Percentage of Businesses That Fail
Entrepreneurs take a leap, giving up a steady paycheck to build their own opportunity. Unfortunately, many will fail. The percentage of businesses that fail has remained fairly stable over time, but it is daunting: Roughly half of small businesses will fail by year five.
Most companies that fail do so because of money problems. Under the US Bankruptcy Code, a company can reorganize and continue, or it can eliminate all its debts in an organized way. Each case is unique, so the right solution depends on the company, its debts and the owner’s goals.
Many business owners shudder when they hear the “B” word, but bankruptcy can be the tool that gives back control of your business and a fresh start.
Bankruptcy filings were trending down for years, even during COVID.
Experts are forecasting an increase in business bankruptcies as pandemic relief programs end. Borrowing costs are more expensive, prices are rising, and staffing shortages and supply chain problems are causing issues for businesses.
In the year ending June 30, 2021, the number of business bankruptcy filings was 18,511, with 10,466 Chapter 7; 6,375 Chapter 11; 982 Chapter 13. Commercial filings in the first quarter of 2022 were down 25%, according to Epiq, compared with a year earlier.
About one in five new businesses fail in the first year. Only a third remain after 10.
So why do businesses fail? Here are the usual suspects for when small businesses end up bankrupt:
- Having too little money to get the business going.
- Poor planning.
- Difficult business conditions such as more competitors and higher costs.
- Mistakes by management.
- Trade Credit issues.
- Losing customers.
- Dealing with tax troubles.
- Disputes with creditors such as foreclosures, lawsuits, contract disputes.
- Personal issues such as illness, divorce.
- Calamities such as fraud, theft, accidents, natural disasters.
Most small businesses lack insurance for lawsuits and other issues that are commonly causes of bankruptcy, according to Insureon, a small business insurance marketplace. Without a policy in place, one lawsuit or accident could be enough to put a small business into bankruptcy.
Six Chapters
The US Bankruptcy Code consists of six chapters, numbered 7, 9, 11, 12, 13 and 15. Small businesses and their owners most frequently use 7, 11 and 13. Here is a run-down of the alternatives.
Chapter 7 is also called liquidation. It is the most typical and simple kind of bankruptcy. The debtor turns over all non-exempt personal and business assets, they are sold, and creditors are paid.
In most cases, sole proprietors get to discharge their debt. Exceptions are debts that involve certain taxes, alimony. Corporations, partnerships, LLCs do not get to discharge debt but the business will cease to exist. When the company shuts down, there’s no one for creditors to try to collect from. Owners with liability protection are safe because creditors can’t get to the owners’ personal assets.
Chapter 7 does not necessarily end the proprietorship. For example, if you were a service provider, you might be able to keep the basic tools of your trade exempt from liquidation. So your future services can’t be liquidated. You don’t need to go out of business.
Under Chapter 11 reorganization, sole proprietors, partnerships, corporations, and limited liability companies keep their business alive. This chapter is best if you want to keep assets and emerge healthy. Keep in mind that while under Chapter 11 protection, you stay in control of the company, working out a plan to pay off the creditors over time.
The first step is filing a petition, after which the debtor has 120 days to propose a plan of his or her own (for example, lowered interest rates or longer repayment plans). The plan is a detailed description of how each debt will be restructured and how each creditor will be repaid. Every creditor must agree to the plan or it can’t be approved by the court.
Downsides are numerous and include complication, slowness and expense. Also, the plan could be rejected, and the company must have enough money to make the new payments. Even if your plan is approved, there’s no guarantee that your business will make a profit when it comes out of bankruptcy.
There are two special Chapter 11 routes for small business: Small business case and subchapter 5. The maximum debt for subchapter 5 was raised in the CARES Act from $2,725,625 to $7,500,000. That emergency bump expired March 27, 2022. Congress is trying to decide if it should make it permanent.
Chapter 13 is only for individuals, including sole proprietors. It is not for partnerships, corporations or limited liability companies. It works similar to Chapter 11, but with lower debt limits.
But keep in mind the business has to make enough to cover the new Chapter 13 payments. Chapter 13 repayment plans run three to five years. If you finish the plan, you can wipe out most unsecured debt. Your disposable income might all be required by the plan, so a living situation that is low cost may be necessary. This may mean several lean years for the proprietor.
If the business is in Chapter 11 then a trustee can be avoided, but if the business is in Chapter 13 then a trustee is always appointed. The business pays the trustee, who in turn pays the creditors in order of priority.
Chapter 13 is generally less expensive and less complicated than Chapter 11 and it discharges more types of debt. It can be a bad fit if the business uses expensive equipment that is not exempt and the business can’t generate enough income to cover new payments.
Bankruptcy is not to be taken lightly, and its impact on your business and personal finances can reverberate for years to come. Consider every option carefully before filing.
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.
