The last three years saw nearly one-third of small business operations – defined as a company with 100 employees or less – close their doors permanently. While these were extraordinary circumstances, the fact remains that running a small business is challenging, and economic factors can influence cash flow and lead to a financial crisis. Most experts agree that other options should be considered before a small business resorts to bankruptcy, such as improving cash flow management, obtaining new financing, or selling the business. If none of these strategies work, a business bankruptcy might be the best option to avoid losing everything the owner has worked for.
What is small business bankruptcy?
A small business may find itself in financial trouble for various reasons, including poor market conditions, lack of financing, cash flow issues, data breaches, network downtime, or lawsuits.
Through bankruptcy, a company may see its debts eliminated, or the court may put them on a repayment plan. Both individuals and businesses are eligible to file for bankruptcy, and in the case of a sole proprietorship, the business owner may choose which option is right for them.
There are two primary reasons that small business owners may choose to file bankruptcy:
Bankruptcy allows quick closure: Business owners can avoid the normal activities of closing a business, such as liquidating equipment and collecting open accounts receivables.
Keep the business up and running: If you want to continue operating, filing bankruptcy can keep you in business while lessening your debt.
How does the small business bankruptcy process work?
Federal courts have jurisdiction over bankruptcies. To start the bankruptcy process, a business will file a petition with the local federal court, triggering an automatic stay that prevents creditors from collection activities.
The type of bankruptcy and the business structure determines what takes place after the initial filing. In some cases, business debts are eliminated, but the owner’s personal assets may be at risk in other cases.
Three main filing options are available for businesses: Chapter 7, Chapter 11, and Chapter 13. The first option is a liquidation process, and the last two include reorganization.
Liquidation: The business closes, and the trustee distributes assets among creditors.
Reorganization: The company continues to operate, and the court authorizes payment plans to reimburse creditors.
Who can file each type of bankruptcy?
Chapter 7 bankruptcy can be filed by individuals and businesses, including the following types of business structures:
Limited liability companies (LLCs)
Chapter 11 bankruptcy can be filed by individuals and businesses, including the following types of business structures:
Limited liability companies (LLCs)
To qualify for Chapter 11, businesses must have enough incoming cash each month to make the new payments.
Chapter 13 is available only to individuals and sole proprietors and wipes out personal liability for business debts—not the business debt itself. Partnerships, corporations, or LLCs cannot file Chapter 13.
Expert Tip: Sole proprietors often file under Chapter 7, as it is less complicated and less costly than other options. If you run a sole proprietorship and are considering bankruptcy, be sure to consult with a local bankruptcy attorney regarding your situation and options.
Richard V. Ellis is an experienced bankruptcy attorney with offices based in Sarasota and Bradenton. He and his team have helped hundreds of individuals navigate the complex process of bankruptcy and regain financial footing. Contact us today at (941) 841-1210 for more information.