share your financials and prove that you can and will pay. All types of bankruptcy are reviewed by the U.S. bankruptcy court in your jurisdiction (in part, to ensure that you are filing in good faith, as you are requesting to have your debts reduced or eliminated).
Step seven is to repay or liquidate. For Chapter 11 and 13, once the court and creditors approve your restructured plan, you continue operating as long as you meet the new payment schedule. You may have to regularly report to the court. For Chapter 7, you have your assets liquidated.
Step eight is debtor education. All individual debtors must complete a court-approved debtor education course after filing. This is not the same as credit counseling. Before your debts are discharged you must complete the debtor education course. The Department of Justice maintains a list of approved courses.
How long does the filing process take? Filing can take anywhere from a few months to several years. It ends either when your assets are liquidated or you have satisfied the repayment terms of your petition. Chapter 7 filings take 3-6 months on average as this involves just asset liquidation. Chapter 11 and Chapter 13 can take much longer, often 3-5 years, because of the repayment periods attached.
A Huge Black Mark on Your Company’s Credit Scores
Then there is your credit, since bankruptcy causes a huge black mark on your company’s credit scores and can decrease them significantly. Getting financing will be difficult until your company can rebuild a positive history, which may be years. You can expect it to be a few years before you qualify for the best possible rates and terms on financing from lenders.
Bankruptcy Should Be the Last Resort
That is why bankruptcy should be the last resort. Consider the bankruptcy filing only if you cannot foresee generating enough revenue to pay your debts and your creditors have refused to modify loan terms. The benefits of bankruptcy should outweigh the downsides. In fact, before you file, you should attempt to negotiate modified plans with your creditors. This entails a modified payment plan, which could include lowering your interest rate, loan terms, and/or monthly payments. You could also consider an income-based repayment plan, modified graduated payments, or balloon payment solutions. You can also refinance or consolidate higher-rate debt into lower-rate debt. This also means lower payments and the total could be stretched over a longer time frame. Finally, consider restructuring the business itself. Focus on generating revenue, or reducing expenses to boost cash flow. This could mean selling off assets, or cutting expenses that do not hamper your operational effectiveness (cleaning, landscaping, employee benefits, etc.).
Bankruptcy can be time consuming, expensive and a black eye because it shows others that you have mismanaged your business. However, it can offer a fresh start and allow you to reduce or even eliminate debt that was unmanageable. If you are weighing it, talk to a team of professionals before you go down that road.
