Whether you have personal liability for some of your business debts will influence your decision on whether to close your business, file for bankruptcy, or both.
If you personally signed for a business loan—that is, you signed on behalf of yourself and not the business—then you’ll be personally responsible for the loan. You’ve made a personal guarantee.
Your bank or lender might require a personal guarantee to assure that the loan can be repaid if your business doesn’t have enough collateral or assets, or a steady revenue stream. If your business can’t pay the loan, then the creditor can come after you personally.
For example, assume Samantha just opened her new boutique and applies for a loan under her LLC to help her with operating costs. Because Samantha has a new business and doesn’t have many assets or much revenue to show, the bank requires Samantha herself to personally guarantee the loan. Two years later, her business has hit a snag and she can’t make payments on the loan. The bank can come after Samantha directly for payment because she personally guaranteed the loan.
Even if you haven’t provided a personal guarantee, you could still be personally responsible for a business loan or debt. Your personal liability will depend on your business’s structure.
If you’re a sole proprietor, your business debt and personal debt are one and the same. Because legally you’re considered a single entity, you’ll be personally liable for your business’s debts, and creditors can come directly after you.
In a partnership, if your business can’t pay its debts, the partners will be liable for making up the difference with their own money. State law or a partnership agreement will lay out how much each partner is responsible for.
Creditors can come after any or all partners to collect on a debt, because the partners are considered jointly liable. If one partner ends up having to pay the creditor more than they should‘ve had to according to the partnership agreement or state law, then that partner would have to recoup the difference from the other partner or partners.
For example, suppose one partner pays a creditor a $10,000 debt but the partnership agreement says the partner is only responsible for 50% of the partnership debts.The partner that paid the debt could then recover $5,000—50% of the $10,000 debt—from the other partner.
As the name would suggest, LLCs offer their owners and managers limited personal liability. Unless the owners or managers commit some wrongdoing or don’t treat the LLC as a separate, distinct entity, the LLC alone is responsible for all business debts.
For instance, if the members of an LLC pay for business expenses with personal funds instead of business funds, then the LLC becomes less of a distinct entity and the members could be liable for the company’s debts.
Much like LLCs, corporations shield their officers, directors, and shareholders from liability. You’ll only be responsible for business debts in a corporation if the corporate veil is pierced. A corporate veil is pierced either when the court decides that the officers, directors, and shareholders and the corporation act like a single entity or when there’s been fraud or other misconduct. Piercing the corporate veil is common in smaller corporations because there’s more involvement by individuals in the corporation’s day-to-day activities.
For instance, suppose Kim, Arjun, and Leon are the sole shareholders of their corporation and also serve as the directors and officers. They regularly pay for rent and supplies with their own money and haven’t made bylaws or held annual meetings. Due to their actions and inactions, a court could rule that the corporate veil has been pierced.
If your business bank account is empty and you're in a lot of debt, you might be considering business or personal bankruptcy. Although it doesn’t guarantee that your business will survive, it can at least give you some breathing room.
There are three primary types of bankruptcy:
Any individual can file for Chapter 7, 11, or 13 bankruptcy for personal debts. However, because Chapter 11 is usually used to reorganize a business, individuals usually file under the other two chapters.
Chapter 7 and Chapter 11 bankruptcy are available to all businesses for business debts. Businesses can’t file under Chapter 13, unless they’re a sole proprietor.
Keep in mind that, if you're a corporate shareholder, LLC owner, or partner in a partnership and you've signed personal guarantees or pledged collateral for business loans, putting your business through bankruptcy won't protect your personal property.
If you're a sole proprietor, you can file for any type of bankruptcy. Any of the chapter bankruptcies can be used for personal or business debts because legally you and your sole proprietorship are the same entity and therefore have the same debts. But you might find that Chapters 7 and 13 are the most advantageous.
Ultimately, whether you file for personal or business bankruptcy and which chapter you choose involve a number of considerations. You might find that your business is ineligible to file for a particular type of bankruptcy or that it would be more beneficial if you filed for personal bankruptcy rather than business bankruptcy. (To help you with the considerations, we cover the three bankruptcy chapters in detail below.)
Bankruptcy can seem like a scary, doomsday alternative. But companies and individuals file for it every day.
There are some great advantages to filing for bankruptcy:
If you’re looking for a way to close one chapter and start anew—whether you’re a business or individual—Chapter 7 bankruptcy can help.
Both businesses and individuals can file for Chapter 7. It’s a useful option for businesses that are looking to close and pass off the burdensome task of liquidating the business. For individuals, Chapter 7 can discharge qualifying debt and offer a fresh start.
Any business can file for Chapter 7, but the business owner should understand that all of the business assets will be sold. So, Chapter 7 business bankruptcy won’t make sense for business owners unless they’re looking to close their business.
While any business can file for Chapter 7, not every individual qualifies. Individuals who have more personal (or “consumer”) debt than business debt must pass a means test to be eligible to file. (11 U.S.C. §707 (2022).)
The means test determines whether your income is low enough to qualify. If it is, then you can go forward with the Chapter 7 filing. If it isn’t, then you’ll have to consider other bankruptcy options.
In a Chapter 7 bankruptcy, a trustee is assigned by the court to sell your assets and pay your debts. The trustee will set aside any secured property and exempt assets you have and sell the remaining nonexempt property.
Your state defines what qualifies as exempt. Most states allow you to keep some equity in your home, which can end up saving it. Because Chapter 7 is meant to give you a fresh start, you’re usually allowed to keep the basics.
The trustee usually has two kinds of creditors to satisfy: secured and unsecured. Your trustee will satisfy secured creditors’ debts using the property that secured the loan, called the collateral or secured property.
To fully satisfy the secured creditors’ claims, the trustee will either:
The trustee will usually sell the secured property when it’s worth more than the debt owed. By selling the secured property, the trustee can pay back the secured creditor in full and have money left over to disburse to unsecured creditors. If the trustee returns the property to the creditor, then the debt is satisfied regardless of how much the property is worth.
For instance, if Hugo owes $2,000 on a secured loan and returns the secured property worth $1,000 to the creditor, then Hugo no longer owes the secured creditor any money. Even though the secured creditor will be reclaiming property that’s worth less than the loan, the bankruptcy court will consider the debt settled.
With the secured creditors satisfied and your assets sold, your trustee will pay your unsecured creditors next. The trustee will first pay priority unsecured creditors and then general unsecured creditors. Any qualifying debt will be discharged.
Types of common dischargeable debt include:
For example, imagine Steve has $2,000 in medical bills, $3,000 in student loans, and $2,000 left of a secured loan on a car worth $6,000. The trustee sells the car and uses the $6,000 to pay off the secured loan. The medical bills are discharged. So, the trustee uses $3,000 of the remaining $4,000 from the sale of the car to pay off the student loans, leaving Steve with $1,000.
If you’re a small business owner or corporate shareholder, you’re better off filing for personal Chapter 7 bankruptcy than business Chapter 7 bankruptcy to take advantage of debt discharge. Importantly, businesses can’t discharge their debt, which is a critical reason why most close after filing.
You’ll benefit most from Chapter 7 if you don’t have many assets. If you don’t have much property, then you don’t have much to lose. You can get rid of some debt and make financial recovery a little easier.
Chapter 7 bankruptcy is significantly different from Chapters 11 and 13 (which we cover below). Notably, debtors filing for Chapter 7 are looking to wipe their slates clean and to get rid of their debts immediately, while debtors in Chapter 11 and 13 are trying to address their debts over time so that they don’t have to start back from scratch. For more information, read about the other important differences between Chapters 7 and 11 and between Chapters 7 and 13.
The short answer is no. It will, however, clear most debt. But don’t expect to leave all debts behind.
You should be able to satisfy your debts with secured creditors by giving up any collateral you used to secure the loans. If you’ve decided to keep your collateral and the secured creditor agrees to let you do so, then your loan will survive bankruptcy. (You usually have to agree to continue making payments on the loan for the creditor to agree in this situation.) After your case is done, you’re still be responsible for paying back any secured loan when you keep the collateral.
For instance, assume Dana has $4,000 in medical bills and $1,500 in credit card debt. She has a $5,000 secured loan on her car, which is worth $3,000. Knowing that bankruptcy will wipe out her medical bills and credit card debt, Dana believes that she can now afford to make her car payments. The lender—realizing the loan is worth more than the car itself—agrees to let Dana keep her car if she keeps making payments. As promised, Dana continues making payments on her car after her bankruptcy case ends.
Most unsecured debt will be discharged in bankruptcy. If your debt is discharged, you won’t be liable for it after bankruptcy. But you’ll need to pay back any remaining unsecured debt that isn’t discharged in bankruptcy.
Common nondischargeable debt debt can include:
Again, business debt isn’t dischargeable. Businesses—and individuals who are sole proprietors or who have made personal guarantees—will still be liable for any business debts that remain at the end of their business bankruptcy case.
You can only discharge business debt if you’ve given a personal guarantee for the business loan or are a sole proprietor and you’ve filed for personal bankruptcy. When you file for personal bankruptcy, the court looks at your personal debts and determines which of these debts can be discharged.
As a sole proprietor, your business debt is considered your personal debt and the bankruptcy court would treat the two types of debt as the same. If you personally guaranteed a business loan—regardless of your business structure—then the personally guaranteed business loan would be considered a personal debt and potentially dischargeable in personal bankruptcy.
While Chapter 7 is used for businesses looking to dissolve, Chapter 11 is used for businesses that want to remain open. So if you’re a business owner who wants to stay in business, wants to file for bankruptcy, and doesn't want to file for personal bankruptcy, Chapter 11 is your best option.
Businesses and individuals can both file under Chapter 11 bankruptcy. However, because Chapter 11 is used as a reorganizing tool for businesses and Chapter 13 is available to both businesses and individuals, it’s more common for businesses to file under 11.
Individuals whose income is too high to qualify for Chapter 7 and whose debts are too high to qualify for Chapter 13 will need to file under Chapter 11.
Unlike in other bankruptcies, a trustee isn’t assigned in Chapter 11 bankruptcy. Instead, you remain in control of your business and assets.
You’ll work with your creditors and the court to come up with a repayment plan—known as a plan of reorganization—and the plan will usually cover a three- to five-year payment period. There aren’t many rules to follow, and as long as the creditors and court agree, you can craft your plan to fit your needs.
