Opening and running a small business is risky even under the best of circumstances. Nearly one out of two new companies close their doors for good within their first five years, and the COVID-19 pandemic has generated new hurdles for struggling enterprises.
According to an October 2020 survey conducted by Small Business for America’s Future (SBAF), 28% of small business owners have contemplated closing shop permanently because of COVID-19. An additional 19% are confronting potential bankruptcy due to the pandemic.
Bankruptcy is not always bad news. It can be an opportunity for company restructuring and to settle debts to get you back on your feet; however, it also comes with short- and long-term consequences.
If your business is one of the millions facing insolvency during these uncertain times, you should carefully consider what happens if your company goes bankrupt. Continue reading to learn more.
The effects felt by your company will depend largely on the type of bankruptcy you file. There are three distinct bankruptcy chapters in Title 11 of the federal code. Each chapter has a unique rule set regarding the business type eligible and the actions taken following the petition’s approval.
Chapter 7 bankruptcy is a pathway to liquidation for companies not intending to remain in business. For these businesses, restructuring is not a reasonable goal.
Entities most likely to choose Chapter 7 are those that:
- Lack assets.
- Are overwhelmed by debt.
- Are run as sole proprietorships. Although not as common, corporations and partnerships can also file for Chapter 7 bankruptcy.
Operations stop as soon as the court approves bankruptcy, and the process ends in dissolution and closing of the business.
The court appoints a trustee to take charge of assets to pay off creditors. When that is completed, business owners that run their companies as sole proprietorships are “discharged” from remaining debts. However, partnership and corporation owners may be liable for unpaid obligations. In other words, creditors could still come after personal assets to cover debts.
Yet not all Chapter 7 protection appeals are approved. For example, if the owner has gone through bankruptcy in the prior eight years or brings in too much personal or business income to pass the means test, the court will deny the request. (Means testing is a financial investigation to prevent companies with too much earnings from gaming the system, intentionally or not.)
Chapter 11 bankruptcy is a way for struggling companies to remain in business through debt reorganization. It can provide an opportunity for a fresh start though it’s a more complicated, lengthy, and expensive process than other bankruptcy options.
Companies most likely to file for Chapter 11:
- Are often larger corporations, but individuals and partnerships are also eligible.
- Have a steady income but heavy loads of debt.
- Possess assets they do not want to liquidate.
After filing, a business has four to 18 months to propose a reorganization plan explaining how it will run operations and how it expects to repay debts. During this time, creditors cannot pursue what they are owed from the company, and the business is often allowed to operate as usual.
The reorganization plan can include petitions to reduce the balance of secured debt to match the collateral asset’s current value or to negotiate more favorable interest rates and other terms from creditors.
Chapter 13 is a bankruptcy reorganization intended for individuals rather than businesses. Because of this, not every entity is eligible to file.
Companies that might petition for Chapter 13 bankruptcy:
- Are sole proprietorships — the business owner’s finances and business finances are linked, and the company is not a separate entity. Corporations and LLCs are not eligible.
- Plan to reorganize and hold onto assets rather than liquidate to pay off debt.
- Have low enough debt levels and high enough income to pay these debts back within three to five years.
Individuals filing for Chapter 13 must complete credit counseling before petitioning the court. The court will appoint a trustee to help create the reorganization plan, which, similar to a Chapter 11 plan, may include requests for debt modifications to make repayment more manageable.
Although bankruptcy can help your business stay afloat during tough times or provide relief from crushing debt, there are substantial negative ramifications as well. These include:
- Business downsizing — Your business may have to downsize, close down, or sell off assets to meet remaining debt obligations.
- Forfeiting personal assets — In some situations, you could also lose personal assets to satisfy business creditors.
- Injuring your reputation — The bankruptcy will be public information and could affect your reputation.
- Travel restrictions — During the bankruptcy process, you could have restrictions on where you can travel.
- Damaged credit — Your business credit will be damaged by the bankruptcy. If you gave a personal guarantee for outstanding business debts, your credit could also be affected. This can make it challenging to acquire financing in the future since bankruptcy stays on your credit report for seven to 10 years.
What Happens After Bankruptcy?
If your FICO score took a hit following previous bankruptcies, your financing options might be limited. Banks place a lot of weight on credit scores when reviewing loan applications. A bankruptcy can knock you out of the running for a business credit card or line of credit.
Revenued Is Here to Help if Your Company Goes Bankrupt
Bankruptcy is complex, and how it affects your assets, debts, and future will depend on your particular situation. Consult with a financial advisor for a detailed analysis of your case and reach out to Revenued today.
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