When and How Do You Know If Your Business Should File for Bankruptcy?



There are lots of reasons a small business might fail, and many are beyond the control of the owner. If your small business is failing, you’re certainly not alone. But what can (or should) you do about it? You have some options, and one of them is bankruptcy. However, that’s not always the best choice for you and your business. It depends on the circumstances you find yourself in, and what other choices you may be able to make where your business is concerned. With some careful consideration, you can make the right choice and decide if bankruptcy is the best option for your small business.

When Is it Time to File Bankruptcy?

The time to file for bankruptcy is when your business is failing and your personal assets are at risk. Whether those assets are at risk from creditors depends on the type of business structure you have. In a sole proprietorship, for example, you are the only one who owns the business, and you are liable for the mistakes and problems of that business.

Your personal assets could be at risk from creditors and judgements if the business were to fail. In that case, bankruptcy can help to protect you personally if your business goes under. You don’t want to lose everything that belongs to you just because your business didn’t work out, so bankruptcy can be the best choice in that scenario.

If you have an LLC (limited liability corporation), you probably don’t need to file bankruptcy. Your personal assets aren’t at risk, because the only liability is on the company itself. The assets of the owner or owners aren’t touchable, and creditors won’t be able to take them away from you if the business goes under. You can lock the doors and walk away, because there isn’t anything a creditor of the business can actually do to you in that case. The need to file bankruptcy wouldn’t be there, and doing so would actually be unnecessary.

Businesses close all the time, and many of them simply disappear. Of course, it’s best to settle debts and pay creditors when possible, but sometimes things go wrong. Speaking strictly in regards to filing for bankruptcy, an LLC would protect you from the need to do that, whereas a sole proprietorship would not.

Which Type of Bankruptcy Is Right for You?

Once you decide to file bankruptcy, the next decision is which type. There are several options, and each one is a little bit different. Chapter 7, 11, or 13 are the most common types of bankruptcy.

It’s unlikely that your small business will file a Chapter 11 bankruptcy, as this is generally for larger companies and corporations — especially those that are traded publicly. This type of bankruptcy is costly, and it takes a lot of time. Creditors won’t want to go through the process, and most likely neither will you. However, if you have regular income and a very high personal net worth, you may still want to consider Chapter 11. Most small business owners don’t fall under that category, so Chapter 7 or Chapter 13 will be much better choices.

In a Chapter 7 bankruptcy, everything gets liquidated and the business comes to an end. It’s the simplest type of bankruptcy, and it’s often used by individuals as well as businesses. The process is also far less costly and time-consuming than other types of bankruptcy, allowing you to liquidate the business and move on. It’s a hard hit to your credit, but it may be better than getting further behind with creditors because you can’t pay monthly bills or buy any inventory to continue your operations. A Chapter 7 bankruptcy is probably the most straightforward option, but your business will be gone and you won’t be able to continue to operate. High debt and very low (or no) income and asset value generally means a Chapter 7 filing is the best choice.

If you want to keep your business but you need help getting your finances straightened out, you may want to consider a Chapter 13 bankruptcy. In this type, you enter into a repayment plan with your creditors. Your business can continue to operate, but you’ll probably spend quite some time paying most of your profits out under the agreement you made in bankruptcy court. Still, if your business has just hit a very rough patch and you want to see it succeed in the future, Chapter 13 could be an option. Businesses with income and asset values that are high, and relatively low amounts of debt, can be good candidates for a Chapter 13 bankruptcy filing.

What Are the First Steps?

If you’ve decided that bankruptcy is going to be the right choice for you, it’s important that you handle the process properly. The very first step, no matter what type of bankruptcy you’re considering, is to consult with an attorney who routinely handles small business bankruptcy filings. Trying to do it yourself is not a good idea, and could lead to significant legal and financial problems. It’s much better to be safe instead of sorry, and to choose an attorney who can work with you to make the bankruptcy process as easy as possible.

Once you’ve met with your attorney, there will be forms or worksheets you’ll need to fill out, and documentation you’ll need to provide. That information will be used to complete the petition that will be given to the court, asking the judge to grant the particular chapter of bankruptcy that you and your attorney have chosen. There will also generally be schedules created by your attorney, to show how you plan to address any repayment or other factors surrounding your bankruptcy. Once the petition is filed, there is a “stay” granted, during which no creditors are allowed to try to collect from you. They must leave you alone, and wait for the bankruptcy proceeding. How that proceeding is handled and what you will do next will depend on your individual circumstances and the type of bankruptcy you’ve chosen.

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