Small business bankruptcies? That is a phrase no business owner wants to hear, but sometimes, it seems as if it’s the only way out of the situation they may be immersed in. The help of a bankruptcy lawyer in these cases is invaluable.
Key Takeaways
- Causes of Bankruptcy: Cash flow issues, high debt levels, economic downturns, and poor financial management are major factors that can lead to small business bankruptcies.
- Bankruptcy Options: Small businesses can choose between Chapter 7 (liquidation), Chapter 11 (reorganization), and Chapter 13 (repayment plan for individuals/sole proprietors) depending on their financial situation and business viability.
- Professional Guidance: Consulting with experienced bankruptcy attorneys is crucial for navigating the bankruptcy process and making the best decisions for the future of the business.
What are some challenges that can lead to small business bankruptcies?
Business bankruptcy is something no one wants to go through, but understanding some of the reasons that may lead to a company having to make this decision can also avoid future small business bankruptcies. We can name the following:
Cash Flow Problems
It is not uncommon for a company to figure out how to file business bankruptcies if they are experiencing cash flow problems. Small businesses often struggle to maintain a balance between incoming revenue and outgoing expenses, and issues such as delayed payments from customers, unexpected expenses, or seasonal fluctuations can lead to cash flow problems.
High Levels of Debt
There are many reasons a small business may find itself in a lot of debt. Some reasons could eb that they took a significant loan to start their operations, or the debts have a high-interest rate that can become overwhelming.
We cannot avoid mentioning that credit card debt also affects small businesses. When entrepreneurs rely on payment methods for everyday expenses, it can lead to unmanageable debt levels very quickly.
Economic Downturns
Small business bankruptcies can occur when the country’s economic situation takes a downturn. Economic recessions, changes in market demand, and industry-specific setbacks can severely impact a small business’s revenue.
Poor Financial Management
Lack of proper budgeting, financial planning, and forecasting can lead to financial mismanagement. Also, inadequate record-keeping and financial oversight can result in unnoticed financial problems until they become critical, leading to small business bankruptcies.
What are bankruptcy options for small businesses?
There are three options for filing bankruptcy, and these are: Chapter 7, Chapter 11, and Chapter 13. Let’s discuss them.
Business bankruptcy Chapter 7
Chapter 7 bankruptcy, often referred to as “liquidation bankruptcy,” involves the sale of a debtor’s non-exempt assets by a trustee to pay off creditors. It is typically used when a business has no viable future and cannot continue operations.
Who can file for this type of bankruptcy? Both individuals and businesses can file for Chapter 7. For small businesses, this option is usually considered when the business has insurmountable debts and insufficient income to cover them.
Chapter 11 bankruptcy
Chapter 11 bankruptcy, known as “reorganization bankruptcy,” allows a business to continue operations while restructuring its debts. It is designed for businesses that have a viable future but need relief from overwhelming debt.
Any business entity, including corporations, partnerships, and sole proprietorships, can file for Chapter 11, and it is often used by larger businesses but can be utilized by small businesses as well.
It is essential to mention how Chapter 11 differs from Chapter 7. Unlike Chapter 7, Chapter 11 allows the business to continue operating, and instead of liquidating assets, debts are restructured to be paid off over time. Also, the business owner typically retains control of the business, whereas, in Chapter 7, a trustee takes control.
Chapter 13 bankruptcy option for small businesses
Chapter 13 bankruptcy, also known as “wage earner’s plan,” allows individuals, including sole proprietors, to reorganize their debts and create a repayment plan based on their income. It is designed for individuals with regular income who can pay off their debts over time.
Take note that only individuals, including those operating sole proprietorships, can file for Chapter 13. It is not available to corporations or partnerships.
You may be wondering, “Can I keep my business if I file Chapter 13? The answer is yes! Sole proprietors can continue running their businesses while repaying debts through the Chapter 13 plan.
You are not alone: Bankruptcy attorneys will guide you through your best options
S&B Legal offers low-cost solutions to your small business if you are thinking about filing for bankruptcy in San Diego or Los Angeles. Contact our experienced bankruptcy attorneys to better understand if bankruptcy is your best option. We are ready to help with our low cost services!
Summary
Navigating the complexities of small business bankruptcies is challenging but often necessary for businesses facing insurmountable financial difficulties. Cash flow problems, high levels of debt, economic downturns, and poor financial management are common causes leading to such situations. There are three primary bankruptcy options available for small businesses: Chapter 7 (liquidation), Chapter 11 (reorganization), and Chapter 13 (repayment plan for individuals and sole proprietors). Understanding these options and seeking professional legal advice can help business owners make informed decisions about the future of their business. Experienced bankruptcy attorneys can provide invaluable guidance and support throughout this process.
Frequently Asked Questions
What is the difference between Chapter 7 and Chapter 11 bankruptcy for small businesses?
Chapter 7 bankruptcy involves the liquidation of the business’s assets to pay off debts. This usually results in the business closing down. Chapter 11 bankruptcy allows a business to reorganize its debts and continue operations while developing a plan to pay creditors over time. Chapter 11 is more complex and expensive, typically suited for larger businesses, but small businesses can also file under Chapter 11 [1].
How does filing for bankruptcy affect a small business owner’s personal credit?
If the business is a sole proprietorship, the owner’s personal and business finances are intertwined, and filing for bankruptcy can directly impact personal credit. For corporations and LLCs, the business’s bankruptcy does not directly affect the owner’s personal credit unless the owner has personally guaranteed the business debts. However, personal credit can be indirectly affected if the owner had to rely on personal assets to support the business.
What debts are discharged in small business bankruptcy?
In Chapter 7 bankruptcy, most unsecured debts (like credit card debt and medical bills) can be discharged, but some debts, such as taxes, student loans, and court-ordered payments, may not be. In Chapter 11 bankruptcy, the business aims to reorganize and pay off its debts according to a court-approved plan, which may include discharging some debts, renegotiating terms, or reducing amounts owed [2].
Can a small business continue to operate during bankruptcy proceedings?
Yes, under Chapter 11 bankruptcy, a business can continue its operations while it reorganizes its debts. The business operates as a “debtor in possession” and maintains control of its assets while working out a repayment plan with creditors. In Chapter 7 bankruptcy, the business usually ceases operations as the assets are liquidated to pay off debts [3].
What are the steps to file for bankruptcy as a small business?
1. Evaluate the Financial Situation: Consult with a bankruptcy attorney to determine if bankruptcy is the best option.
2. Prepare Necessary Documents: Gather financial records, including income statements, balance sheets, tax returns, and a list of assets and liabilities.
3. File the Petition: Submit the bankruptcy petition and necessary schedules to the bankruptcy court.
4. Automatic Stay: Once the petition is filed, an automatic stay goes into effect, halting most collection activities against the business.
5. Creditors’ Meeting: Attend a meeting of creditors where the business owner answers questions under oath about the financial situation.
6. Plan Confirmation (Chapter 11 only): Propose a reorganization plan that must be approved by the court and creditors.
7. Discharge (Chapter 7) or Plan Implementation (Chapter 11): In Chapter 7, the court discharges the remaining eligible debts. In Chapter 11, the business follows the court-approved plan to repay creditors.
