Business Bankruptcy: Keeping Your Small Business

Entrepreneurs start new small business every day with the ideal in mind that they will be wildly successful.  Unfortunately, the truth of the matter is that most new businesses fail within a relatively short period of time.  Most business men will work very hard for success, but at some point find that they have accumulated more debt than revenue and eventually face the fact that they may need to file for small business bankruptcy. 

Business Bankruptcy Defined

Small business ventures fail financially for all sorts of reasons, finding themselves facing the decision to file bankruptcy or not.  Business bankruptcy is a process that the federal courts have available to business owners that is designed to help them and their business by either eliminating all their debt or restructuring  the debt while under the protection of a bankruptcy court.  In general, small business bankruptcies are either liquidations or reorganizations depending upon the type of bankruptcy the owner decides to go with. 

Depending upon the form you business takes, there are three potential types of bankruptcy that a business might file for. 

• Sole proprietorships are really simply legal extensions of the owner himself.  Therefore, the owner is responsible for the assets and the liabilities of the business. Generally, sole proprietorships have the right to file for Chapter 7, Chapter 11, or Chapter 13. 

• Corporations and partnerships are legal business entities apart from the owner.  As such, these business types can file for bankruptcy under either Chapter 7 or Chapter 11.

Chapter 7

If the business has no future, Chapter 7 Bankruptcy may be the best option.  In this case, the business will be liquidated, particularly if the business debts are so overwhelming that there is no reasonable way to restructure them.  If the business simply doesn't have any substantial assets, Chapter 7 may make a great deal of sense.  As long as the business itself is really just an extension of the owner and his skills, it doesn't make much sense to reorganize.  Chapter 7 is usually the best option, although it generally means that the business is over.

With Chapter 7 Bankruptcy, a trustee of the court is appointed to take possession of the business assets and liquidate them, distributing the money raised among the creditors.  Once this is complete and the trustee is paid, the business owner receives a discharge.  This means that the owner is released from any obligation to pay on these debts.  By contrast, Partnerships and corporations do not receive a discharge.

Chapter 11

If the business has a future, then Chapter 11 may look like a more attractive option.  Under Chapter 11, a plan that reorganizes the company financially, allowing the business to continue under this new structure.  The reorganization is completed by a court-appointed trustee.  It is possible for the company owner to be the trustee.  In this case, the company files a reorganization plan describing how it will deal with its creditors.  The creditors are allowed to vote on the plan.  If the court agrees that the plan is both fair and equitable to all parties involved, they will approve it.  Reorganization plans provide creditors with payments that can stretch out as long as 20 years, or longer.  Chapter 11 Bankruptcies can be very complex, and quite often fail. 

Chapter 13

In general, Chapter 13 Bankruptcy is a reorganization tool reserved for consumers; however, it can also be used in the case of sole proprietorships.  In this case, the owner files a repayment plan with the court explaining in detail how he is going to repay his debts. The amount the owner is able to repay depends upon the amount he earns, the amount he owes and the amount of property he has.  When personal assets are mixed with business assets, which is quite common with sole proprietorships, the debtor is given an opportunity to avoid losing his house if he files under Chapter 13, as opposed to Chapter 7.

How to Avoid Business Bankruptcy

Depending upon how dire your financial situation is, these ideas will help keep your business out of bankruptcy court with varying degrees of effectiveness.   

• Cut Expenses -  If your business isn't bringing in enough revenue to pay the bills you need to slow the cash flow.  The first step in doing this is to cut your expenses as much as feasible.  Develop a temporary short-term cash flow analysis.  Use it to decide which bills you have to pay immediately (taxes and overhead for example) and pay those.  Attempt to negotiate the other expenses with your creditors and suppliers.  They may be able and willing to extend the terms of your agreement until your financial situation is overcome.  There is a strong likelihood that they would rather work with you and eventually get paid than end up losing out completely in bankruptcy court.
• Bank Accounts - If you borrow from the same bank in which you keep your account, the bank may be able to raid your account in order to pay the bill.  Use more than one back when managing your financial affairs.  This is a typical business practice.  You may want to open two different business accounts, including an account at the bank in which you have taken out loans; the bank may insist on this so that it serves as a compensating balance.  Keep all your other money, other than what is necessary for the compensating balance, at your other bank.
• Pay Payroll Taxes - Payroll taxes are not discharged when you go through bankruptcy.  It is important that you pay these taxes on time and in full.  The IRS can hold you personally responsible for the amount you are supposed to take out of your employee's paychecks, and they have no problem assessing penalties on unpaid payroll taxes.  Be sure and pay these if you do nothing else.
• Don't Hide Assets - Remember that the purpose of bankruptcy court is to protect some of your assets from creditors.  Some business owners think that by going into bankruptcy they will lose assets and try to hide (particularly personal assets) them with family members or trusted friends.  It is very important that you not do this.  They'll be found if you go to bankruptcy court and when they are you will be accused and convicted of fraud.
• Full Disclosure - If you borrow money in an attempt to consolidate your debts or for any other reason, be sure to fully disclose your financial situation to your lending institution. Failure to do so could also lead to accusations of fraud.

Consult with an Attorney

Your best bet is to always consult with legal counsel.  If you business is facing a potential bankruptcy, a competent attorney will have ideas that might allow you to save your business.