For small and medium-sized businesses (SMBs), financial struggles can sometimes lead to the difficult decision of filing for bankruptcy. While the process may seem daunting, understanding the implications, types and long-term effects enables entrepreneurs to navigate this challenging phase. This guide explores small business bankruptcy, the different chapters available and how to emerge stronger from the experience.
Bankruptcy is designed to help individuals and enterprises repay debts under the federal court's protection. For SMBs, it can provide a fresh start or a structured path to financial recovery.
The type of bankruptcy filed determines the outcome for the business and its owners. The most common forms of bankruptcy for small businesses are Chapter 7, 11 and 13, each serving distinct purposes.
Chapter 7 is where a company opts to liquidate its assets to pay off creditors. Experts advise this approach only when all other alternatives become unavailable.
If you’re wondering, “Can I keep my business if I file Chapter 7?” The answer depends on the corporate structure and whether it can operate without the liquidated assets. In most cases, the operation closes and its assets are sold to settle debts. Some types — like sole proprietors — may retain certain personal assets exempt under state law. However, the filing remains on their credit report for a decade, making future financing more difficult.
Chapter 11 is designed for brands that wish to continue operating while settling their debts. Though more complex and costly than other options, this alternative offers flexibility for SMBs with viable long-term prospects.
Under this filing, a court-approved plan outlines how debts will be repaid, often with renegotiated terms that ease financial pressure while keeping the enterprise afloat. This path exists to assist those that want to restore profitability through debt adjustments and reorganization, making it the most viable option for SMBs with considerable assets.
While primarily for individuals, qualifying sole proprietors can file under Chapter 13 to reorganize debts by creating a realistic repayment plan. To qualify, the total debt needs to be within the limit of $2.75 million and there must be a reliable source of income for the repayment. In this agreement, the debtor proposes a three- to five-year repayment schedule to creditors, detailing how they plan to settle their debts over the specified period.
A small business filing for bankruptcy under Chapter 13 retains control of itself while gradually paying down obligations. Over time, this structured approach can help rebuild factors that demonstrate financial responsibility and contribute to an improved credit score.
The aftermath of filing depends on the path taken. If it’s Chapter 7, the entity usually closes because its assets are liquidated to pay creditors. The remaining debts are discharged. Should you opt to file under Chapters 11 or 13, you can continue operating while observing a court-approved repayment plan.
Photo by Tina Bosse on Unsplash
The legal structure of a business also significantly impacts how bankruptcy affects its owners. Sole proprietorships and partnerships offer no separation between personal and corporate finances, exposing owners to personal liability for such debts.
In contrast, a limited liability company (LLC) or corporation has a legal distinction between the owner and the organization. This separation ensures creditors only pursue the company’s assets and not the owner’s personal property in the event of bankruptcy or lawsuits.
For entrepreneurs in high-risk industries like healthcare or construction, this protection is invaluable. By structuring their enterprise as an LLC or corporation, they can mitigate personal financial risk while maintaining operational flexibility.
The process of filing for business bankruptcy follows the following steps:
Before filing, SMBs should consider these alternatives:
Financial setbacks don’t always spell the end of an entrepreneurial journey. Walt Disney’s famous failure, for example, was when his first animation company failed and filed for bankruptcy. Yet, his unwavering commitment to creativity led to the creation of Mickey Mouse, Disneyland and the global empire that bears his name — a testament to the power of resilience and vision in overcoming adversity.
Small business bankruptcy is a significant decision. While it can offer relief, understanding the differences between the various options available to SMBs and the protections offered by different business structures can help entrepreneurs make informed choices.
* This post is written in collaboration with our guest contributor, who has financially supported its publication.
Cover Photo by Melinda Gimpel on Unsplash
Alex Quin is a full-stack marketing expert and global keynote speaker. Founder and Chief Marketing Officer of UADV Marketing - a member of the Forbes Agency Council.
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