However, you’ll need to prove to your creditors and the court that you can afford your proposed plan before they’ll approve and confirm it. Make sure your plan is reasonable and attainable. Don’t promise to repay a debt in two years if you’ll likely need five.
You might decide to keep all of your assets or to sell some or all of them. Most businesses choose to keep their assets because they’re critical for business operations to continue.
Chapter 11 bankruptcy cases can take just a few months or a few years—depending on the complexity of the debts and reorganization plan—from the time you file to the time the court and creditors approve your reorganization plan. Some small businesses can qualify for a faster case (under Subchapter V), which can save you time and money. But this streamlined process requires more oversight and less flexibility.
The answer is complicated. When a court approves your reorganization plan, the debt is considered discharged because the plan replaces the debt, essentially removing it. But in the context of Chapter 11 bankruptcy, “discharged” doesn’t mean “dismissed.” You must still follow the proposed payment schedule laid out in your plan to satisfy your debts.
Under your plan, some debts might be paid in full, some paid partially, and some eliminated. Your plan can also change or delay due dates for payments and decrease the interest rates on loans. For example, you might be able to lower a 7%-interest bank loan to 5% interest and give yourself 60 days to make your next student loan payment rather than 30 days.
You can wipe out a debt in a Chapter 11 reorganization plan as long as:
(11 U.S.C. §707 (2022).)
If you’re a business, the court will typically dismiss all remaining debt once your plan is confirmed. If you’re an individual, the court will usually wipe out your remaining debt once it has determined you’ve completed your payments outlined in your plan.
Chapter 13 can be a good option for business owners and corporate shareholders to file for personal bankruptcy. If you can get rid of some personal debt, it may free up funds for you to finance your business. While business debts can’t be discharged, with Chapter 13, you can discharge any business loans you signed for as a personal guarantee.
Only individuals and sole proprietors can file under Chapter 13. Businesses can’t file under Chapter 13.
You’re eligible to file as long as your debts combined (secured and unsecured) are less than $2.75 million. (11 U.S.C. §109(e) (2022).)
Chapter 13 works similarly to Chapter 11, where you propose a repayment plan to last three to five years. You again need to prove that you can afford the repayment plan for it to be approved. As with Chapter 11, you get to keep your property.
Unlike in Chapter 11, a trustee is assigned to Chapter 13 bankruptcy cases. You make monthly payments to the trustee, and they’ll use that money to pay back your creditors.
You’ll likely only have to pay a small portion of unsecured debt under Chapter 13. Qualifying debts will be discharged, which could potentially include personally guaranteed business debts.
Your business debts won’t be discharged because you’re filing for Chapter 13 as an individual for personal debts. (And bankruptcy doesn’t usually discharge business debts anyway.) So you’ll need to come up with a plan to pay off those debts.
You can try negotiating with creditors to lower your business debt. But rest assured, your business creditors can’t come after you personally if you’ve already addressed their claims in your bankruptcy case.
But what happens if you can’t pay a personal debt under your payment plan—if, for instance, you’ve lost your job or are injured and temporarily unable to work? If you’re not able to make your payments and want to avoid your case getting dismissed, you have a few options:
For more information on handling business debt, see our section on small business bankruptcy. In the end, if you’re seriously considering bankruptcy, you should get in touch with a knowledgeable small business attorney with bankruptcy experience. They can help you choose the right bankruptcy filing and guide you through the process.
You can also consult a small business attorney about the option of trying to save your business by selling most or all of your business assets outside of bankruptcy to have more cash on hand for operating expenses. (With this approach, when everything else has failed, you might have to sell your business.)
You'll also learn why the most effective way to erase your responsibility to pay business debts is to file for Chapter 7 bankruptcy yourself. But keep in mind you could lose property in Chapter 7, making it essential to meet with a knowledgeable local bankruptcy lawyer.
In most cases, no, because unless the business is a sole proprietorship, a business can’t discharge debts in Chapter 7. The business will remain responsible for the obligation.
Learn about small businesses and bankruptcy.
Yes, many debts that might drive a business owner to consider filing for bankruptcy can be erased if the business owner files an individual Chapter 7 case. Because of this, it's common for business owners to wait until after the business closes to file a personal Chapter 7 than put the business itself in Chapter 7.
This approach is more beneficial because the owner can wipe out personal guarantees for business debt and the filer's personal debt. Also, a filer doesn't have to take the Chapter 7 means test to qualify for Chapter 7 if the filer's business debt is more than the filer's personal debt.
Find out more about what happens when you're personally responsible for business debts.
You can erase any business debt you're responsible for paying if the debt generally qualifies for a Chapter 7 discharge. For instance, The following is a list of debts anyone can wipe out in Chapter 7 bankruptcy:
It's important to notice you must return collateral to erase a "secured" loan. But in all likelihood, you'd need to do so if the Chapter 7 bankruptcy was part of a company winddown. You'll find more about using Chapter 7 to close a company below.
A creditor with a lien on collateral can take back the property securing the loan if you don't make your payments, even if you file for bankruptcy. Find out more about what happens to liens in Chapter 7 bankruptcy.
Some types of debt aren’t dischargeable in Chapter 7 bankruptcy regardless of whether the obligation is a personal or business debt. Some common types of nondischargeable debt include:
Learn more about using Chapter 7 bankruptcy for business debts in Chapter 7 for Small Business Owners: An Overview.
If the Chapter 7 trustee sells your property, it's likely the proceeds will be used to pay toward your nondischargeable debt, lowering the amount you'll owe after bankruptcy. The trustee must pay priority debts first, and most priority debts are nondischargeable, although student loans are a notable exception.
You can use Chapter 7 bankruptcy to wind down a business transparently, but better options usually exist. Not only does Chapter 7 bankruptcy hold special problems for partnerships, such as opening up the partners' personal assets to creditors, but filing Chapter 7 for a corporation or LLC might not be a good idea, either.
Not only does the business not receive a debt discharge, but the bankruptcy opens up a forum for creditors to easily address other potential grievances and attempt to make officers and others personally liable for business obligations.
Before moving forward with a business Chapter 7, consider retaining a bankruptcy attorney or business lawyer. A lawyer is in the best position to advise you about your options when dissolving the business.
Did you know Nolo has been making the law easy for over fifty years? It’s true—and we want to make sure you find what you need. Below you’ll find more articles explaining how bankruptcy works. And don’t forget that our bankruptcy homepage is the best place to start if you have other questions!
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We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.
]]>Can a creditor raid your personal bank account, garnish your wages, take your car, or foreclose on your house to recover debts incurred by your business? It depends on the nature of the debt, how your business is structured, and the state where you operate.
You are personally liable for your business debts under the following circumstances, which we cover below:
Business debts include loans, leases, trade credit (accounts payable), and judgments against you in lawsuits. If you are personally liable for a business debt, you are on the hook for it if your business fails to pay.
To determine whether your personal assets can be taken to pay your business debts, the first thing you’ll need to look at is your company’s structure.
The different types of business entities–sole proprietorships, limited liability companies (LLCs), partnerships, and corporations–define the legal relationship between the business owner and the business. The more your business entity type separates you, as the owner, from the business, the less likely it is that your personal assets can be used to pay for your company’s debts.
With a sole proprietorship, you and your business are legally the same, which is another way of saying that you personally owe every penny that your business can't pay. With a few exceptions—most states allow you to keep some portion of your assets in bankruptcy proceedings—a creditor can reach your personal assets to pay debts your business owes.
The same principle applies to general partnerships. The business debts belong to each partner personally with this added twist: Each partner is personally liable for 100% of the business's debts, not just the share that represents each partner’s ownership percentage.
If your partnership can’t pay its debts, and your partners refuse or claim poverty (but you have the wherewithal to cover the debt), a creditor can take your assets to pay off all the business debts. (If you pay the entire debt, you can always sue your partners for reimbursement.)
If your business is organized as a corporation or LLC, you and your business are separate legal entities. As a shareholder of a corporation or a member of an LLC, you aren’t personally liable if your business can’t pay its debts. In other words, you have LLC limited liability or corporate limited liability protection. You have this protection as long as:
Secured debt is a loan, line of credit, or purchase you finance by agreeing that your property or other personal assets can be used as payment if you default. When a business takes out a loan, the lender will typically require a personal guarantee from the owners if the business isn’t robust and financially secure. In this situation, the personal guarantee secures the loan.
A loan, line of credit, or purchase that’s made with no such condition is unsecured debt. This kind of debt isn’t secured by a personal guarantee or collateral (property that you’ve pledged in exchange for the loan). If a business debt is unsecured, the creditor is out of luck if the business defaults on the debt. For this reason, most business debt is secured by a pledge of collateral or a personal guarantee.
Credit cards are technically unsecured because you don’t have to pledge your property to get one. But as you’ll see below, your personal assets can be used to repay your business’s credit card debt.
If you’ve ever financed a car purchase at the dealership, you’ve taken on a secured loan. The loan agreement you signed gives you the ability to pay for the car in installments, and it gives the dealer the right to repossess the car if you fail to make the payments. In this case, the car is what’s called collateral. If you fail to make your payments, you can (and likely will) forfeit your car.
Debt can be secured by a pledge to give up the property you are purchasing if you don’t make payments, as in the car dealer example above, or it can be secured with property you already own. SBA lenders, for example, might require you to put up your house or other property as collateral to get a business loan. If your business defaults on the loan, the bank can sue you to foreclose on the property (some states allow lenders to skip the lawsuit) and use the proceeds of the sale to pay off the loan.
When you’re a small business owner, many creditors will require you to personally guarantee your business’s debts. Banks might require you to co-sign or personally guarantee a loan, and many leases require personal guarantees.
Landlords typically require the owner of a new business to personally guarantee the lease. For example, if you sign a three-year lease for offices for your business, and it includes a personal guarantee clause, you can be held personally liable for paying the rent for the duration of the lease term if your business closes. Personal guarantees are less likely when the business is established, has a good credit history, and has solid assets.
As signaled above, even owners of an LLC or corporation can’t rest easy if they use their business to buy items that have nothing to do with the business, in the hopes of saving their personal assets if they don’t make the payments. Creditors can reach this kind of owner’s personal assets, which is known as “piercing the corporate veil” (more examples below).
Here are some additional exceptions to limited liability faced by all business types.
