Running a small business used to be easier. Competition and the economy keep you on your toes. Then there’s the daily grind of running a business. Business owners are often stressed out more than other people realize.
Lots of business owners borrow to expand so they can earn more money, and most businesses could not even get off the ground without some kind of loan capital. It can make a lot of sense to borrow when business is good.
Getting a loan with only an expectation of more revenue puts lots of borrowers in a bind when business does not take off. Many people are surprised to find themselves with a personal guarantee on their business loan, but if you started or expanded your business and you needed a loan to do it, you probably did give the lender a personal guarantee. It is easy to find that you are personally on the hook for the loan, even if the business closes or files bankruptcy.
If that happens, it is better to settle the debt or to file bankruptcy on the personal side if needed. That may well be what saves the business. Don’t try to duck the problem. Taking more loans to repay the one you have is worse. A new loan will do nothing but push the problem down the road. And add to the balance of what you owe.
There’s no option that’s right for every borrower. Some owners borrow only so they can keep their doors open. No matter what the reason you borrowed, the next step is to look at the type of business and how it is organized, because it’s business organization that decides your options.
The Business’s Debt Is Your Personal Debt
If you are the sole proprietor of a small business, for legal purposes your assets and the business’s assets are the same. For this reason, the business’s debt is your personal debt. So when you file for bankruptcy, the debts for the business will also be listed in the bankruptcy. This is the same as for any personal debts. The personal debts and business debts will all be discharged. So a lender who lends to a small business is in effect lending to you. Any debt relief would have to be personal debt relief.
If you run a small business as a sole proprietor, you have three choices. Chapter 7 bankruptcy, chapter 13 bankruptcy, or debt settlement. It all depends on what your income is, what your assets are, and what you are willing to save for debt settlement.
In a debt settlement, you negotiate with each creditor. You try to get them to accept less than the full balance owed. How much less depends on the type of debt and on how quickly you can pay. Typically, it is easier to settle an unsecured debt. For many borrowers, the secured debts are harder. You might get something near half the balance if you can pay in full soon. If you can’t reach a deal, many business creditors will file a lawsuit against you personally.
A secured lender will, in many cases, take the collateral back before trying to negotiate on what is left owing. Many small businesses have assets of little value that are not worth repossessing. If the collateral is old or worthless, the lender may not bother with it, and the loan can be settled like unsecured debt. The first question in any settlement is whether the debt is secured and, if it is, how much the collateral is worth now.
A lender that holds no collateral, or worthless collateral, will in many cases cut you a deal for about half the balance. To get a better deal, you will probably have to pay the debt all at once or within a couple of months. That is not an option for everyone. Before choosing settlement, be sure to be honest with yourself about whether or not you can save enough for a lump sum or how long that will take you to do. If you cannot save enough money in two years after defaulting, it may not be worth trying. There is no token-payment plan to get the debt settled. If a lender sues you and gets a judgment, they can garnish your income, take your bank balance and put a lien on your home. That’s why getting sued matters, even after a business is gone.
Chapter 7 Bankruptcy
If you cannot save enough money to settle the debt, and you own few assets, Chapter 7 bankruptcy may be an option. To qualify for Chapter 7, most filers must pass a means test. The means test compares the income for your household with your state’s limit for the number of people in your household. Those limits are adjusted twice a year, so last year’s limit may not apply. Earners above the limit may still qualify if they have no positive disposable income. Chapter 7 wipes out most debt, often leaving you with your assets.
In Colorado, as of October 2023, filers with a household income under $75,710 for a single-filer or $98,365 two-person household qualified. Limits are updated every November and April. Filers who have a higher income will have to complete a disposable income review.
If you are above the limit, you will have to show your expenses line by line. Only certain expenses count. The remainder is disposable income. Whatever is left over usually rules out Chapter 7. Filers with mainly non-consumer debt like business debt and taxes skip the means test. A mortgage is consumer debt, so many homeowners will not qualify for that exception.
Typically, Chapter 7 wipes out your business and personal debt. That includes credit cards, your personal guarantees on business loans, broken business leases. Many filers can walk away keeping everything they have. In Colorado, for example, filers who use their business as a primary income can keep up to $60,000 of business assets, $20,000 for filers who use the business as a secondary income. In Chapter 7, a trustee can take and sell any asset that is not protected. That is why exemption limits are an issue.
Chapter 13 is for filers who earn more than Colorado’s Chapter 7 income limit, or who prefer its benefits. In some cases, a Chapter 13 can be better. In Chapter 13, the trustee will not take unprotected property. That means you keep the equipment you need to run the business. If a creditor has a lien on a business asset, you can reduce the debt to what the asset is worth. You repay the balance over a 3 to 5 year plan. Say you overpaid for a truck and trailer used in the business. In Chapter 13, that loan can be cut down to the current value of the truck and trailer, and paid through the plan.
Personally Liable for the Loan
A business LLC or corporation is an entirely separate legal entity. Its assets and liabilities are kept separate from the owner’s. Many lenders will not lend to the business unless the owner personally guarantees the loan. If you guarantee it, you are personally liable for the loan. SBA loans, merchant cash advances, credit cards, leases and lines of credit are often underwritten with a personal guarantee. Many times, even if you have the LLC or the corporation, you will have guaranteed the loan personally and so the lender does not even have to go after the LLC or the corporation. They can simply come after you. You will need your own relief, not just relief for the business.
The owner’s personal liability and often the company’s liability on those debts can be settled. Not all debts can be settled, though. The debts can often be settled once the company dissolves, usually at a lower price. You can also settle the debts while the business is still operating.
If the business has enough debt to need bankruptcy, and the owner guaranteed the debt, both the business and the owner need relief. Filing for the business but not the owner leaves the owner on the hook. Filing for the owner but not the business will leave the business on the hook. Converting the business into a sole proprietorship prior to the owner filing for bankruptcy will often be much cheaper than filing for the business and the owner. You would first change the business from an LLC or a Corporation into a Sole Proprietorship, then file one personal bankruptcy to cover the debts and the guarantees.
Business bankruptcy, especially Chapter 11 or Subchapter 5, can be much more expensive than a personal filing. A one-person sole proprietor business can benefit from the tools of the trade exemption, that an owner of an LLC can’t. You can keep the doors open, and the employees and customers needn’t know that anything happened. A lot of relief for not much money as long as it’s done right.
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.
