The Impact of Bankruptcy on Small Business Owners
Operating a small business is a rewarding endeavor. According to the U.S. Small Business Administration Office of Advocacy, small businesses made up 43.5% of the country's GDP and employed approximately 45.9% of American workers in 2024. However, despite being a driver for the U.S. economy, running a small business has significant financial risk.
For many small business owners, financial issues are a common hardship and frequently cause debt accumulation. If you run a small business and are dealing with overwhelming debt, filing for bankruptcy can provide a way to regain your financial footing. While bankruptcy can feel daunting, it can help provide a path forward.
Located in Hackensack, New Jersey, The Law Office of Marc G. Alster is experienced in helping small businesses resolve insurmountable debt and manage their financial obligations. Attorney Alster's goal is to help you understand whether bankruptcy is right for your business, and/or for you or your spouse individually, and how it would impact your future business operations and personal finances.
Reasons a Small Business May Need to File for Bankruptcy
There are countless reasons why a small business might face financial hardships. Unexpected events, such as a recession or a global pandemic, can reduce customer spending, disrupt supply chains, or cause other disruptions that can significantly impact your business's revenue streams.
You may also experience mounting debt, especially if you took out loans to finance the initial startup, expansions, or expensive equipment purchases. Unfortunately, if your business income can't match its expenses, these debts can quickly become unmanageable, causing cash flow problems that make it difficult to cover your day-to-day operating expenses.
Legal challenges or lawsuits can also lead to financial distress. A breach of contract, an employee dispute, or a product liability claim can result in expensive legal fees or settlements. Additionally, poor business planning or failure to adapt to changing market conditions may drive your small business toward insolvency, prompting you to consider bankruptcy as a potential relief option.
Bankruptcy Options for Small Businesses
If your small business is facing financial distress or insolvency, there are several bankruptcy options available under the U.S. Bankruptcy Code. The most common options for businesses include Chapter 7 and Chapter 11 which can provide temporary relief and/or help restructure your business's debts to keep it operating. While a business cannot file for Chapter 13 protection (which is much less expensive and easier than a Chapter 11 filing), a business which operates as a sole proprietorship can also file a chapter 13 bankruptcy protection, since there is no existing, separate business entity beyond the individual.
Chapter 7 Bankruptcy
Chapter 7, also known as liquidation bankruptcy, is a common option for small businesses seeking to cease operations and discharge debt. This type of bankruptcy involves the selling of the business's material assets, if the sale would provide a meaningful recovery to the business's unsecured creditors.
Chapter 7 bankruptcy allows for a fresh start. Once the process is completed, your business will no longer be responsible for any discharged debts. However, it is important to note that certain types of debts, such as many taxes cannot be discharged through a Chapter 7 bankruptcy.
Chapter 11 Bankruptcy
Chapter 11 bankruptcy, known as a "reorganization bankruptcy," enables your business to reorganize its debts into a court-approved repayment plan and explore opportunities to maintain its daily operations.
For some small businesses, Chapter 11 can feel resource-intensive and costly. Under Subchapter V of the Small Business Reorganization Act (SBRA) of 2019, small businesses that file for Chapter 11 can undergo a process that is typically more streamlined, faster, and less expensive than traditional Chapter 11 bankruptcy filings.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is a common option for small business owners operating as sole proprietorships (not separate business entities) with a strong income stream who want to develop a manageable repayment plan to repay debt while continuing their business operations. This option consolidates your business's debts over three to five years, allowing you to retain control of your business while addressing your financial obligations.
The Impacts of Bankruptcy on Small Businesses
While bankruptcy is a useful tool for handling overwhelming debt, it will strongly impact your business in one way or another. Often, there are ways to recover from these impacts, but it's important to understand the risks before deciding whether to file.
Severe credit damage: Bankruptcy can lower your business's credit rating/score, which may affect your ability to secure financing in the future, and may even cause your interest rates on current debts to increase. Generally, a Chapter 7 and Chapter 11 bankruptcy filing will stay on your business and/or personal credit reports for ten years, while a Chapter 13 filing will remain on credit reports for seven years.
Loss of financing/purchasing power: Bankruptcy will severely impact your business's financing options and limit your ability to borrow money in the future. Depending on your type of business, some clients or suppliers may require cash-on-delivery for goods or services.
Asset loss: In some cases, your bankruptcy Trustee may face a sale or you may have to sell some or all of your business assets when filing for bankruptcy protection. This is especially true for Chapter 7, which involves liquidating your assets, which cannot be protected in business bankruptcies in order to pay back creditors.
Personal liability: If your business is a sole proprietorship or if you provided personal guarantees when doing business, your personal assets and finances will likely be affected by a bankruptcy filing. This is essential to consider before deciding to file and must be discussed with your bankruptcy attorney.
Impacts on your reputation and relationships: While bankruptcy is a useful tool, it can erode trust and reliability in your business. Bankruptcy filings are a matter of public record, and some suppliers, manufacturers, or customers may lose trust in your ability to uphold certain contracts or warranties.
Can a Small Business Survive Bankruptcy?
Whether your small business can survive bankruptcy depends largely on the type of bankruptcy you file, the state of your business is finances, and the viability of your business plan moving forward.
For Chapter 7, survival is typically not an option, since your company will generally be dissolved as part of the liquidation process. However, if your business files for Chapter 11 or Subchapter V bankruptcy protection, survival is possible if your business can adapt and make the necessary changes to ensure long-term stability.
While bankruptcy is often considered a last resort, it doesn’t have to mark the end of your business. If you are considering filing for bankruptcy as a small business owner, reach out to a qualified attorney who can provide clarity on the different bankruptcy chapters, help you understand the impacts, and establish a stronger foundation for the future.
Contact an Experienced Bankruptcy Attorney in New Jersey Today
If your small business is facing financial challenges or overwhelming debt, bankruptcy could be a viable tool to help you regain your financial footing. With a commitment to serving small business owners of all types, The Law Office of Marc G. Alster understands the challenges small businesses face and is committed to helping you explore your available options.
Located in Hackensack, New Jersey, Attorney Alster serves clients in both New York and New Jersey. Reach out today to schedule a consultation.