If your business has employees, you are required to withhold taxes from your their paychecks and send those taxes to the state and IRS. If your business fails to follow the required procedures for paying withholding taxes, you, as the owner, are personally liable for the payment regardless of the type of business entity you have.
Each state sets its own rules for corporations and LLCs, including when it comes to liability exceptions. Some states are considered creditor-friendly and others are considered debtor-friendly because of the way their laws are written and interpreted by the courts.
For example, a court in Arizona found that members of an LLC in Arizona can be held personally liable if the company fails to pay privilege tax (a type of sales tax). State ex rel. Arizona Department of Revenue v. Tunberg, 464 P.3d 688 (Ariz. App. Div. 1 2022)
States can amend their rules through legislation and court rulings, so it’s important to keep abreast of changes.
Of course, your business can’t physically sign a contract or purchase agreement, and you, as the owner, must sign on behalf of the business. But you can jeopardize your limited liability if you enter a contract using only your name and fail to include your business name and your relationship to the business in the contract.
Let’s say you are the owner and CEO of Glam Footwear, an LLC that operates a small chain of shoe stores. You place a large purchase order for the fall season, and you neglect to carefully review the purchase agreement. The agreement starts with, “Purchase agreement between Jane Smith and Shoe Importers, Inc.” The contract should say that it is “between Glam Footwear, LLC and Shoe Importers, Inc.” You sign the agreement as “Jane Smith” instead of “Jane Smith, CEO of Glam Footwear, LLC.”
Now imagine that Glam Footwear’s business drops dramatically over the summer, and by the time the shoe shipment arrives, the company’s cash flow is depleted to the point it can’t pay for the fall merchandise shipment. The way you entered into and signed the purchase agreement could make you, Jane Smith, responsible for paying the invoice, even though your company structure gives you limited liability.
Creditors can hold you personally responsible for your business’s debts if your corporation or LLC doesn’t follow the rules established by your state for that business entity. Again, this situation is known as “piercing the corporate veil.” Some examples are:
When a creditor is able to show that any of these types of criminal activity, fraud, misrepresentation, or sloppy recordkeeping occurred, a court can decide that your business entity is really just a sham, meaning that you don’t have limited liability.
The other side of the coin is whether creditors can come after your business if you fail to pay your personal debts. In general, the same rules apply.
If you’re an owner of a corporation or LLC, you are a separate entity from the business, and the business isn’t responsible for your personal debts. But while creditors generally can’t take your business assets to pay your personal debts, they can take funds your business owes you. (Getting money that the LLC owes its member is called a “charging order,” in which the court orders the LLC to pay the creditor instead.) In a corporation, a creditor with a judgment against a shareholder could end up controlling the business, as you’ll see below.
For example, a creditor with a judgment against an LLC member can come after any distributions that would have been made to the member, but not the member’s share of ownership in the LLC. Most states will not order a forced sale to pay the debt.
]]>Whether there’s been an economic downturn or you’re ready for your next chapter, learn here about important considerations when deciding the fate of your business.
The decision to sell or hibernate your business lies in the outlook for potential profits and in your and your associates’ personal investment in the venture. If you’re ready to end your association with the business to enjoy retirement, start a new business, or rejoin the workforce, then selling your business could be the best option.
But if you don’t want to close the doors just yet and your sales have hit what looks like a temporary lag, there’s a less permanent solution. Hibernating a business can be a great alternative for people who:
For instance, suppose a gym opened in 2016 and experienced good profits before the pandemic hit but is having trouble getting customers to come back. The owner might want to hibernate the business until customers feel safe returning to the gym. In the meantime, the owner could close their physical location and switch to offering their own personal trainer services in the park.
We take you through the ins and outs of selling and hibernating a business below. As you read and think about whether to sell or hibernate, consider how your business’s structure factors in. For instance:
In a partnership or limited liability company, you’ll usually need every partner’s or member’s consent to sell the entire business.
Hibernating your business means that your business still legally exists, but its operations have either completely or mostly ended for the time being. You and your co-owners should strip your company to its bare bones. You should only have enough money coming in to cover the most basic expenses.
If you choose to hibernate your business, you’ll want to cut costs wherever you can to stay afloat. Focus on the expenses and operations that are absolutely necessary. For some businesses, that means limiting yourself to one or two clients or projects per year to help you break even.
As you start to cut expenses, you might realize that your business doesn’t need to fully hibernate to survive. Instead, maybe you can downsize and restructure your business to make more money. The key to downsizing a business is to categorize costs to find ways to save money.
Essential costs are any costs that are necessary to keep your business legal and operational. These costs include paying any fees to the Secretary of State’s office so your business can remain in good standing as well as any licensing or membership fees that are required by your industry.
If you have employees, payroll software is usually essential. The penalty for cutting corners on payroll software is a risk of liability—both criminal and civil. Struggling with your payroll duties can also cost you lots of time. It’s a big responsibility for most business owners to learn and maintain appropriate payroll services, but it’s also an essential one.
Nonessential costs are costs that aren’t necessary to your business. Often you can reimagine and reduce nonessential costs, or even cut them out completely, depending on your business functions. Business owners can often reduce or eliminate the following nonessential costs.
Rent
In many industries, employees can work from home instead of making the trip to the office every day. Alternatively, you can trade in your office building for a part-time or shared workspace to reduce rent. And, if you’re in retail, a physical storefront can be turned into a virtual one.
For example, a clothing store can switch to selling goods online through their own website or through a third-party like Amazon or Etsy. The shop owner will need to pay a small fee for the web hosting or product listings, but this fee will be a drastic reduction from their rent.
Staffing
Perhaps the most difficult choice and change to a business is reducing the roles of staff. There are two options to cut costs when it comes to staffing.
The more straightforward option is to reduce the number of staff. Weigh the costs and benefits to keeping each team member. For example, if your coffee shop has seen fewer customers throughout the week, it might make more sense to keep two baristas on staff rather than three.
The other option is to switch some employees from full time to part time or to take on an independent contractor (if the nature of the work allows you to) rather than continue with an employee. Part-time employees usually don’t require benefits, and independent contractors are often less expensive to hire.
Customer Relationship Management Software
If you’re hibernating your business, then cutting out customer relationship management (CRM) software makes sense. But if you’re downsizing, you’ll likely still benefit from keeping your CRM platform.
If you need it, keep this software, but to save money consider a free option or downgrade to a less expensive plan in your current subscription. When downsizing, you probably won’t need all of the higher-tier features, so revisit which features are most important. For example, you might not need a plan that offers unlimited data storage and advanced customization.
Accounting
You can reduce accounting costs in various ways. For instance, if your business uses an accountant year-round, you can save money by switching to accounting software and hiring an accountant during tax season to tie up loose ends.
If your business already uses accounting software, you might be able to find free accounting software or take advantage of accounting services that are built into your CRM platform.
Other Software
There are plenty of software tools that make managing your business more convenient. But when you’re trying to reduce costs, these software options might be the best ones to cut early, especially when free versions are available.
From time and project management to sales and marketing, take the time to compare pricing and research ways to make the free offerings work for your business.
If you decide to put your business into hibernation, you should take these steps:
1. Cut costs. Eliminate any expenses that aren’t essential to the legal operation of your business.
2. Plan for business staff. Since you’re hibernating your business, you’ll probably no longer need people to perform their usual duties. You might be forced to lay off some or all of your employees. Alternatively, you can furlough employees, which requires them to take some time off during the hibernation. By furloughing employees, you avoid layoffs. But make sure you’re not violating the Fair Labor Standards Act by furloughing an exempt employee.
3. Finish existing contracts. Factor in any responsibilities for existing contracts when timing your business’s hibernation. You can either continue these contracts or assign your responsibilities under the contract to another company, if the contract allows it.
4. Notify customers. Let your customers know that your business is taking a break but that you expect your business to return. For example, you can say that your business is closing temporarily but you hope to reopen next spring.
If you’ve decided against hibernation or downsizing and are ready to sell your business, then it’s time to start the winding down process. You’ll want to work with an attorney throughout the sale process to ensure the sale is successful and finalized. Here are some key steps to selling your business.
1. Determine your business’s value. Make sure you have your finances in order so you can clearly demonstrate your assets, liabilities, and profit projections. You can work with a valuation expert or self-evaluate your business to determine an appropriate listing price.
2. Broker the sale. Determine whether you want to use a broker to help you secure a buyer. A good broker can identify serious buyers, reach a favorable price and deal, and handle the legal and tax complexities associated with the sale. A broker’s fee is usually a percentage of the sale. You can also sell your company online. Selling your business online has one big advantage: You have access to a whole network of potential buyers that wouldn’t be available in the physical world.
Here are a few ways to sell your business online:
3. Prepare and sign the sales agreement. To officially sell your business, you’ll need to prepare and sign a sales agreement. The agreement should cover the purchase price and terms of payment. It should also address what’s included in the sale—for example, is all the kitchen equipment included in the sale of a restaurant? The agreement should further specify how the transfer of ownership will take place (gradual or outright), and what conditions each side must meet. Have an attorney draft or look over your sales agreement to protect your business interests.
4. Notify your employees. It’s usually best to tell employees right after the sale is finalized. During the transition period, you should answer their questions and introduce employees to the new owner, if possible.
5. Review existing contracts. Review any existing contracts to make sure the change in ownership won’t affect these agreements. In any case, you’ll want to inform the other party to any contract of the change in ownership—the contract might even require the notification.
6. Notify your customers. Once you finalize the sale, you should have a period to notify all past and existing customers of the sale. For example, you might send a notice through email or letter and post an announcement on your website or storefront. You can also post a notice in the newspaper or in your company newsletter. Give your customers a way to contact the new owners and update them on any changes they can expect from this ownership transfer. You may also need to notify your county or state of your intention to sell your business assets. For example, in California if you are selling inventory of a retail, wholesale, or manufacturing business (in a “bulk sale”), you’ll need to record the notice with the county recorder, publish a notice of the sale in the local newspaper, and notify the county tax collector 12 days before the sale.
7. Figure out taxes on the sale. You’ll need to determine how much you owe in taxes from the sale. You can ask a CPA to help you figure out how much you owe and what forms you need to file. You’ll probably need to complete IRS Form 8594, Asset Acquisition Statement and file it with your final tax return.
