When Business Bankruptcy Makes Sense for a Small Business

Filing for bankruptcy can be a difficult decision for any business owner – but sometimes, it’s the best option to save a struggling small business. This article will walk through when bankruptcy might make sense for a small business, the different types of bankruptcy, and what the process entails.

Knowing When It’s Time

As a small business owner, you’ve probably poured your heart and soul into building your company. The thought of closing up shop or declaring bankruptcy can feel like a personal failure. But sometimes, bankruptcy is the most strategic option to save your business. Here are some signs it may be time to explore filing bankruptcy:

• You’re consistently late on vendor payments or unable to make payroll
• You’ve maxed out credit cards and loans trying to stay afloat
• You’re facing lawsuits from unpaid creditors
• Your debts are more than your assets

If this sounds familiar, it may make sense to consider bankruptcy. Of course, every situation is unique and there are always alternatives like negotiating with creditors or liquidating assets. But often bankruptcy is the surest path to a fresh start.

Understanding the Types of Bankruptcy

There are a few main types of bankruptcy designed for businesses:

Chapter 7 Bankruptcy

Chapter 7 bankruptcy, also called liquidation, involves closing down your business and using the proceeds to pay off debt. Any remaining debts are discharged. Pros:

• Get out of debt quickly
• Stop creditor harassment

Cons:

• Lose all assets
• Business closes

Chapter 11 Bankruptcy

Chapter 11 allows you to restructure and modify debt while continuing operations. You submit a plan to repay debt over time. Pros:

• No liquidation
• Negotiate better terms
• Keep running business

Cons:

• Complex and expensive process
• Risk of creditors rejecting plan

Chapter 13 Bankruptcy

Chapter 13 is less common but allows individuals running sole proprietorships to restructure debt into a 3-5 year payment plan. Pros:

• Keep assets
• Affordable payments
• Only sole proprietors eligible

Cons:

• Up to 5 years of payments
• Risk of creditors rejecting plan

As you can see, each type has pros and cons to weigh given your specific situation. Many small business owners opt for Chapter 7 or Chapter 11.

The Bankruptcy Process

Here’s a quick rundown of what a business bankruptcy entails:

1. File petition with bankruptcy court
2. Automatic stay stops collections
3. Debtor meets with creditors
4. Debtor submits repayment plan
5. Court approves/confirms plan
6. Debtor makes payments over time
7. Debts discharged upon completion

Some key steps are the automatic stay, which pauses collections, and discharge of remaining debts. Each type of bankruptcy follows a similar process with variations.

Pros of Filing Business Bankruptcy

While bankruptcy should never be taken lightly, it does offer struggling businesses significant benefits:

• Pause collections – The automatic stay immediately halts collection efforts and harassment. No more angry calls or lawsuits.
• Cancel contracts – You can eliminate burdensome contracts and leases.
• Discharge debt – Debt is wiped away giving you a fresh start.
• Keep operating – With Chapter 11 or 13, you can keep running your business.

For businesses facing unmanageable debt, these can be lifesavers. Bankruptcy gives you time to catch your breath and get back on the right track.

Cons of Business Bankruptcy

Bankruptcy can be the best path forward, but also has downsides like:

• Damaged credit – Your business credit score will plummet.
• Costs and fees – Lawyer and court fees can get expensive.
• Public records – Bankruptcy is public data that anyone can access.
• Lose assets – With Chapter 7, your assets are liquidated.

Be sure to think through if the pros outweigh the cons for your situation. Every business is unique.

Alternatives to Bankruptcy

While bankruptcy is a solution, it’s not the only option. Some alternatives to explore first include:

• Negotiating with creditors – See if they’ll agree to reduced/delayed payments.
• Selling assets – Liquidate assets not critical to operations.
• Cutting costs – Reduce overhead any way possible.
• Obtaining investors – Find an investor to inject capital.
• Filing tax settlements – Settle tax debts for less than owed.

If these alternatives don’t resolve your financial issues, then bankruptcy may be the best option. The pros often outweigh the cons for small businesses who truly need a fresh start and relief from crippling debt.

The bankruptcy process seems daunting, but an experienced attorney can guide you through it. They’ll help analyze if bankruptcy makes sense for your situation and which chapter to file under. Be sure to thoroughly discuss all the implications, timelines, costs, and requirements involved.

It’s smart to consult with both a bankruptcy attorney and a tax professional. They can work together to develop the most strategic approach. As mentioned in[1], tax-loss harvesting could allow you to offset taxes owed by selling assets at a loss prior to filing. Your advisors should explore tactics like this.

The IMF paper[2] also provides useful perspective. It recommends policies to limit the tax benefits of debt financing. This could impact some of the advantages of bankruptcy. Keeping up with the latest tax and policy changes is key.

While emotionally difficult, viewing bankruptcy through a business lens can be helpful. The legal system allows financially distressed companies a path to start over. With proper planning and advice, you can emerge stronger. There are always alternatives, but bankruptcy provides important options worth understanding.

References

[1] How Tax-Loss Harvesting Works for Average Investors – Investopedia (https://www.investopedia.com/articles/taxes/08/tax-loss-harvesting.asp)

[2] Tax Biases to Debt Finance: Assessing the Problem, Finding Solutions – IMF (https://www.imf.org/external/pubs/ft/sdn/2011/sdn1111.pdf)