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Declaring bankruptcy is not an easy decision to make. It is the solution business owners turn to after going through all the other options. Business owners realize they need to make a major move to pay off outstanding debt and close or reorganize their companies.
In this guide you will learn more about how the process of filing for bankruptcy works, the types of bankruptcies, and what to expect when you enter bankruptcy for your business.
What is Business Bankruptcy?
Bankruptcy is a legal proceeding for businesses (and individuals) to cancel debts and provide creditors a method to receive payment from a business that is struggling. Business owners try to avoid bankruptcy because it often means the company’s end and results in a black mark on the company’s (and owner’s) credit report.
A business should file bankruptcy when the amount of debt you have is too overwhelming and you know you need legal help to erase your debt problem. After coming up with different options of what you can do to save your business and you still think it is time to call it quits, you can choose the following types of bankruptcies.
Types of Bankruptcies
There are three types of bankruptcy, which are also known as “chapters” for small businesses.
Chapter 7 Bankruptcy: Liquidation
Chapter 7 bankruptcy is a liquidation option for individuals and businesses. It means that you cannot continue operating your company and you must liquidate your business’s assets to pay off your debts.
If you are a sole proprietor, the business’ liabilities and assets are not legally separate from the business owner’s personal assets. Sole proprietorships file for personal bankruptcy under chapter 7. Bankruptcy exemptions vary by state, and some let you keep essentials such as your home, car, or professional equipment. Some exemptions protect the entire value of the asset, while others just protect a portion of the asset’s value. However, most business property is not exempt, and you will likely lose it to liquidation.
Chapter 7 takes four to six months and once your proceedings have been approved you will receive a bankruptcy discharge meaning that you are no longer responsible for the debt.
Chapter 13 Bankruptcy: Reorganization
Chapter 13 is another option for sole proprietors. It is used by individuals and not business owners, very small businesses, or sole proprietor with just a few creditors can use chapter 13 too. Chapter 13 allows sole proprietors to reorganize their debts and keep their business operating.
Under Chapter 13, the trustee can access the sole proprietor’s personal and business assets and debts, and personal and business property may be used to pay back the debt. If you choose to file for Chapter 13, you must submit a reorganization plan to the court to show how you intend to pay back the debt—usually for three to five years.
Chapter 11 Bankruptcy: Reorganization
Chapter 11 is for any entity, LLC, corporation, sole proprietor, or partnership that wants to run their business while reorganizing its debt. Businesses that are struggling follow this course when the situation is not hopeless, and they continue operating with assistance from the bankruptcy court.
When the company shuts down and the trustee controls the business’ assets and debts in chapter 7, chapter 11 is where the business owner maintains the control and makes decisions for the company as long as the court agrees. The goal is to pay off the debts in a specified time from and then emerge from bankruptcy as a debt-free operational organization.
In order to qualify for chapter 11, your business needs to still generate income. With chapter 13, you must submit a reorganization plan to the court to show how you intend to pay back the debt. The court and your creditors need to review and approve your plan.
The Bottom Line
Although bankruptcy stays on your credit report for a few years, building back good credit can start right after discharge. Pay your bills on time and consider autopay. Also, be sure to check your credit reports regularly for any mistakes and contact them so that they can make changes if needed.