The requirements to hibernate or sell your business can also vary from state to state, so be sure to check your state statutes and revenue and tax codes—or lean on your lawyer for the relevant information. You should also look back at your bylaws or operating agreement, if you have one, for any instructions on selling your business.
Selling or hibernating your business is a big decision. Although the information in this article should help, if you’re seriously considering selling your business, it’s a good idea to consult an attorney on whether it’s time to sell and for help closing the deal.
]]>In these tough economic times, many small business owners are scrambling to keep their companies afloat or are closing down. If a corporation or LLC ends up having to shut its doors, the last thing a small business owner wants is to have to pay the business's debts. But when cash is tight and owners aren't careful, if an unpaid creditor sues for payment a court might "pierce the corporate veil" (lift the corporation or LLC's veil of limited liability) and hold the owners personally liable for their company's business debts.
Read on to learn the rules about piercing the corporate veil. (To learn about other ways you can become personally liable for corporate debt, see Nolo's article Are You Personally Liable for Your Business's Debts?)
Corporations and LLCs are legal entities, separate and distinct from the people who create and own them (these people are called corporate shareholders or LLC members). One of the principal advantages of forming a corporation or an LLC is that, because the corporation or LLC is considered a separate entity (unlike partnerships and sole proprietorships), the owners and managers have limited personal liability for the company's debts. This means that the people who own and run the corporation or LLC cannot usually be held personally responsible for the debts of the business. But, in certain situations, courts can ignore the limited liability status of a corporation or LLC and hold its officers, directors, and shareholders or members personally liable for its debts. When this happens, it is called piercing the corporate veil. Closely held corporations and small LLCs are most likely to get their veils pierced (corporations that are owned by one or just a few people are called closely held corporations, or close corporations for short).
If a court pierces a company's corporate veil, the owners, shareholders, or members of a corporation or LLC can be held personally liable for corporate debts. This means creditors can go after the owners' home, bank account, investments, and other assets to satisfy the corporate debt. But courts will impose personal liability only on those individuals who are responsible for the corporation or LLC's wrongful or fraudulent actions; they won't hold innocent parties personally liable for company debts.
Courts might pierce the corporate veil and impose personal liability on officers, directors, shareholders, or members when all of the following are true.
The most common factors that courts consider in determining whether to pierce the corporate veil are:
Some corporations and LLCs are especially vulnerable when these factors are considered, simply because of their size and business practices. Closely held companies are more susceptible to losing limited liability status than large, publicly traded corporations. There are several reasons for this.
Failure to follow corporate formalities. Small corporations are less likely than their larger counterparts to observe corporate formalities, which makes them more vulnerable to a piercing of their corporate veil. To avoid trouble, it's best to play it safe. It's important for small corporations and LLCs to comply with the rules governing formation and maintenance of a corporation, including:
Commingling assets. Small business owners may be more likely than their larger counterparts to commingle their personal assets with those of the corporation or LLC. For example, some small business owners divert corporate assets for their own personal use by writing a check from the company account to make a payment on a personal mortgage -- or by depositing a check made payable to the corporation into the owner's personal bank account. This is called "commingling of assets." To avoid trouble, the corporation should maintain its own bank account and the owner should never use the company account for personal use or deposit checks payable to the company in a personal account.
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]]>Meet with any senior managers to make sure they are fully in the picture and understand (even better, fully agree with) your plans. Include your human resources person or bookkeeper who will handle the necessary paperwork, if you have one. All these people must commit to 100% confidentiality.
Choose a day where all senior managers will be in the office to break the news to the laid-off employees. Contrary to advice you may read elsewhere, we don't believe that there is a magic best day. Pick a day when the maximum number of people you'll be letting go will be in the office. Choose a time that lets you give departing employees a couple of hours to leave the building, and still leaves you time to gather remaining staff for a company meeting to help restore morale.
Have your bookkeeper prepare final paychecks, which should include pay for the entire final day plus all accrued vacation. Some states require you to pay employees their final paychecks on their last day; others on the next scheduled payday or within 72 hours. To be sure you comply with your state's law, it makes sense to give employees their paychecks on their last day. In addition, some states require you to pay out accrued but unused vacation days on the last day, something that is more efficient than trying to do it later. Almost all states have penalties for not paying wages when due—with some charging $1,000 per employee, per pay period, and others exacting a penalty of 30 days' wages per employee not paid on time.
Also prepare a polite letter of recommendation for each departing employee, giving dates of employment, duties, and a general statement of approbation. Your employees will appreciate your courtesy, and it may make the day go more easily for all. Even if you are laying off a worker who fell far short of the ideal, don't include anything negative—just limit this person's letter to dates of employment and duties.
If you plan to grant severance pay, prepare a separate check to be given to the employee in exchange for agreeing not to sue you over the termination. You'll need to prepare an appropriate release to have the departing employee sign. State law requirements differ somewhat in this area, so you should consult an employment lawyer about the release, especially if you suspect an employee might sue.
No law requires you to pay laid-off severance to employees, unless you've promised it (in your employee handbook or an employee contract, for example). But if you can pay modest severance without putting the survival of your business at serious risk, it's a good idea for several reasons:
How much severance you pay is up to you. Obviously, you can't absorb a hefty hit to your bottom line. Typically, small businesses already in severe economic distress can't afford to pay more than a week's pay for each year served. But to avoid claims of discrimination, be sure to be consistent in how you pay severance, using an objective formula to calculate it.
On the appointed day, if you have enough managers, have them meet with each departing employee, and then have the managers escort the employees to a private meeting room or, if necessary, your office. If you fear an employee might become violent, arrange for appropriate help to be standing by, as unobtrusively as possible.
Start the meeting by briefly explaining the economic necessity that requires the layoff. Because people will likely be shellshocked and unable to absorb lots of information, keep it brief. For example, if your business just lost a $200,000 contract and the bank is threatening to pull your line of credit if you don't quickly cut expenses, it's enough to say just that. Don't forget to thank the departing employees for their hard work and, if you feel it's appropriate, apologize for the fact that economic necessity has forced you to cut such loyal people. Then tell people that in the envelope in front of them, they'll find their pay through today plus accrued vacation. At this stage, if you have a human resources manager, or failing that, an office manager, you may feel that it's less embarrassing to all to step out of the room, leaving the details of collecting keys, signing releases, and answering practical questions, such as eligibility for health coverage under COBRA, to someone else.
While the departing employees are still in the conference room, send a short email (or otherwise notify) all continuing employees of what's going on and ask them to attend a company meeting later the same day. Your email should simply say that the difficult economic times have forced you to reduce overhead and cut the number of employees. It should include all employees on the layoff list, thanking them for their hard work and dedication. That's it—leave the longer explanation for the company meeting.
While laid-off employees are in the meeting room, have whoever handles your computer system disable the computers of any laid-off employee who has enough knowledge to destroy or steal data or crash your network. If a departing employee wants to remove personal files from their computer while packing up, you can have someone sit with them while they do so.
Departing employees should be given an hour or so to pack up and be out of the building. It's polite to have boxes at the ready and to allow coworkers to help them pack. But in a couple of hours, everyone should have left. If you haven't already done it, make sure all computer access passwords and codes have been disabled.
The same day, if possible, convene a company meeting and explain what happened and why. The more honest and up front you are, the more you'll be respected. This is not a time for an in-depth PowerPoint about financial details, but a few slides illustrating your business's financial situation might help.
For more information, see out HR article on how to conduct a layoff.
]]>Dealing with clients who won’t pay up is a common complaint among freelancers. Late fees are one good way to discourage this kind of behavior, but they aren’t appropriate in every situation. You’ll need to review the terms of your agreement with your client and the laws of your state to determine when and how much you can charge. In some cases, you might find that finance charges are causing you to lose clients and your business would benefit from forgiving the occasional late payment.
A late fee, also known as a finance or service charge, is an amount of money a company assesses on a past due invoice. You can also think of a late fee as a charge for extending credit to a late-paying customer, as the company is allowing the individual more time to pay for a debt they currently owed. Calculated properly, late fees compensate the creditor (you) for the direct losses you suffer when the debtor doesn’t pay on time: lost interest (assuming you’d place the money in an interest-bearing account); and the cost of calculating the fee, sending the notice, and pursuing payment. The mere presence of a late fee provision often encourages clients to pay invoices on time.
If you decide to impose late fees, you must determine when and how much to charge. Consider your own cash flow needs and standards of your industry when setting deadlines and fees (never treat late fees as an additional way to make money—they are not a profit center). As for timing, your policy could be that invoices are due on receipt and will incur late charges if paid later than 30, 60, 120 days, or longer.
Next, you should consider how much you want to charge in late fees. You might set late fees as a percentage of the invoice amount, calculated on an annual basis (more on that calculation below). Alternatively, you might charge a flat late fee, such as $10 for each day overdue, with a cap. In either case, late fees cannot be more than an estimate of the actual costs you incurred due to the client’s late payment, and your state’s statutes might restrict how much you can charge per year.
If you charge no more than 10% per year, you probably won’t run afoul of your state’s statutes, but your client could challenge the fee amount in court if you charge more than a reasonable estimate of your actual losses. To calculate your potential losses, consider the following:
Be careful applying an interest rate to large invoices, as the fee could end up much higher than your actual expenses. If you charge a flat fee, verify that the charges do not go over the state’s limits for small invoices. For example, if the invoice is for $100, and you charge $10/day for overdue invoices, you would be over the legal limit of 10% per year after one day.
You should assess a late charge only if the client was on notice, at the outset, that you reserved the right to do so. If you have a written agreement with the client, it should specify how long they have to pay and the flat fee or monthly finance charge for paying late. You should include the same language on your invoices by including the phrase "accounts not paid within __ days of the date of the invoice are subject to a __% monthly finance charge." Never, never describe the fee as a “penalty” for late payment; it’s a tip-off to a judge that the amount you’re charging is meant to punish the debtor, not compensate you for your losses, which can result in the court refusing to enforce your provision. If your written agreement and invoice did not include provisions regarding late fees, you likely cannot impose finance charges.
A late fee is normally assessed as a monthly finance charge, which you can calculate by completing two steps. First, divide the annual interest rate set in your agreement as a late fee by 12 to determine your monthly interest rate. Next, multiply this monthly rate by the amount due to determine the amount of the monthly late fee.
