Leaving Your Business

Everything You Need to Know About Small Business Bankruptcy

It’s every business owner’s worst-case scenario: reaching the point where you can no longer meet your monthly expenses and have no other way out. At this juncture, many business owners decide their only option is to file bankruptcy. If you’re thinking about it, here’s everything you need to know to make an informed decision.

Before You Make a Move

The Small Business Administration (SBA) has a little known program that may offer a glimmer of hope to those thinking about bankruptcy. Called America’s Recovery Capital (ARC) Loan Program, it was created for business owners who are unable to meet their debt obligations because of the troubled economy. The basics of the program are:

  • Loans are given in amounts up to $35,000, and deferred for 12 months. After that, they will be repaid over five years.
  • Those qualified to receive them are for-profit businesses that need help paying their current debts.
  • Loans are interest free and SBA guaranteed. There are no fees associated with these loans.

In addition to investigating an ARC loan, you should also try to work with your creditors and ask for reduced terms, or attempt to get a short-term loan from friends and family.

Bankruptcy Options

If you decide that bankruptcy is your only option, you will have three basic choices. It’s critical to understand each one to make the right decision. Some options will even allow you to retain your business and assets and continue to operate, hopefully coming out stronger in the end.

  • Chapter 7, or liquidation: In 2005, the Bankruptcy Abuse Prevention Protection Act was passed, making it more difficult to file for this type of bankruptcy and encouraging individuals and sole proprietors to file for Chapter 13 instead (see below). But if you’re a sole proprietor and owe some of your business debts personally, you’re eligible for Chapter 7. This option is most often taken when a business has few or no assets and the owner doesn’t believe the business has a chance to survive. Once you’ve filed a petition in court that includes a list of your creditors, the court will appoint a bankruptcy trustee. After you and the trustee meet with your creditors in an attempt to reach agreements, the trustee will sell all assets and use the proceeds to pay off outstanding debts. Once the money is gone, the remainder of the debts will be discharged and the business will be closed.
  • Chapter 11, or reorganization: This form of bankruptcy allows a business to continue operating under a reorganization plan. The court will appoint a trustee who will reorganize your business and then oversee your operations until your debts are repaid. All forms of businesses can use this form of bankruptcy, but it is most often granted to a business that is considered to have more “goodwill” in the community than the sum of its assets.
  • Chapter 13: This type of bankruptcy is typically used for individuals, but if you are a sole proprietor or have an unincorporated business other than a partnership, it is available to you. With it, you’ll submit a plan to the bankruptcy court that outlines exactly how you intend to repay your debts. The repayment time should be within three to five years, and will be determined by your monthly income. This type of bankruptcy allows a sole proprietor to keep personal assets, such as a home or car, whereas you would likely lose them when filing Chapter 7. In addition, your creditors won’t be allowed to begin or continue trying to collect from you during the repayment time.

You’ll also need to consider the tax implications for filing a business bankruptcy. For instance, even if a debt is canceled, it’s subject to taxation. The IRS Bankruptcy Tax Guide has full details. In addition, you’ll need to file some specific forms with the court when you file bankruptcy.

Despite the negative connotations of bankruptcy, there my be a silver lining for people who go through it. According to a working paper released last month by the National Bureau of Economic Research, people who successfully file Chapter 13 bankruptcy increase their yearly earnings by over $5,500, and decrease their mortality rate by 1.2 percent.

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