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What Happens If Your Small Business Faces Bankruptcy?

Roughly 20% of small businesses fail by the end of their first year, half are done by the end of their fifth year and only about 35% of these companies remain after a decade.

The point of these sobering statistics? Small business bankruptcy, while a worst-case scenario, is also a realistic one that may spring up. And if it does, no amount of avoiding the uncomfortable subject will make it go away.

So, we’re going to talk to you about small business bankruptcy, and why it’s in your best interest not to duck your head into the sand if the situation ever arises.

What Is Bankruptcy?

It’s important to understand the most basic principles of bankruptcy before figuring out how to alleviate it.

Some people confuse being bankrupt with being broke – but they’re not quite the same thing. A person or a business entity that is “broke” has completely run out of money. It’s not a good situation to be in, but even then, you at least have the option of say, putting money on a credit card, taking out a loan or otherwise tapping the debt markets to make necessary purchases.

But bankruptcy is worse. Bankruptcy is a legal process you undergo when you are so deeply indebted that you likely can’t pay it all off, and thus need some sort of assistance. Typically, the debtor will need to give up some assets in exchange for some of the debt essentially being wiped clean. As far as businesses go, there are a few types of bankruptcy filings that provide certain protections.

Types of Business Bankruptcy

Depending on the structure of your business, you’ll have a few bankruptcy options. These are the most common:

Chapter 11: If a business turnaround is a possibility, this type of bankruptcy filing makes the most sense. The business will be given a chance to reorganize and operate under a court-appointed trustee. Creditors must approve of the reorganization plan, which typically will include some sort of long-term repayment plan.

Chapter 7: This bankruptcy filing is intended for companies that don’t have a reasonable chance of continuing, in most cases because debts are so overwhelming that creditors don’t have a chance of recouping their money, even with a long-term repayment plan. In Chapter 7 bankruptcy, the business immediately ceases operating, and a court-appointed trustee takes control of assets and liquidates them to pay back creditors.

Chapter 13: Chapter 13 bankruptcy actually is a personal bankruptcy, but is applicable to businesses that are structured as sole proprietorship. Essentially, because a sole proprietor is responsible for both personal and business debt, his or her assets can be used to pay off the debt as part of a reorganization. In some cases, you’ll get to keep some property, and some loan balances may be reduced.

Other Considerations

Here are a few other things you should know if your small business is in the uncomfortable position of considering bankruptcy.

For one, filing for bankruptcy doesn’t automatically grant forgiveness of your federal tax debts. You can have some tax debt discharged if it meets a number of conditions (it must be income tax, the debt is at least three years old, you did not file a fraudulent return, etc.).

Moreover, business income tax filings must continue – though who does the filing depends on the type of bankruptcy filing.

Also, understand that bankruptcy is a very specific legal process that you can go through once you’ve exhausted all other options. But one option that some small businesses don’t even think to consider when debts stack too high is trying to work with creditors out of court. In some cases, you may be able to develop a repayment plan while keeping your business open – without ever having to officially file for bankruptcy.

But none of these options are paths you should walk alone. Bankruptcies are complex processes, and getting it right could mean an enormous difference in your business’ ability to emerge from bankruptcy, and in your ability to keep certain assets. So while money might be tight, consider the bigger picture and invest in professional bankruptcy and insolvency services. McManamon & Co. can help your small business with numerous services, including management consulting, solvency analyses, expert witness testimony. And we can work with everyone involved in the process – creditors, trustees, legal representation, shareholders and more.

The worst thing you can do when a financial crisis occurs is stick your head in the sand like an ostrich. The more you know, and the quicker you act, the better chance you have of coming out with minimal damage. Call 440.892.9088 or contact us online to find out how McManamon & Co. can help your business navigate these murky waters.

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