For example, if the annual interest rate is 3%, the monthly interest rate is 0.25%. If a client owed you $10,000, you'd multiply this amount by 0.25% to figure out how much the client owes you every month as a late charge. One-quarter of a percent of $10,000 is $25, so the client would owe you an extra $25 for every month their payment was late. In this example, the annual interest rate caps the fine at 3% of the original debt (not compounded). You would charge $25 per month even though the debt increases. Refer back to your agreement to determine if and when to compound interest, again verifying that the annual amount does not exceed the legal limits.
Late fees can result in unnecessary stress and tension with your customers. In some cases, the better option is to ask for payment before completing services. When advance payment is not practical, consider whether late fees are truly necessary, or whether they are causing you to lose customers. When you forgive the occasional late payment, you could make more money in the long run by maintaining positive relationships with your clients.
Instead of punishing customers for paying late, you could instead reward early payments by offering a discount for payments made up front or within a specified time, so long as you do not offer discounts as a way to get around the restrictions on late fees. The incentive might reduce the number of late payments, and you will enjoy the added benefit of speeding up cash flow to your business. It is important to verify that the difference between the discount and the invoiced amount does not exceed the law’s limits on late fees. If the discount is large, a judge might find that it is a disguised illegal late fee and rule that your agreement is unenforceable.
In some cases, a client just won’t pay but you need the money to keep your business going. First, resend the invoice and reach out to your client to find out what the holdup is. The client might have an issue you can easily resolve, such as forgetting to submit payment or running into an issue with your online payment system.
If the client still won’t pay, it might be time to take legal action. If the amount is small, you can file a claim in small claims court, which you can read more about here. For larger disputes, consider reaching out to an attorney for legal advice.
]]>If you have employees and you withhold taxes from their paychecks, get those withheld amounts to the government on time, every time. It may be tempting to borrow from these funds, because after you collect the taxes, you usually have a few weeks before you must deposit them. Don't ever do it, no matter how behind you are on your bills or how angry your suppliers, landlord, or other creditors are getting. Here's why.
As an employer, you withhold money from your employees' pay to pay payroll taxes (Social Security and Medicare) and your employees' income tax withholding. If you don't pay withheld Social Security and Medicare taxes and federal income withholding taxes (called the "trust fund" portion of these taxes), you will owe a penalty equal to the entire amount of the unpaid trust fund taxes, plus interest. Some states impose similar penalties for failing to deposit state income tax withholding and sales taxes that you have collected.
The trust fund penalty can be imposed on any and every person who fails to see that the taxes are paid, including all owners and officers of the company, whether or not they normally pay the bills or monitor finances. Even directors and minority shareholders can be held personally liable if they were responsible or partially responsible for deciding to pay other pressing bills in lieu of the trust fund taxes. Even if your company is a corporation or LLC, you and your co-owners can be held personally liable for the trust fund taxes and the resulting penalty.
And that's not the worst part. To pay these trust fund taxes and the resulting penalty and interest, the feds can seize business equipment, money your creditors owe to you, and any property you own personally. The IRS can also garnish your wages (if you receive a paycheck) or pension plan payments and seize the assets in your individual retirement accounts (IRAs). Filing for bankruptcy will not protect you. Finally, the IRS can charge you with a crime for failing to deposit your payroll taxes. If your business is in such poor financial condition that you can't pay your payroll taxes, you might want to ask yoursef if it's time to close down. (See Nolo's checkup on when it's time to close your business.)
Make sure you continue to pay your employees' wages on time. There are hefty state law penalties for not paying wages on the day they are due—some states charge a penalty of $1,000 per employee, per pay period; others charge a penalty of 30 days' wages per employee. And if you fail to pay wages for even a few weeks, the state labor commissioner can padlock your business. And worse, unpaid wages cannot be fully wiped out in bankruptcy.
Independent contractors' fees do not fall in the same category as wages (unless the contractors can successfully argue they were employees). Instead, a contractor has the same legal status as any other unsecured creditor, meaning that a contractor who didn't get paid would have to sue you to get a judgment before being able to seize your assets. (And if you're organized as an LLC or corporation, the contractor couldn't grab your personal property.)
You obviously can't run a business without electricity and water. If you're behind on these bills, your utility provider probably has the legal right to cut you off without going to court. Try to negotiate a payment plan rather than not paying your bill. If you wait until your service is cut off, you'll have to pay a fee to get it turned back on, including, possibly, a large deposit.
And assuming you use a land line for business and plan to stay in business, this is another bill that should have priority, so customers can continue to reach you.
Failing to pay child support can land you in jail if a court finds you are not destitute. Your wages or business income can also be grabbed by the state to pay it, without a court judgment. What's more, a child support debt never goes away—it is always collectible, and you can't wipe it out in bankruptcy. (If you truly can't make your payments, go to court and ask the judge to reduce your obligation. That's the only way you can change it.)
If your business is a sole proprietorship or partnership, you're personally liable for all of your business debts. But if your business is a corporation or LLC, you'll be personally liable only for loans or agreements that you personally guaranteed. It follows that, to protect your personal assets, you'll want to pay the debts you personally guaranteed before other unsecured debts, which are obligations of your business only. Learn more about which business loans you're personally liable for.
If a creditor has already gone to court and won a judgment against you, the creditor can pay to have a sheriff seize your property or garnish your wages (and in some circumstances, those of your spouse (see Nolo's article Spouse and Partner Liability for Jointly Owned Business Debt). Obviously it makes sense to make arrangements to pay court judgments before unsecured debts that you haven't yet been sued over.
A debt is secured if a specific item of property (called collateral or security) is used to guarantee repayment of that debt. If you don't repay the debt, most states let the creditor take personal property without first suing you and getting a court judgment. If the property is something you or your business cannot live without, such as a forklift, truck, or cash register, stay current on your payments or expect the company to promptly repossess its property.
If you want to keep your house, you obviously need to keep paying your mortgage (and second mortgage, if you have one). If you don't, the lender can foreclose on the house because it is collateral for your mortgage. And if you pledged equity in your house as collateral for a home equity loan or line of credit, you'll need to keep current on those payments as well. (However, if there isn't enough equity in the house to cover the home equity loan, line of credit, or other second mortgage—meaning that the second mortgage is no longer secured—it might make sense to continue paying only the first mortgage, because the second mortgagor is unlikely to sue to recover the loan amount.)
However, if you know you can't afford your mortgage payments because your business is doing poorly, and you have equity in your house, in the medium term you might be better off selling your home (if you can), renting a moderately priced place, and the money left over to pay your debts.
On the other hand, if you can't sell your house for more than you owe and you can't make the payments, your best bet may be to stop making payments and let the house be foreclosed on -- stay in it for as long as possible without making payments and use the money you save to pay other critical bills. For more information on this strategy, see Nolo's Foreclosure section.
If you need a vehicle to continue your business or keep your job, do what you can to make the payments. Otherwise your vehicle will be quickly repossessed. But if you're paying for a more expensive car than you need, consider selling it and buying a cheaper one. This will save you a bundle in the long run—even if it costs you a few dollars to pay off the difference between what you owe and what you sell your car for. If your car is leased, websites like swapalease.com and leasetrader.com may be able to get you out of your lease and into something cheaper.
If you're already late on your car loan payments, consider voluntarily turning the vehicle over to avoid repossession—even though you will legally owe any difference between what the lender can sell the car for and what you owed on the loan. If the deficiency is not too large, try to negotiate with the lender before you surrender the property, to get the lender to cancel the entire debt—in writing—in exchange for your cooperation. But understand that a voluntary surrender might still show up as a repossession on your credit report.
After several months of trying and failing to collect a debt, many creditors turn their debts over to a collection agency, which will immediately launch a steady stream of scary letters and phone calls. The next step could be a letter from a collection attorney or a lawsuit, if the creditor or collection agency believes you have enough assets to make it worthwhile to sue you.
Collection agencies often collect a percentage of whatever they recover, so they are often willing to agree to a cash settlement for less than the amount owed—especially if they believe that you otherwise plan to file for bankruptcy.
If you plan to keep your current commercial space, pay your rent. If you don't, the landlord is sure to start eviction proceedings against you fairly promptly. But if you can survive without your commercial space or office by moving to a much smaller space or even into a spare room in your house, consider trying to get out of your lease. But remember that if you move out when you have time remaining on a lease, your landlord can sue you in court for the remaining months' rent if the landlord is not able to rerent the space. Learn more about getting out of your business lease early.
Premiums should be further down on your list, but you don't want to pile a liability claim on top of all your other financial problems because your premises liability or auto insurance ran out and you're not covered for a slip-and-fall lawsuit or a car accident. (And remember, if you are operating as a sole proprietor or partnership, the costs of any mishap not covered by insurance will be a personal debt.) Instead of letting coverage lapse, try to reduce your premiums by trimming unneeded insurance coverage and raising deductibles.
If you're a sole proprietor or partner, you're personally liable for supplier's bills, but a creditor must sue you and get a judgment before threatening your personal assets. For this reason, suppliers' bills generally have a fairly low priority, unless of course you need to order more goods or supplies from the same supplier. If you do need to keep ordering goods from a supplier, try to make payment arrangements with the supplier. If you don't, you risk having them cut you off, or at the very least require you to pay COD.
If your business is a corporation or LLC and you haven't guaranteed suppliers' debts with your personal signature, these bills are an even lower priority unless, again, you need to order from the same supplier.
Credit card balances are normally unsecured, personal debts, even if the card is in the name of a business organized as a corporation or an LLC. But because the creditor can't grab your property without first suing and getting a judgment against you, and because credit card debt is easily dischargeable in bankruptcy, credit card balances are a lower legal priority to pay. But remember that penalties and interest on credit cards add up fast, so unless you're considering bankruptcy, failing to make at least the minimum payments will quickly put you in a big debt hole that it will be hard to get out of.
If your business is in the toilet, chances are you can decrease or eliminate your usual estimated tax payments, if you haven't already. How? Most people base their estimated tax payments on their previous year's net income, but in a financially troubled year, your income is sure to be much lower than it wasin the previous year. As long as you end up making estimated payments equal to 90% of your income tax liability for each quarter, you won't be assessed a penalty. If you do underpay your estimated tax liability, there will be a small penalty, but if skimping on estimated tax payments allows you to pay other more critical bills, it may be worth it.
