Each year, countless small-business owners face the frightening “fight-or-flight” stage of a owning a struggling company — the point at which they have to make the decision to continue pumping money into the venture to keep it afloat, or to cut their losses and close down. Often, business owners who closed up shop could have survived if they just had more time to recover.
One way to save a struggling business is to file for bankruptcy. A bankruptcy is not just a method for liquidating a business, it can serve as a way for you to keep your doors open while you regroup. If you’re sure all you need is time and some help with your debts to save a business with long-term profitability potential, filing for bankruptcy might be in your best interest. Here’s what you need to know if you’re considering bankruptcy.
Chapter 13 vs. Chapter 11
While a Chapter 7 bankruptcy liquidates a business, filing for protection from creditors under Chapter 11 or 13 of the U.S. bankruptcy code gives you breathing room while you get back on your feet. Even if you do decide to close your business in the end, a Chapter 11 bankruptcy gives you more time to manage the liquidation so you can reduce your losses — and might save your personal assets.
If you are a sole proprietor with regular income, you might be better off choosing a Chapter 13 bankruptcy (corporations and partnerships aren’t eligible). This is a plan for helping you repay debt over three to five years.
If you have creditors looking to close your business, significant assets, and high debt, but also a realistic future potential for profits, Chapter 11 might be a better idea. Chapter 11 requires a formal turnaround plan and approval by the court (with input from your creditors). For many small businesses, Chapter 11 will be too costly and time-consuming. An attorney with bankruptcy experience can help you determine which choice is right for your situation.
Benefits of Bankruptcy Protection
The main benefit of filing for bankruptcy is protection from creditors who, if you can’t pay them on time, may attempt to liquidate your business. You will eventually have to pay your creditors some or all of what you owe them, but under bankruptcy reorganization, you temporarily stop, permanently reduce, and/or delay your payments.
In addition to lowering your overhead costs by reducing debt payments, you might able to reduce your operating expenses if your vendors and suppliers agree to lower their prices on future orders. They might do this to help you generate future sales and profits to help pay back the money you owe them and to keep you as a long-term customer. During a bankruptcy, you can also break contracts, such as leases or employee agreements. Some employees might be happy to temporarily renegotiate their pay and benefits if it means keeping their jobs.
When you reduce your expenses during this process, you can often reduce the prices of your products, which could potentially make you more competitive in the marketplace.
At the same time, although it might seem counterintuitive, your customers, vendors, suppliers, and employees might be more willing to work with you if you tell them you have been approved for a structured bankruptcy reorganization. If you’ve been struggling and rumors have been flying about whether you’re about to close down, sharing your reorganization plan with partners and the public can actually result in fewer supplier, lender, employee, and customer defections.
Finally, when you file for Chapter 11, creditors form a committee to provide their input to the court about your situation. They might support your plan, oppose it, or submit a plan of their own. Creditors want their money back, and a structured, court-supervised reorganization can increase their confidence in you. During a bankruptcy, some creditors might agree to take a reduced payoff while others might offer better terms (such as reduced interest rates or longer repayment periods). Some lenders might give you more money to manage a restructuring plan they believe will benefit them.
Organizing Your Documents
If you’re using a simple spreadsheet to manage your finances, upgrading to small-business accounting software will help you generate relevant reports a court-appointed trustee or a creditor committee can use to make their decisions. The more organized your financial documents and easier they are for stakeholders to read, the more confidence people will have in your reorganization or debt-service plan.
Another factor to consider in record-keeping is that cancellation of debt might have to be reported as income on your tax return, according to Kevin Hood, owner of C. Kevin Hood Accounting & Tax in Hilton Head Island, South Carolina. There are a few exceptions to this rule, Hood notes, so you should be patient when dealing with creditors. “Try to include any debt settlements in the bankruptcy rather than before,” he advises. “It could save you money in taxes.”