May 08, 2020

What Happens If Your Small Business Files for Bankruptcy

You’re likely fighting hard to keep your small business alive through the coronavirus. Whether that means cutting back on unnecessary expenses, restructuring client contracts, or applying for small business loans, you’re working around the clock to keep your business afloat.

Unfortunately, many US small business owners are feeling overwhelmed, overworked, and over-leveraged—leaving them contemplating bankruptcy. 

It’s not just small businesses struggling right now. The XFL, which launched this year for the first time in almost 2 decades, had to lay off employees, suspend business, and file for Chapter 13 bankruptcy because of the coronavirus.

Bankruptcy might seem like an appealing option for struggling small businesses, but it’s not without risk and repercussions. 

Moving forward with bankruptcy affects the future of your business and credit. Here’s what happens when you decide to declare bankruptcy for your small business. 

You Go Through the Same Process as Debt Consolidation

There is no need to file for bankruptcy right away. The process is complicated and can significantly impact your reputation and business. 

Instead, start with the basic debt relief and consolidation steps to better understand your financial situation. You will need to do this exercise if you file for bankruptcy, so it won’t hurt to do it beforehand. 

During the debt consolidation process, you review all obligations to determine which debts can be paid immediately, which ones can be combined, and which ones can be delayed. Essentially, you are optimizing your debt repayment plan and finding the best recourse for your business.

For example, you may be able to use a short term loan to pay off several debts at once, consolidating the obligations into one reasonable low-interest loan.

Once you have consolidated your debt, you can move forward with selling unnecessary equipment and cutting back on business expenses.

With these steps completed, you can see whether or not you need to declare bankruptcy. Fortunately, the process should be easier now that your debt is consolidated and your assets are reviewed. 

You Will Likely Have to Close Your Business

Some companies can declare bankruptcy and stay in operation, but this process is expensive, complex, and time-consuming. Companies that stay in operation file Chapter 11 and work with the courts to create a plan to pay off the debt over time. 

Most small businesses that declare bankruptcy file Chapter 7 bankruptcy and close their doors immediately. This bankruptcy option requires asset liquidation (selling anything of value) to pay off their debt obligations.

For example, a restaurant may declare bankruptcy and sell its catering van to pay off a few existing obligations. Then, it would sell its kitchen equipment, furniture, and remaining inventory to reduce debts further. By the time those steps are done, the restaurant owner won’t be able to continue operating anyways. 

Bankruptcy is not just an easy way to erase debt—it could cause you to lose your business entirely, leaving you and your employees without work.

You Still Have to Pay Off Your Debt

Your small business is not absolved of debt just because you declare bankruptcy. On the contrary, the courts you work with will prioritize reorganizing your company to ensure the debts are paid. 

It is very rare that a company declares bankruptcy and has its debt forgiven. Even if creditors accept a loss on your loan or take a smaller payment, you will still be responsible for paying off the new agreed-upon amount.

Bankruptcy courts work to maximize the amount that you can pay off to help your creditors recoup their losses. 

This reality is why most financial experts recommend looking for ways to reduce your debt on your own before choosing the more drastic option of filing for bankruptcy. Moreover, by working with creditors and taking a proactive approach to finding a resolution outside bankruptcy courts, you can save your business and credit score.

Sole Proprietors May Get Help With Personal Debt

While most small business owners will file Chapter 7 bankruptcy, sole proprietors have another option: Chapter 13. With this option, you may be able to list both personal and professional debts in your bankruptcy filing. For example, if you operate your business out of your home, you may be able to include missed rent payments.

Another way Chapter 13 bankruptcy helps sole proprietors is by keeping them in business. You may be able to stay operational as you work down your debt and get out of bankruptcy over time. 

Using the home-based business again, it is much harder to liquidate assets as these sole proprietors would have to sell their houses and their cars to pay off debt, leaving them homeless and otherwise unable to work. 

However, the combination of your personal and professional finances in Chapter 13 bankruptcy may impact your credit score. Chapter 7 bankruptcy is recorded on your credit report for up to 10 years, while Chapter 13 is reported for up to 7 years.  

In some cases, bankruptcy is unavoidable. If you decide that you need to go this route, make sure you know your options. Be informed about the bankruptcy process and the steps you can take to make it go smoother. 

About the author

Derek Miller
Derek Miller
Derek Miller is a writer specializing in entrepreneurship, small business, and digital marketing. His work has featured in sites like Entrepreneur, GoDaddy, Score.org, and StartupCamp. He’s currently the CMO of Smack Apparel, the content guru at Great.com, and a marketing consultant for small businesses.

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