Your lowest payment priority is for run-of-the-mill bills for things like advertising, entertainment, dues and subscriptions, repairs and maintenance — and, on the personal side, medical bills. Though you may get hit with late fees if you don't pay, these unsecured creditors have to sue you and get a court judgment to be able to take your business or personal assets. Plus, most unsecured debts can be discharged in bankruptcy, if things take a turn for the worse. Do keep in mind that if you are 30 or more days late on a bill, the information can go on your business or personal (if you're a sole proprietor or partner) credit report.
For more information, see Nolo's article What Can Creditors Do If You Don't Pay?
]]>The fourth approach—ignoring your debts and hoping your creditors will ignore you—might be tempting, but don't go that route. It’ll probably result in your spending the next couple of years hounded by collection agencies, repo people, lawyers, and lawsuits.
Assuming you can't pay all your debts in full, the question becomes: How much less will your creditors settle for? As you might guess, it depends on the type of creditor, the legal details of the debt, and the attitude of the creditor.
For example, suppose your business is an LLC or corporation without any personally guaranteed debts. In that case, a creditor will know that it doesn't have the option of collecting from you personally, so it might be more willing to accept a small portion of what your business owes as complete payment. But if you owe a debt personally—or perhaps worse, a friend or relative cosigned for it—the creditor has much more leverage.
Whatever the amount or type of debt, it’s not going away. You’ll need to negotiate a debt settlement with each creditor to have your debt paid or forgiven. You can negotiate your own debt settlement or hire a business lawyer, specifically one with experience in debt settlement or bankruptcy.
If you want to try it on your own, follow these five steps to debt settlement negotiation.
When you’re short on cash, it’s a good idea to prioritize your debts. Determine which debts are most important and pay those first.
If you've pledged an asset as collateral and want to keep it, you'll want to pay that debt first. The collateral is also called “secured” property and your creditor will be a secured creditor. For example, a business might offer its machinery as collateral for a business loan from a bank. The bank would be a secured creditor and the loan would be secured by the collateral. Because you have something to lose, you should prioritize secured debts first, as long as you want to keep the property.
After paying your secured creditors for property you want to keep, you should then pay:
If money is left over, then you can pay suppliers, credit card companies, lease deficiencies, and bills for random business expenses—for instance, advertising, travel and entertainment charges, dues and subscriptions, and repairs and maintenance.
No matter the legal status of your debts, it’s worth trying to settle if you can pay 30% to 70% cash upfront. Many creditors, knowing that they’ll have a hard time collecting the debt once you’re out of business, might agree to settle your debt for 50, 60, or 70 cents on the dollar—or even less if you hire a lawyer to negotiate for you.
Keep in mind that it won't help you much to settle one or two small debts for a reasonable amount while not being able to settle larger ones. So it might make sense to tell your creditors that your offers are contingent upon all of your creditors agreeing to settle their debts.
It’s easy to procrastinate this step, but it’s important that you reach out to your creditors sooner rather than later so you’re not falling even further into debt. Depending on the number and type of creditors you have and your relationship with them, you should send them a letter or email, call them, or meet with them. (We get into negotiating with the different kinds of creditors in more detail below.) If you have an attorney, they can contact your creditors for you.
Reach out to equipment lessors first. Since you’re likely required to make payments in exchange for use of the equipment you’re leasing, time is a factor. You don’t want another payment to come due while you’re trying to decide whom to call and what to say.
Next, call your secured creditors. Because a secured creditor can take your collateral for nonpayment, you should focus on working out a deal before that can happen.
Call your unsecured creditors last. Because debts to unsecured creditors can be fully or partially discharged in bankruptcy, these creditors will normally be motivated to negotiate a settlement. (If you end up filing for bankruptcy, they’ll need to go through the court process for payment, with the possibility that there’s not enough money available for them.)
If the creditors accept your terms, great. Get each creditor to sign a release for the entire amount in exchange for your partial payment.
But the release is critical—without it, you have no proof that the debt has been satisfied. Creditors could sue you or the business for the remainder of the debt, which would be expensive and time-consuming to deal with, even if you end up not being liable for the debt.
Once an amount is agreed to, make your final payment to each creditor. If your business has set aside some money to pay its creditors, use those funds.
If you have a partnership, there should be some agreement between the partners—for instance, a partnership agreement or partnership dissolution agreement—that outlines who's responsible for the business’s debts. If there’s not, it’s likely that you’ll divide the payments equally. But look to your state’s laws on partnerships or consider speaking with a lawyer before you come to any understanding.
Regardless your business’s structure, and regardless of whether the money is coming from your business or personal account, keep a record of:
You should work with an accountant to make sure your accounts have been reconciled and that you can track your debts from when you took them on to when you paid them off. An accountant will also help you sort through all the numbers and prepare your tax filings for you.
Now that you know the five basic steps to negotiating a business debt settlement, you should know about considerations having to do with the type of creditor you’re dealing with. Each type requires a different approach and strategy in debt settlement.
Make arrangements to return leased equipment such as copiers, machinery, and vehicles. But, if you return the equipment before your lease term is up, you’ll no doubt be liable for either the remainder of the payments in the lease term or for an early return penalty.
Try to negotiate a better deal while you've still got the equipment. For example, you might offer to return the forklift to the leasing company along with two months' additional payments in exchange for a complete release of further obligations.
Again, if lots of money is at stake and the lessor isn’t willing to cooperate, having a lawyer call, possibly with the suggestion that you might file for bankruptcy, can be a huge help. No lessor wants to cope with bankruptcy court and the fact that their property might deteriorate in the meantime.
Before you turn over any property to a secured creditor, try to negotiate with them to release you from owing a deficiency, which is the difference between what you paid the creditor and what you owed on the lease or contract. If you surrender your collateral, aren't able to negotiate a release, and still owe the creditor money, there’s a deficiency. That deficiency is now like any other unsecured debt. In other words, it's not secured because there’s no collateral attached to the debt.
Again, a call from a lawyer could make a big difference. In bankruptcy, a secured creditor’s debt is satisfied when you surrender the collateral, and any deficiency is wiped out (or “discharged”). Your attorney can help explain the bankruptcy alternative to your secured creditors, including the fact that it’ll be hard for them to collect any unsecured deficiency. Also, if you file for bankruptcy, your secured creditor will have to wait to recover their property. They’ll likely prefer recovering their equipment now and agreeing to waive their claim to any deficiency.
Next, you’ll need to negotiate with unsecured creditors. After you notify your unsecured creditors that you’re going out of business, they’ll start calling you, demanding payment. Often it's best simply to explain that you’re preparing as fair a settlement offer as possible and will be in touch. Even if it takes a few weeks to be sure how much you owe and how much cash you have to divide among your creditors, it's worth the time to get it right.
After you've collected outstanding accounts receivable and sold off any unsecured inventory and equipment you own, you should have at least a small amount of cash to use to discuss settlements.
Prepare for your negotiations by following these tips:
If some creditors want to negotiate for substantially more or are threateningly uncooperative, it's time to involve a lawyer. Doing so will immediately raise the seriousness of the negotiations because the lawyer will be able to convincingly let the creditors know that you might file for bankruptcy if settlements aren't reached.
Creditors know that the costs and delays inherent in bankruptcy would mean that they’ll almost surely receive less than what you’re offering, and that they wouldn't get the money for many months. So most will probably accept your settlement.
A lawyer can also advise you on whether it makes sense to fully pay a creditor who refuses to accept less. Similarly, if a creditor makes a request for payment that you dispute, an attorney can tell you what your next steps should be or get involved on your behalf.
If, after making settlements with your creditors, you have any cash or assets left, you should set aside some money for potential future claims. Invariably, after you close up shop, a creditor will come out of the woodwork.
Do your best to estimate any unpaid bills that might later surface or any potential lawsuits that could come up against your business. Some experts recommend you set aside 1% of your annual revenue to provide for surprise creditors, but a reasonable amount depends on the hazards of your particular business.
You can keep the money in your regular business bank account, a savings account, or, if the amount is significant, an escrow account. Some states actually require you to deposit the money into a trust account with the state controller or commissioner of revenue.
If your business is an LLC or corporation, keep the money set aside for two to five years, depending on your state's law. Doing so is important because if a corporation or LLC distributes its assets to its owners after it dissolves and then a creditor appears within the two- to five-year period, the creditor can sue the business owners personally, to the extent of the assets distributed.
If your business is a sole proprietorship or partnership, you might want to keep a contingency fund for three to ten years, depending on your state's statute of limitations. You can keep the funds in a trust account and name yourself or your partners as the trust beneficiaries. Doing so will allow you to dissolve and wind up your business—because the trust account won’t be under your business’s name—but still give you access to your business’s dedicated funds.
QuickClean Cleaners, Inc. closes its doors after months of competing with three different dry cleaners within a three-block radius in downtown Stamford, Connecticut. After laying off employees, paying suppliers and creditors, and dissolving their corporation, the owners want to tie up loose ends.
They know that customers take a while to make claims for lost or damaged apparel and that QuickClean usually has to pay out about $6,000 per year in claims not covered by insurance. Wanting closure but not wanting to risk later personal lawsuits, QuickClean sets aside $6,000 in a trust account, distributes the remaining assets to its three shareholders, and dissolves the corporation.
If there’s money left over in the account in six years, they can split the money among themselves.
If you think significant claims could surface after you close your business, see a lawyer. They can help you determine whether the claims are valid and how much you’re on the hook for. They can also explain what your options are if you don’t have enough money to pay your creditors.
]]>First, know that you can't be thrown in jail for not paying your debts (with the exception of back child support, if you could pay but don't). And a creditor can't just take money from your bank account or grab your tax refund—unless you owe back taxes or you've defaulted on a student loan. To collect a debt, the general rule is that most commercial creditors must first sue you and win a money judgment (a court award) against you.
But, there is a big exception to this rule: Creditors don't have to sue first if the debt is guaranteed by collateral. Common examples are a car loan where the car you bought is security (collateral) for the loan, or a mortgage or home equity loan where the house itself is pledged as collateral (though in about half of the states, a lender has to go to court before foreclosing).
Because you may be up against some lenders with sophisticated financial knowledge and legal resources, it's important for you to understand the legal status of each and every one of your debts and what each creditor's rights are.
Debts and creditors fall into different types of legal categories, meaning that some of your creditors have more rights to collect and a bigger ability to negatively affect you and your business than do others. The two main categories of debts and creditors are secured and unsecured.
