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When Should a Small Business File for Bankruptcy?

Author

David Rodeck

More by David
Author

David Rodeck

More by David

Declaring bankruptcy may seem like giving up on your entrepreneurial dreams. But in some cases, it might be the only way to save your business and your career. Should your business file for bankruptcy? Let's take a look.

When Bankruptcy Makes Sense

Companies file for bankruptcy when they cannot pay their debts and do not believe that they'll be able to pay them in the near future. Bankruptcy is a court process that can forgive most of your debt (though there are exceptions), or restructure them so you can continue in business.

Whether you should consider bankruptcy often depends on whether your business problems can spill over into your personal life. How is your business structured? If it's a sole proprietorship or partnership, you can be held personally liable for business debts. This means that creditors can go after your personal assets for repayment. Filing for bankruptcy may be a way for you to protect your personal assets from your business debt.

According to Intuit, certain types of business structures, such as corporations and LLCs, offer limited liability. This means the owners generally aren't held liable for business debts. So, if you want to shut down your business, you could just walk away from your debts without filing for bankruptcy. That said, creditors can still come after you if you personally signed for business loans and other debts. In this case, declaring bankruptcy could be the right move.

Types of Bankruptcy

There are a few different ways to declare bankruptcy. If you declare Chapter 7, there is a process that potentially allows you to liquidate your business, and therefore discharge debt. You don't have to pay the outstanding debts, but creditors may be able to take whatever business assets you have left as payment, depending on the ajudication process. Until you go through the legal proceedings, it's difficult to accurately predict what the resolution will be.

Under Chapter 11 and Chapter 13, you have the opportunity to restructure your debts to help you keep your business running. You tell creditors you still want to repay them but they need to accept a plan with lower monthly payments. You keep your business assets and stay open.

Choosing Bankruptcy

Chapter 7 makes sense if you want to shut down your business. Generally speaking, it involves walking away and starting over again. All types of business structures can file for bankruptcy under Chapter 7.

Chapter 11 and Chapter 13 restructure your debts so you can continue operating with lower debt payments. These options could make sense if you feel as though you can pay off your debts with a little more time and after adjusting your business model.

Chapter 13 is only available for sole proprietorships, while other types of businesses can file Chapter 11. However, filing Chapter 11 can involve an expensive, lengthy court process, so it usually isn't worth it for small business owners, according to Intuit.

Protect Yourself

To help protect yourself from personal liability for the debts of your business, consider structuring your business as an LLC or corporation versus a sole proprietorship or partnership. This puts an extra layer of protection between your personal assets and your business. You should generally avoid personally signing for business debts whenever you can.

Finally, keep your personal and business assets separate. For example, do not use your personal bank account to pay business expenses, because creditors may be able to claim that the assets associated with that account are part of your business.

Hopefully, you can avoid filing for bankruptcy, but if you've determined that bankruptcy is the best choice for your business, choosing the right type of bankruptcy filing can be crucial when it comes to protecting the personal assets you've worked so hard for. These tips can help you assess the advantages and potential disadvantages of the various types of bankruptcy. However, when making such a critical decision, it is important to seek out the advice of your personal legal and financial advisers, who will be able to advise you on the best course of action for your specific circumstances.