Reasons to File a Small Business Bankruptcy

Running a small business can be exciting and lucrative, provided that you have a well-thought-out business plan and the ability to execute it. Although most entrepreneurs never consider the possibility of failure, eight out of ten small businesses fail within the first 18 months, according to Bloomberg. When a small business owner is faced with insurmountable debts and is unable to pay off creditors, both the business and personal assets may be in jeopardy. In this situation, it may be necessary to file for small business bankruptcy.

Small Business Bankruptcy 101

Although many equate bankruptcy with financial ruin, this is not necessarily the case. In fact, there are options that may allow a business to continue operating while reorganizing its debt. Additionally, filing for bankruptcy can give an entrepreneur much-needed time to delay and/or reduce his or her debt payments, thereby protecting the business from liquidation proceedings.

Generally, there are three forms of bankruptcy protection available to small businesses: Chapter 7, Chapter 11, and Chapter 13, depending on the type of business organization. A sole proprietor may file under all three chapters, while partnerships and corporations can only utilize Chapter 7 and Chapter 11. Nonetheless, a business that files under any of these chapters is granted a “temporary stay” which automatically stops all collection activities by creditors, giving the business time to make plans to regain its footing, if possible.

Under Chapter 7, the business will be closed and the assets sold off to pay off as much debt as possible. In the case of a sole proprietorship, the owner files a personal bankruptcy for both the business and personal assets. Business owners typically file for Chapter 7 when they cannot resolve their credit problems and be relieved of the debt burden outweighs the drawback of losing the business.

On the other hand, business owners can file for Chapter 13 bankruptcy by creating a 3-5 year plan to pay off debt with proceeds from future income. However, the plan must be approved by the court, and the owners must be able to demonstrate that the business has a likelihood of returning to profitability, otherwise the petition will be denied and the business must file for Chapter 7.

Finally, small business owners, partnerships, and corporations can file for Chapter 11 bankruptcy. This form of bankruptcy is really designed for a business entity that is still viable but needs to reorganize its debts to become profitable once again. In short, the business must devise a court-approved repayment plan that reorganizes the business debts while allowing it to continue operating and retaining its assets.

The Bottom Line

Given the challenges associated with running a small business, it is crucial to have proper legal representation. If your business and personal assets are on the line, you are well-advised to engage the services of an experienced bankruptcy attorney.