A secured creditor is any creditor to whom you or your business has pledged collateral in exchange for a loan, line of credit, or purchase. Collateral might be business property, such as inventory and equipment, or your own property, such as your house, car, or boat.
There are also "involuntary secured creditors"—those who have filed a lien (legal claim) against your property because they have a judgment against you or you owe a tax debt.
Either way, if you or the business can't pay back the debt, a secured creditor can repossess or foreclose on the secured property, or order it to be sold, to satisfy the debt.
An unsecured creditor is one to whom no collateral has been pledged and who hasn't filed a lien. Typically, unsecured debts include credit card charges and amounts your business owes for inventory, office supplies, furnishings, rent, and advertising, as well as what's owed for services such as maintenance, equipment repair, or professional advice.
Many businesses owe secured debts—businesses typically pledge collateral for credit lines, and business owners often pledge their personal property for business debts. Let's take a look at how quickly lenders can call in or foreclose on collateral when a secured debt is not paid.
As you probably know, if you miss a payment or two on your car loan (and, as is typical, the loan was used to buy the car and is secured by the car), the lender has the legal right to physically repossess the car and sell it to recover the money you owe, plus the costs of the sale and attorney's fees. To do this, the lender doesn't have to get permission or a court judgment. Under the terms of the contract you signed with the lender, a repo man can simply reclaim the lender's property. (In many states, the lender doesn't have to give you notice of the repossession; you will just wake up and find your car gone.) When all is said and done, you will still owe the difference between what the lender sells the car for and what you owed on the loan, called a "deficiency." Also, the repossession will appear on your credit report for seven years.
Cars are the most commonly repossessed type of property, but if you borrowed money to buy business equipment or machines and used the purchased equipment as security, the creditor will have the same repossession rights. Also, some department store credit cards provide that the creditor automatically takes a security interest in the property you buy, so if you don't pay the bill, the creditor might try to repossess the property. However, because creditors must get a court order to enter your house or business, repossession of property other than vehicles is rare.
Similarly, with leased vehicles or business equipment, if you miss a lease payment, the leased property can usually be immediately reclaimed without a court order.
If you have a mortgage or deed of trust on your house, or an open home equity line of credit, you must make payments on time to keep the house. If you don't, the lender can and probably will foreclose on your house, because it is collateral for your debt. But foreclosures are not as quick as vehicle repossessions. In half of the states a lender has to go to court before foreclosing, and in the other half, advance notice is required from the lender.
Similarly, if you pledge your house as collateral for a business loan or line of credit and you default on that loan, the lender can foreclose on your house. (In this situation, the lender must always file a foreclosure action in court, no matter what state you're in.) To avoid having the lender foreclose, you must either repay the debt or, if the debt is more than your equity in the house, at least pay the lender that amount so that it no longer has a reason to foreclose.
The foreclosure process works differently in different states. In some states, the lender must file a lawsuit to foreclose on a house (called judicial foreclosure). In others, it can foreclose on property without going to court (nonjudicial foreclosure). A judicial foreclosure typically takes several months longer than a nonjudicial foreclosure (though in California a nonjudicial foreclosure can take a year or more), giving you time to save some money and, if necessary, find a new place to live.
If you're behind on your mortgage, you might be able to negotiate a loan modification with your lender. For example, the lender might agree to add your missed payments to your loan balance, to stretch out your loan over a longer term, or to convert an adjustable rate mortgage to a fixed-rate one. Your other options are selling your home for less than you owe (called a short sale), returning the deed to the lender (called a deed in lieu of foreclosure), or refinancing through the Federal Housing Administration (FHA) or the Homeowner Affordability and Stability Plan. For up-to-date information about your options if you are facing foreclosure, see The Foreclosure Survival Guide, by Stephen Elias (Nolo).
Filing for bankruptcy can delay foreclosure. When you file for bankruptcy, all creditors, including mortgage lenders, must cease collection activities and foreclosures. However, the lender can ask the bankruptcy court for permission to proceed with a foreclosure if you're behind on your payments, so a bankruptcy may delay a foreclosure only a couple of months. (For more on bankruptcy in general, see Nolo's Bankruptcy Center.)
Unsecured creditors such as credit card companies and most trade creditors must first sue you and win a money judgment against you before they grab your income and property. This is true whether you are personally liable for the debt (as is the case for sole proprietors and partners, or because you signed a personal guarantee for your corporation or LLC) or whether only your corporation or LLC is liable for the debt. (Learn whether you're personally liable to pay your business's debts.)
Typically, however, before seriously considering a lawsuit, a creditor will try to collect the debt for several months and then turn it over to a collection attorney or agency, which will restart the process. In some instances, the creditor will conclude that you don't have enough property that can easily be grabbed to pay off the judgment, and won't bother suing.
For instance, say your house is worth less than you owe on your mortgage, meaning that there is no equity in it for creditors to take. Also suppose that your consignment shop has few business assets and is doing so poorly that you don't anticipate having more than a few dollars of steady income that a creditor could grab (by ordering the sheriff or marshal to take money from the business premises). Your creditors, or any collection attorney or agency your debt is turned over to, may not sue you because they know it's unlikely they could collect the money judgment. That's called being "judgment proof."
Instead, the creditor may simply write off your debt and treat it as a deductible business loss for income tax purposes. Typically, in five or six years, depending on your state's statute of limitations, the debt will become legally uncollectible. (Only a few states, such as Kentucky, Louisiana, Ohio, and Rhode Island, have longer statutes of limitation, up to ten or 15 years.)
However, you can expect to be sued if there is significant money at stake and you have valuable personal or business assets (or just business assets, if your business is a corporation or LLC)—or if the creditor expects you to acquire significant assets in the future. For instance, if you are a sole proprietor and have an advanced degree, your creditor might assume you'll eventually make a decent salary and will sue you now—and just wait for you to make some income. (In many states, a court judgment can be collected for at least ten years.)
What does a creditor think is worth suing for? Significant amounts of cash or accounts receivable, valuable business equipment and property, and, if you're personally liable for a debt, valuable personal assets such as jewelry, fine art, collectibles, antiques, motorcycles, expensive bicycles, boats, or a vacation house.
Don't try to hide assets. Sometimes, out of desperation, a business owner tries to protect personal or business assets by giving them to friends and relatives or otherwise trying to hide them from creditors. Although few small business people have the knowledge necessary to move cash to an offshore bank account, many try to hide it in the name of a parent, child, coworker, or friend. Don't do this. Creditors' attorneys are experienced in ferreting out such hidden assets, and in extreme cases, these tactics can even give rise to civil and criminal charges of fraud.
If a creditor does take you to court and wins a judgment against you, it obviously makes sense to pay the court judgment before any other unsecured debts that you haven't yet been sued over. (See Nolo's article on Prioritizing Which Business Debts to Pay First.)
Collecting a judgment is harder than winning it. If a creditor has gone to court and won a judgment against you for collection of an unsecured debt, theoretically the creditor (now called a judgment creditor) will be able to take any cash in your business's bank account, your business income, and your business assets to pay off the debt. If you're a sole proprietor or partner, or you signed a personal guarantee for a debt, the judgment creditor could also garnish your wages and take money from your personal bank account, as well as take your nonexempt personal property, to pay off the debt. However, to take money or property, the creditor must first locate it and then get a court order and pay the sheriff to take it.
Probably the most common collection method is for a creditor to obtain a writ of garnishment, under which a sheriff could garnish 25% of your wages to pay the debt (except in Pennsylvania, South Carolina, and Texas, where garnishments are not allowed). But assuming you are a self-employed business owner without a side job, garnishing your wages will be pretty difficult since you don't get a paycheck (unless you're an employee of your corporation). However, your spouse's wages could be garnished to pay your business debts if you live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin), assuming your spouse is named in the court judgment.
Often a more effective collection technique (if your business sells goods or services for cash) is for the sheriff to come to your business and take any money he can find there—in the cash register (called a "till tap") or on your person. Or a sheriff could be authorized to take business vehicles, equipment, or tools of the trade to pay your debts, something that will happen only if those items are clearly worth more than you owe on them. It's also possible that the creditor could get a court to order your bigger customers and clients to pay any money they owe you directly to the court.
However, most creditors won't go to these lengths to get your property. Instead, many will simply attach a "judgment lien" to any real estate or assets the business owns (or valuable personal property or real estate that you own, if you are personally liable for the debt). The lien will allow the creditor to collect the debt when you sell or refinance the property.
Check to see if any liens are recorded against your business. The Secretary of State's office in every state maintains a registry of liens, listing judgment liens, tax liens, or security interests that creditors claim in your property. You can do a Uniform Commercial Code (UCC) records search online at your Secretary of State's website to search for your personal and business names to see what liens have been recorded against you. If you find any incorrect information—say you have paid off a debt but it hasn't been reflected—ask the lender in question for a UCC release, something that is required by law.
If you do have regular wages coming in, perhaps from a side job or because you are an employee of your corporation, your wages can be garnished to enforce a court judgment. The total amount your creditors can take from your wages is 25% of your net pay. That limit applies whether you have one creditor or many. And if your wages are low, there are additional protections—you must be left with weekly income equal to 30 times the federal hourly minimum wage. (A few states have lower limits.) But if you owe back child support or back taxes and your wages are being garnished, expect to lose a much larger percentage of your wages—50% or more, depending on whether you are supporting others. Social Security checks, retirement plan proceeds, unemployment and disability benefits, or workers' compensation awards cannot be garnished, except to pay federal taxes or child support (or unless they have accumulated in your bank account).
Although a judgment creditor can usually grab cash from your bank account or force the sale of most business assets, a judgment creditor can't take personal property that is legally exempt from creditors. Most states provide that a certain amount of your personal assets, such as food, furniture, and clothing, cannot be taken by creditors or by the bankruptcy trustee in bankruptcy court. In addition, most states exempt from creditors:
Find your state's exemptions. To find out how much your state exempts for your vehicle and house, and a complete list of exempt property, see our section on bankruptcy exemptions.
Most states also let you keep a couple of thousand dollars' worth of business equipment and tools of the trade, as well as money in tax-deferred retirement plans. Also, in most states (except community property states, discussed above), a creditor can't take property that belongs to you and your spouse if the debt is in your name only. (For more information, see Spouse and Partner Liability for Jointly Owned Debt.) The practical effect of these exemptions is that, no matter how many debts you have and no matter how many judgments are entered against you, creditors can't grab much essential property.
