The owners of the struggling business know that the clock is ticking. Losses are mounting, vendors are going unpaid, and the bank isn’t interested in another loan. Making a decision about bankruptcy depends on whether you believe your business can realistically turn around. Either way, there are things that the owners of an underfunded business can do in preparation for bankruptcy.
Before rushing off to the courthouse for bankruptcy, it’s always a good idea to figure out whether you can fix your financial problems. Financial planning experts warn that it should be your last resort. Advisors will usually point you toward selling assets, merging with another company, restructuring, laying off staff or pivoting to a new market. For instance, if you’re a struggling manufacturer, maybe you can sell some of your equipment to raise cash, or partner with another firm to combine resources and reduce costs. If you’re a retail shop, perhaps you can shift your business model. Try to renegotiate debts with suppliers and vendors – they’d rather get some money than lose it all. It may seem easier to avoid calling the people you owe money to, but keeping communication channels open will put you in a better position whatever happens next. So before you start your bankruptcy journey, check out what’s on the table.
Types of Business Bankruptcy
If you find yourself considering business bankruptcy, it’s crucial to understand the different types of business bankruptcy available. Chapter 7 bankruptcy is a type of liquidation. This means that your business assets will be sold off to pay off your debts. Chapter 7 is typically used for businesses that cannot continue operating. In Chapter 7, your business will be completely wiped out, but you will get a fresh start. Chapter 11 is the opposite. Part of Chapter 11’s attraction is that the business continues operating. In a Chapter 11 case the business will work with its creditors to create a plan to reorganize and pay off its debts. This provides the business with some breathing room. If you have already tried to renegotiate and got nowhere, creditors who held out may now be forced to negotiate. Liquidation means cashing out and burning the bridge behind you. Reorganization means staying in business for another day.
Chapter 13 is a different case. Individuals can file Chapter 13, not businesses. So if a business is owned by a single person, as a sole proprietorship, Chapter 13 might be an option. But if your business is a C or S corporation, LLC, or partnership, it can’t file Chapter 13. For a sole proprietor it tends to be faster than Chapter 11, with lower administrative and attorney costs, and it may let you keep some personal assets that Chapter 7 would make you sell.
If you own your house and run a business that goes bankrupt, your house might not be safe. What? How can that be? It’s because your house can be used as collateral for the business debt. If you listed your home or another personal asset as collateral when you took out a business loan, a Chapter 7 case may force you to sell it.
The Ultimate Cost of Bankruptcy
You should think very hard about the ultimate cost of bankruptcy and how it will affect you personally, because the law won’t wipe out everything you owe. There are limits on how much of your debts can be discharged in bankruptcy. Will it affect your credit score? In most cases, you should expect that. The damage can last up to 10 years. Repayment can stretch on for 20 years under Chapter 11, or five under Chapter 13. It’s something that people really don’t discuss before choosing bankruptcy. As much as people want a quick solution to their debts, bankruptcy isn’t the quickest option either. Bankruptcy is a long, drawn-out process, which can take many months or even years. It is emotionally draining, too. It is important to understand the cost of the bankruptcy, as well as how long it will be a permanent part of the history of your business, before it is filed.
The Paperwork
Then there is the paperwork. A Chapter 7 or Chapter 11 petition is filed with the bankruptcy court closest to where the business operates, and both chapters have the same filing requirements. A good thing to do now, if you haven’t done it already, is to make sure your books are up to date on your current income and expenses, current assets and liabilities, and your current contracts and leases. Then get a hold of a copy of your latest tax return, as well as any financial statements the court may need. To ensure that the records and paperwork are in order, do a quick check of what’s on your records compared to what’s really out there. A sole proprietor filing Chapter 13 will also need a credit counseling certificate and a monthly net income statement, among other documents. If you pull it all together ahead of time, you’ll be able to focus on the needs of your business and your family instead of scrambling to meet court deadlines.
Finally, get advice. An attorney should always be consulted before going through a bankruptcy filing, and debtors should work closely with lawyers and financial professionals to make the best decisions about restructuring in bankruptcy. Don’t file in a panic. Take time to understand the process. The key is knowing which type of bankruptcy is appropriate for a business and what the consequences of a given type of bankruptcy could mean for the future of a business.
