In a typical year, more than 30,000 businesses file for some sort of bankruptcy protection. Regardless of the state of the economy, small business bankruptcies happen. Even in good times a business can make a crucial miscalculation that puts it in serious financial trouble.
Though your business may never face bankruptcy, you may be affected by a customer or supplier that goes under. Because small business bankruptcy can have an effect on associated businesses, every businessperson should be familiar with the ins and outs of bankruptcy.
Personal versus Small Business Bankruptcies Business bankruptcy should not be confused with personal bankruptcy. The results of each type of bankruptcy have different affects on the financial situation of persons involved, and those facing bankruptcy should note these differences. In a personal bankruptcy, most or all of the individual''s assets are at risk of being liquidated to satisfy debts. A corporation or limited liability company (LLC), on the other hand, only risks losing the assets owned by the business, not the personal assets of its shareholders or members. It is very common, however, for creditors to ask for personal guarantees from small business owners for things such as: agreeing to a leaseopening a credit accountproviding a startup business loan. In this case, the owners have given up their liability protections and placed their personal assets at risk to the degree stated in the agreement contract.
Business bankruptcy should not be confused with personal bankruptcy. The results of each type of bankruptcy have different affects on the financial situation of persons involved, and those facing bankruptcy should note these differences.
In a personal bankruptcy, most or all of the individual''s assets are at risk of being liquidated to satisfy debts. A corporation or limited liability company (LLC), on the other hand, only risks losing the assets owned by the business, not the personal assets of its shareholders or members.
It is very common, however, for creditors to ask for personal guarantees from small business owners for things such as:
In this case, the owners have given up their liability protections and placed their personal assets at risk to the degree stated in the agreement contract.
Under the bankruptcy code, most small businesses have two options for filing for bankruptcy. Chapter 7 is referred to as "liquidation," while Chapter 11 is referred to as "reorganization."
Chapter 7 is a complete liquidation of all business assets. The property liquidated is divided among the creditors according to law and the decision of the bankruptcy court. In this case, the company is forced to go out of business.
Chapter 11, however, was written into the bankruptcy code to enable a company to get its finances in order so that it can satisfy its debts without going out of business. This protects smaller creditors from larger ones who might rush to seize business assets and close the company, leaving nothing for the smaller creditor to collect.
During Chapter 11 reorganization, the company continues to operate so it can generate the income to eventually pay its debts. The court holds off the creditors and provides the small business with a U.S. Trustee and a creditor''s committee to monitor the company''s operations while a repayment plan is put into place. When the court accepts a repayment plan, the company is discharged from bankruptcy.
If, at any time during the Chapter 11 proceedings, the U.S. Trustee and the court decide that an acceptable repayment plan is not possible, the case can be involuntarily converted to a Chapter 7 case.
Small businesses may qualify for special treatment under Chapter 11. The court can apply this treatment if the business has less than $2,000,000 in debts and its creditors are not responsive or representative enough to form an effective creditor''s committee. In this case, the U.S. Trustee supervises the company more intensely. The case may be resolved more quickly because filing deadlines are shorter and extensions are harder to obtain.
Creditors are classified into groups according to how much risk they assumed when dealing with the small business on the brink of bankruptcy. Those whose contracts with the debtor provided more security are generally given a higher priority for repayment.
To allow the company to reorganize or liquidate effectively, those who become creditors after the bankruptcy filing have the highest priority.
Secured creditors whose contracts include collateral pledged for the repayment of loans or credit are the second priority group. They generally have the first right to collect the collateral.
Any remaining balance due to creditors may be lumped into the lowest priority group of unsecured creditors. Unsecured creditors (typically suppliers, landlords and service providers) have taken the most risk and stand to be paid the smallest proportion of the debts they''re owed, often cents on the dollar, if anything.
ABC-Amega (2007). Quarterly U.S. Bankruptcy Filings. Retrieved April 5, 2008, from the Credit-to-Cash Adviser Web site: http://www.clevelandclinic.org/health/health-info/docs/1600/1678.asp?index=6957.
Miehe, Shannon (n.d.). When You Can''t Pay Your Business Debts: Personal Liability and Bankruptcy Options. Retrieved April 5, 2008, from the Yahoo! Small Business Web site: http://www.mda.org/publications/Quest/q64mito.html.
United States Federal Judiciary (n.d.). The Process. Retrieved April 5, 2008, from the USCourts.gov Web site: http://www.umdf.org/site/c.dnJEKLNqFoG/b.3042179/.