Bankruptcy for Small Business Owners | Detailed Overview
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Bankruptcy for Small Business Owners

Facing large amounts of debt caused by a failing business is overwhelming. If your small business is going under, you need to start looking at your options. You could end up losing your savings, vehicle, and home if your company falls too deep into debt. Bankruptcy for small business owners can protect you from losing everything you’ve worked for.

Reasons to file bankruptcy for small business

If your business is failing, you have a lot of tough decisions to make. You should consider whether or not to file bankruptcy. There are many reasons a small business owner might file bankruptcy.

Here are just a few causes of small business bankruptcy:

  • Poor market conditions
  • Lack of financing
  • Hasty decision-making
  • Cash flow issues
  • Lawsuits

Bankruptcy for small business owners can help you quickly close your company. You don’t have to deal with wrapping up every aspect of your business, such as selling inventory, getting rid of equipment, and collecting unpaid invoices.

In some cases, bankruptcy can help your business stay afloat if you want to continue operating. Filing bankruptcy can keep you in business while lessening your debt.

In 2015, there were 24,735 business bankruptcy filings and 819,760 non-business filings.

American Bankruptcy Institute

What happens when a company goes bankrupt

Declare bankruptcy by filing a bankruptcy petition with your local federal bankruptcy court. Once you send the petition, you receive an automatic stay. That means your creditors must stop trying to collect money from you.

You must also file bankruptcy schedules to file small business bankruptcy. The schedules list your assets and liabilities, income and expenses, and contracts and leases.

The U.S. Trustee Program assigns a local bankruptcy trustee to your case. The bankruptcy trustee oversees handling your assets and payments to your creditors.

The type of bankruptcy you file and your business structure affect what happens after filing. In some cases, your business debts are dismissed. Depending on the type of bankruptcy and structure you operate under, your personal assets could be at risk.

Types of bankruptcy for small business

There are two ways to deal with a failing business through bankruptcy: liquidation and reorganization. Some types of bankruptcy use liquidation while others use reorganization.


When a company can’t pay its debts, it might have to liquidate the business. During liquidation, the business closes and its assets are divided among creditors.

Chapter 7

Chapter 7 bankruptcy uses liquidation to handle a failing business. If you file Chapter 7, you must close the business and give up your assets. The assets you forfeit depend on your business structure.

Chapter 7 for sole proprietors

If you’re a sole proprietor declaring bankruptcy, consider filing under Chapter 7. This type of bankruptcy is cheaper and easier than others for sole proprietorships.

With Chapter 7, all qualifying business and personal debts are wiped out. You do not need to pay your qualifying debts. Usually, bankruptcy wipes out debts such as credit card debts, loans, back rent, utility bills, and lawsuit judgments. Some debts cannot be eliminated, such as certain tax obligations.

Chapter 7 relieves you of most business and personal debts, but there is a downside. Sole proprietorships and their owners are not separate entities in the eyes of the law. You are personally responsible for all business debts. Your personal assets are at risk.

While some assets are exempt, items such as your equipment, vehicles, and mortgage could be seized and sold to pay debts. Your bankruptcy trustee will sell non-exempt property and give the money to your creditors.

Chapter 7 for partnerships and corporations

Partnerships and corporations can also file Chapter 7 bankruptcy. But, this type of bankruptcy works a little differently than it does for sole proprietorships.

If your business is failing, Chapter 7 can be a streamlined option for closing. Your bankruptcy trustee sells assets and evenly distributes the money to your creditors. Unlike sole proprietorships, partnerships and corporations cannot wipe out business debts with Chapter 7.

Partners of a partnership are considered the same legal entity as the business. Partners are responsible for business debt. The owners must pay the business’s remaining debt to creditors after the assets are sold.

Corporations protect shareholders from being personally liable for business debt. But, shareholders are not always in the clear when it comes to paying business debts.

Once the corporation files bankruptcy, it is fairly easy for creditors to initiate alter ego litigation. Alter ego litigation is a lawsuit that asks a court to make the shareholders pay the business debt. Since the corporation is already filing bankruptcy, creditors go into the lawsuit with a strong case.


Sometimes, there’s hope that a failing business can be saved. A business owner can extend the life of the company through reorganization. Reorganization involves the restatement of assets and liabilities. New arrangements are made to pay creditors and the business continues to operate.

Chapter 11

Chapter 11 bankruptcy uses reorganization to manage failing businesses. With Chapter 11, you continue to run your business under the bankruptcy terms.

Chapter 11 for sole proprietors

Chapter 11 allows you to file bankruptcy without closing your sole proprietorship. Your debts are reorganized so that you can make smaller payments to creditors. You need to have enough incoming cash each month to pay creditors under Chapter 11.

Usually, a sole proprietorship will not use Chapter 11 to file bankruptcy. File Chapter 11 if you want to continue to operate your business, don’t qualify for Chapter 7 bankruptcy, or want to keep property that would be taken under Chapter 7.

Chapter 11 for partnerships and corporations

As a partnership or corporation, Chapter 11 lets you run your business while paying small amounts on your debt.

Although you continue operating, Chapter 11 is more expensive than Chapter 7 bankruptcy. Small businesses tend to stay away from Chapter 11 because, on top of the cost, it is a risky, time consuming, and complicated process. Assess your business’s longevity and ability to pay back debt before filing Chapter 11.

Chapter 13

Chapter 13 is a reorganizing option for sole proprietors. Partnerships and corporations cannot file bankruptcy under Chapter 13.

Chapter 13 is similar to Chapter 11. You continue to run your business while paying creditors.

There are debt limits on Chapter 13. You cannot file Chapter 13 if you owe more than $394,725 in unsecured debt or more than $1,184,200 in secured debt.

Choosing the best bankruptcy option

Bankruptcy should be one of the last options for a failing business. Before filing bankruptcy, look at small business bankruptcy information about alternative options. For example, ask an adviser about how to finance a small business, improve your cash flow management, or sell the business.

If your business is going under, bankruptcy protects you from losing all your personal assets. Speak with a lawyer who specializes in business bankruptcy before filing

Chapter 7 Chapter 11 Chapter 13
Description Bankruptcy trustee sells assets and pays creditors, and the business closes Assets are protected from creditors while you make a plan to reorganize and get OK’d by bankruptcy court Sole proprietor’s income repays debt over specific, court-approved time period
Purpose To liquidate the business To reorganize and stay in business To form court-approved repayment plans for debts
Business Structures Sole proprietorship, partnership, LLC, corporation Sole proprietorship, partnership, corporation Sole proprietorship

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