Accounting

What You Need to Know About Filing Bankruptcy for Your Small Business

Apr 17, 2020 • 5 min read
Going out of business sign hanging in window
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      Businesses fail for many reasons: there wasn’t enough demand in the market, consumer preferences changed, or maybe the business had too many inefficiencies. However, sometimes—as with the coronavirus pandemic—businesses fail because of inexplicable and uncontrollable factors.

      In the wake of COVID-19, many businesses are left contemplating whether to file for bankruptcy. In fact, the newly-revived XFL recently filed for Chapter 11 bankruptcy because of the economic hardships and uncertainties surrounding the coronavirus. 

      Whether it’s from mounting debt, poor management, or a global pandemic. If you’re thinking about bankruptcy, there are a lot of considerations. Keep reading to better understand the nuances of filing for bankruptcy and what it would mean for your personal and professional finances.  

      Understanding Business Bankruptcy

      If a business is floundering in debt and unable to pay its creditors. It can reach out for help through a bankruptcy filing. Depending on the type of bankruptcy. The courts will review your finances and help you create a plan to pay your creditors and eliminate the debt. Bankruptcy is a process that alerts your creditors that you are struggling financially but working to pay them back. 

      Declaring bankruptcy does not absolve you of your debts and financial obligations. It is not a “get out of debt free” card. Often, the assets of the company like delivery vehicles, mortgage equity, and equipment are sold (liquidated) and used to reduce the debt.

      Because you’re liquidating your business assets, bankruptcy typically means that your company will need to shut down.

      Different Types of Bankruptcy

      One of the first steps to filing bankruptcy is to determine the right path forward for your business. There are multiple options for bankruptcy filing that are made for different business sizes and types.

      These chapter options also depend on the future plans of your company.

      • Chapter 11: This option may seem like the most common, but that’s because it’s the typical bankruptcy route of large corporations. Compared to other bankruptcy options, Chapter 11 is the most expensive, risky, and complex, which means it’s not usually the right choice for small business owners. Chapter 11 allows a business to stay in operation, but it will pay less money each month toward its debts. This recourse requires a complicated (and expensive) legal process to reorganize the company, restructure the debt, and create a debt repayment plan. 
      • Chapter 7: With this option, you close your doors, liquidate your assets, and disperse the proceeds to your creditors. Chapter 7 is the most common bankruptcy option for most struggling small businesses. This recourse streamlines the closure process and adds transparency. Helping reduce the risk of creditors claiming fraud or trying to bring the company to court. Small business owners can file for Chapter 7 bankruptcy on behalf of their business or themselves personally. If you are a sole proprietor, both your personal and business debt will be resolved through this process. 
      • Chapter 13: This option is only available to individuals and sole proprietors, which disqualifies many small businesses. Chapter 13 bankruptcy is another way to reorganize both your personal and professional debt. Through this option, you get to keep your assets and pay off your debts through a repayment plan. This recourse allows you to continue running your company while reorganizing assets and repaying debt over time.   

      Before you can file for bankruptcy, you need to know which options you are eligible for and how you want to move your business forward. This means either liquidating and closing entirely through Chapter 7. Another options is restructuring and repaying your debt while continuing to operate through Chapter 11 or Chapter 13. 

      Take Steps to Prepare for Bankruptcy

      If you are considering filing for bankruptcy, you can take a few steps to prepare for it. These steps may also help reduce your debt and even eliminate your need to declare at all.

      • Review your current debt: Know the full amount that you owe and the parties to whom you’re indebted. If possible, pay off the smallest debts first or the debts with the highest interest rates to reduce the long-term impact. 
      • Contact creditors about lower interest rates: Reach out to your creditors and ask for extensions, grace periods, and lower interest rates. Creditors want to be paid back and are often willing to work with you to find a middle ground.
      • Cut back on what you don’t need: Sell equipment and other assets that you don’t need and look for ways to reduce expenses. This proactive approach will help you pay off at least some of your debt before you file for bankruptcy. It will also help you take an inventory before you liquidate. 

      After these steps, you may feel like your debt is more manageable—or you may have a clearer picture of how you want to declare bankruptcy and change your business.  

      Look for Other Options Before You Declare

      Bankruptcy should never be the first choice when your business is failing. Consider other ways to raise funds for your company or pay off your debts. 

      For example, a short term loan can offer a business up to $500,000 on a 3-year term. This financing option gives you more immediate flexibility and could help you consolidate your debt into one source (with a competitive interest rate). While keeping your business in operation. 

      You started your business to strike out on your own and follow your passion. Sometimes, that passion isn’t enough, and you’re left looking for a way out. If you’ve explored all your other options and have decided to file for bankruptcy, just make sure you know that means for you and your small business.

      Did you know your company’s tax preparation could feel as good as a day at the spa? With Lendio, it does.

       

       

      The information provided in this post does not, and is not intended to, constitute tax advice; instead, all information, content, and materials available in this post are for general informational purposes only. Readers of this post should contact their tax professional to obtain advice with respect to any particular tax matter.
      About the author
      Derek Miller

      Derek Miller is the CMO of Smack Apparel, the content guru at Great.com, the co-founder of Lofty Llama, and a marketing consultant for small businesses. He specializes in entrepreneurship, small business, and digital marketing, and his work has been featured in sites like Entrepreneur, GoDaddy, Score.org, and StartupCamp.

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