What Are the Pros and Cons of Filing Bankruptcy?


Declaring bankruptcy as a business owner can feel like giving up. But in brutal economic conditions, filing bankruptcy can give you a fresh start and might even be a way to save your business. With that said, there are also some considerable financial downsides. This guide looks at the pros and cons of filing bankruptcy, along with your options for doing so.

Signs You’re Heading Toward Bankruptcy

Before a business falls into bankruptcy, there are a few common warning signs of serious trouble on the horizon.

Sales Are Dwindling – Pay close attention to your weekly revenue and cash flow. You can still react to a drop in sales if you catch problems early enough. For example, you may be able to pivot by revamping your business plan, cutting costs, and adjusting your marketing strategy.

Clients Stop Paying Their Invoices – During an economic downturn, companies can struggle to pay their bills. If you’re worried about your finances, consider tightening credit to your clients, meaning you ask for more upfront or shorten the length of time they have to pay.

Your Cash Position Is Falling – Cash flow goes through cycles. Your bank balance may dip because you’re investing in equipment or inventory, or maybe you’re going through your slow season. But if your cash flow is falling unexpectedly, that could be a sign of looming trouble, including possible bankruptcy.

You Struggle to Pay Your Bills – While missing the occasional payment deadline happens from time to time, it’s not a sustainable practice to consistently pay your rent, payroll, utilities, and suppliers late. Vendors will stop giving you credit, charge penalties, and could even cancel future orders. You may risk eviction from your location, and employees may grow wary and quit.

You Maxed Out Your Borrowing Limits – If you’ve maxed out your credit cards and can no longer qualify for loans, you may feel like you’re running out of financial breathing room. Once you spend down your cash, then you may have no choice but to declare bankruptcy — but make sure this is actually the case. Alternative lenders may still be willing to give your business an emergency cash flow loan, even if traditional lenders have turned you down.

You Can’t Pay Yourself a Salary – You’re putting in all this hard work to build a better life for yourself. If things have gotten to the point where you can no longer make a salary, it might be a sign it’s time to rethink whether your business still makes sense.

Ways to File Bankruptcy

If it looks like your business may need to file bankruptcy, you have a few options depending on the size of your company and your goals.

Chapter 7 Bankruptcy

When you file Chapter 7, you’re saying that you can’t pay your business debts and need to walk away. You file with the courts and they appoint an independent trustee to review your situation. The trustee will record and sell your remaining business assets, then use the proceeds to pay off your creditors as much as possible.

Chapter 7 makes sense when you want to wind down the business and shut it down. It can also be a good option If you’re running a service-based business with little to no equipment. Even if the creditors take your assets, you can still keep doing your job and reopen.

But if your business needs the equipment to operate and you want to stay open, other forms of bankruptcy may be a better fit.

Chapter 11 Bankruptcy

If you think you could turn the business around if you got some relief on debt payments, you could file for Chapter 11, a less severe form of bankruptcy. Rather than walking away from your debts and selling off your assets, you instead use the bankruptcy system to create a restructured debt payment plan. What are the advantages of filing bankruptcy this way?

First, the new repayment plan could reduce your outstanding debts, modify the payment terms, and restructure everything so you can cover the bills under your current income. On top of debt relief, you also keep your business assets so you can stay open.

Chapter 13 Bankruptcy

If you are the only owner of your small business and operating as a sole proprietorship, you could also file for Chapter 13 bankruptcy. It’s a quicker, less expensive and less complicated version of filing Chapter 11. However, it’s only available for a sole proprietorship. Partnerships, LLCs, and corporations need to file Chapter 11 instead.

In addition, you can only file Chapter 13 if your business has less than $394,725 in unsecured loans like credit cards and less than $1,184,200 in secured debt like mortgages and auto loans, according to Debt.org. This type of bankruptcy is meant for smaller cases.

By filing bankruptcy under chapter 11, a business owner still keeps his equipment.

Advantages and Disadvantages of Filing Bankruptcy

What are the advantages of filing bankruptcy and what are the disadvantages? Filing bankruptcy can buy you some breathing room — but there are also some serious downsides that could last for years.

Advantages of Filing Bankruptcy

Relief From Creditors and Debt – If creditors are hounding you with phone calls and letters to demand payment, your filing for bankruptcy will force them to stop. Filing bankruptcy either discharges your debts or restructures them into a new payment plan that’s easier to cover. Either method can help you achieve a more manageable financial position.

Protection for Your Personal Assets – Bankruptcy laws shield some of your personal assets, like your retirement savings and personal residence. That way, creditors are limited to what they can take as you settle your case.

A Chance to Start Over – Filing bankruptcy can give you a second chance. With restructuring, you can keep running your business but on better credit terms. On the other hand, with Chapter 7, you can wind down a company that just isn’t working anymore so you can move onto something else.

Disadvantages of Filing Bankruptcy

Damage to Your Credit Score – When you declare bankruptcy, your credit score takes a serious hit and can fall by over 200 points. In addition, the bankruptcy shows up on your credit report for between 7 to 10 years. While there are bad credit small business loans, it’s still much easier to borrow when you have a strong credit score.

The damage to your credit score can make it significantly more difficult to take out a credit card, a mortgage or any other type of loan in the future, both for your business and yourself.

Can Be a Lengthy, Expensive Process – It takes several months to complete the Chapter 7 court process and possibly even longer for Chapter 11 and 13. You’re going to be spending time in court, negotiating with creditors and coming up with a plan. You also need to pay for court costs and an attorney, which can add up to thousands of dollars.

Broken Vendor Relationships – Your vendors are also fighting to keep their businesses alive. When you declare bankruptcy, they end up taking a serious loss themselves. Consider reaching out to vendors you have a good relationship with. They may be willing to settle for a smaller amount now so they don’t have to wait on the bankruptcy filing. By extending this courtesy, you make it more likely the vendor will work with you again.

Forfeited Business Assets – When you file Chapter 7, the courts take and sell your business assets to repay your creditors. If your business needs the equipment to operate, this could force you to close. In addition, if you personally secured any of the business debts, the creditors could try coming after your personal assets, unless you also declare bankruptcy as an individual along with your business.

Ultimately, filing bankruptcy is an extreme step with many consequences. But in the right situation, it can save your business and your financial future. Before making any decisions, consult with a lawyer who specializes in this area so you can properly discuss the pros and cons of filing bankruptcy.

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