EXAMPLE: For years, Dax's hobby has been restoring classic cars; he owns two himself, a '64 Shelby Cobra and a '59 Cadillac Eldorado. After being urged by his friends to quit his day job to do what he loves, Dax opens his own shop that offers custom auto detailing, paintless dent repair, auto painting, and classic car restoration. He applies for a business license, rents a small warehouse in an industrial area, buys two auto lifts, and increases his cache of tools, which was already sizable. To pay for everything, he takes a personal equity line of credit out on his house, after striking out in his attempts to get a bank line of credit for the business. Unfortunately, almost as soon as Dax opens his doors, the economy declines, and people cut back on luxury services such as regular car detailing, and even dent and ding repair. At the same time, many classic car enthusiasts are forced to put their hobbies on hold. As a result, Dax doesn't bring in enough money to cover his costs, can't pay his rent, and goes out of business, leaving a mountain of debts.
If he is sued or has to file for bankruptcy, here is what he has to lose and what he should be able to hold on to:
Since Dax lives in California, is married, and has only $60,000 equity in his house (he owes $300,000 and the house is worth $360,000), he will get to keep his house (California law exempts $75,000 of equity for families). He will also get to hold on to his clothing, furnishings, and appliances. He will be able keep only $2,550 in equity in personal vehicles, so he is likely to lose his classic cars. He will also be able to keep up to $6,750 in business assets, if he has fully paid for them and if he continues to use them to make a living, including tools, equipment, and a commercial vehicle. Unfortunately, the rest of his business assets will likely be taken. He also stands to lose the money in his business bank account, as well as his personal bank account, because he was a sole proprietor. If he gets a new job, up to 25% of his wages could also be garnished. And if Dax's wife brings home an income, 25% of that income can be garnished to pay the business's debts, if his wife is listed in the judgment. (If Dax files for bankruptcy, however, the wage garnishments will stop.) Fortunately, Dax's IRA is safe from creditors.
Bankruptcy can get rid of unsecured debts. If you have been sued or have been threatened with a lawsuit, you're at risk of losing cash or property. If the majority of your debt is unsecured and you have little chance of paying it off, you might consider bankruptcy, which can get rid of most, if not all, of your unsecured debt. For more information on bankruptcy and alternatives, see Nolo's overview of bankruptcy for small businesses. Also, if you decide to shut your business's doors, see Nolo's section on Going Out of Business, for information on how to minimize your personal liability while closing your business.
Back rent is treated like any other unsecured debt, but you are subject to streamlined eviction procedures if you don't pay. If you're behind on residential rent payments, the landlord is likely to start an eviction lawsuit against you within a few weeks. Unless the building is found to be uninhabitable (substandard or unsafe), chances are you'll be ordered to vacate within about six weeks. A commercial eviction is quicker than a residential eviction—it can be over in just a few weeks.
You can try to negotiate with the landlord to make up unpaid rent over the next several months, but do this before the landlord files an eviction lawsuit. Your landlord may be likely to negotiate if lots of properties are vacant in your area. If you can show that, while your business is short on cash, you have a believable long-term survival plan, you may be able to get a new lease with lower rent. Your chances will improve if you can possibly show that you or a private lender will invest new capital in the business if the lease and other obligations are reduced. (For more on negotiating your rent down, see our article on ways to cut costs.)
If you have to move out when you have time remaining on a lease—residential or commercial—your landlord can sue you for the remaining months' rent. However, in most states the landlord is obligated to try to rerent the space first to minimize the loss. This is called "mitigating the damages." For more information, see Nolo's article on how to get out of a lease early, with the fewest consequences.
Find a new tenant yourself. A landlord who expects to eventually collect from you all of the rent you owe under the broken lease may move slowly to find a new tenant. If you help find a new tenant and get the space filled faster, you'll limit your future liability under the lease.
]]>If you are sued personally for the debts of your business (a lawsuit names you and your business as defendants, or a creditor threatens to name you personally in a lawsuit), you may need the help of a business attorney to defend yourself. To find an experienced business litigation attorney in your area, go to Nolo's Lawyer Directory.
If you're on the other side of the fence, trying to collect from a defunct corporation or LLC on an unpaid debt or court judgment, you may be able to pierce the corporation or LLC's veil and obtain a court judgment against the owners of the company.
First, read the information above to see if the business from which you want to collect seems susceptible to getting its veil pierced. If it's a small business, you'll have an easier time of it. Many small businesses operate without sufficient funding and without following corporate or LLC formalities. When these businesses make deals that can be considered reckless or fraudulent, a court may lift their corporate veil so that the owners' personal assets can be taken.
Large corporations are not immune from losing their limited liability status either. Courts will often pierce the corporate veil of a large corporation when the officers or directors create a subsidiary corporation and transfer debts to that subsidiary. In one scheme, the owners of a large corporation incorporate several undercapitalized subsidiaries (companies that do not have enough money to support their operations). The large corporation (called the "parent corporation") finances the operations of and exerts control over the subsidiaries. Such subsidiaries are commonly called "dummy corporations" or "corporate shells."
When creditors seek to collect debts from or enforce a court judgment against a dummy corporation, they are often out of luck because the dummy corporation does not have sufficient assets to collect. In this situation, a court might pierce the corporate veil of the parent corporation, allowing the creditor to collect from the owners or members of the parent corporation. This prevents the creditor from suffering unjust cost.
Piercing the veil of a corporation or LLC, no matter how big or how small, will require the help of a business attorney. To find an attorney in your geographical area with experience in business litigation, go to Nolo's Lawyer Directory.
by: Craig T. Matthews, a business, employment, and litigation lawyer from the Dayton, OH area.
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]]>If you use accounting software, such as Intuit's QuickBooks, Sage's Peachtree Accounting, or Accounting Express by Microsoft, it will generate a P&L forecast for you once you enter monthly sales and expense estimates. You can also create your own forecast, using a basic spreadsheet. Just look at the sample P&L below and you'll see how to set it up.
Start by estimating how much you'll take in each month during the next six to 12 months. No question, this will be a guesstimate. If you're already in business, you can extrapolate from current sales levels and allow for significant seasonal fluctuations and other known variables.
EXAMPLE: Emme owns and operates a consignment shop that sells gently used clothes for women and children. She buys her inventory from moms who bring in their own and their children's clothing to sell. Emme is careful to buy mostly well-known brands (and when possible, high-end ones) that she can sell for a premium.
Emme was selling $15,000 of clothing per month when the economy took a dive. Sales have been down almost 30% lately, so Emme wants to create a morerealistic profit and loss forecast for the upcoming year. She estimates that she'll bring in an average of $10,000 per month in sales over the next year—more at back-to-school time and the holidays, less during the slow summer months.
Now estimate the monthly cost to you of the goods or services you'll sell as part of achieving your sales estimate. These are your variable costs. They're called variable, or sometimes incremental, because they go up or down depending on the volume of products or services you produce or sell. (And in retail, they're called "cost of goods.") For example, if you're a mail-order business, then the more you sell, the more you'll pay for shipping costs.
Other variable costs include inventory, supplies, materials, packaging, and sometimes labor used in providing your product or service. In the case of services, count labor costs as variable costs only if they will go up or down depending on how many sales you make. For instance, if you have to hire independent contractors or temps to cover busy periods, those labor costs are variable. But if you employ a manager, bookkeeper, or marketing employee, you'll have to pay their salaries no matter how much sales go up or down, meaning their wages should be listed under fixed costs (overhead) in Step 4, below.
EXAMPLE: Emme used to spend more than $6,500 per month to buy used clothing to resell. But because sales have been down so much, she will need less inventory and estimates that she will probably spend only about $4,500 per month.
Now simply subtract your average monthly variable costs from your estimated average monthly sales revenue to get your estimated monthly gross profit. This number will let you calculate how much of each dollar of sales you get to keep. From that amount, however, you'll have to pay for overhead costs; anything left over is your net profit.
EXAMPLE: Subtracting her inventory costs of $4,500 per month from her sales estimate of $10,000 per month, Emme estimates her new average monthly gross profit will be $5,500. (This is before subtracting her overhead, which is discussed below.)
Your net profit is the most important number you need to determine. This lets you see whether you'll have any money left after paying your overhead costs or, failing that, whether you can at least break even. To arrive at your net profit, make a list of your monthly fixed costs, which are items such as:
Divide any annual expenses, such as insurance premiums, by 12 to get a monthly amount.
To arrive at your monthly net profit (or loss), subtract your average estimated monthly fixed costs from your monthly gross profit.
EXAMPLE: Over the past year, Emme has been able to pay herself $50,000 from the business, but she knows that with sales dropping this won't be possible in the coming year. She guesses she'll need to cut her take-home wages to $30,000—and if she can't bring home at least that amount for living expenses, she won't keep the shop open. So she includes $30,000 in her fixed costs. Emme adds up her total fixed costs, including the following:
- $1,000 for rent
- $100 for utilities
- $4,000 for labor (this includes $12,000 per year for a part-time assistant as well as employment taxes and costs plus $30,000 for her), and
- $100 for insurance (her annual premium is $1,200), and so on.
- The total of her fixed costs comes to $5,500 per month. When she puts one month's numbers together in a spreadsheet, here is what it looks like.
January | ||
Sales Revenue | 10,000 | |
Cost of Goods | 4,500 | |
Gross Profit | 5,500 | |
Fixed Costs | ||
Rent | 1,000 | |
Labor | 4,000 | |
Utilities | 100 | |
Telephone | 30 | |
Insurance | 100 | |
Advertising | 40 | |
Accounting | 130 | |
Miscellaneous | 100 | |
Total Fixed Costs | 5,500 | |
Net Profit (Loss) | 0 |
When you are satisfied with your cost estimates for an average month, fill in estimates for six or 12 months. Then, for each month, subtract your total fixed expenses from your gross profit to get the net profit.
EXAMPLE: Emme fills in an entire year of sales estimates, with the usual dip in sales she experiences in summer and then upswings in September when the kids go back to school and in December, traditionally her best month. Then, using her estimate of $4,500 in monthly variable costs and her estimate of $5,500 in monthly fixed costs, she comes up with a net profit for each month. Emme notices that in the summer she'll lose a little over $1,000 per month for a few months in a row, but will make it back up by December.
Emme's Profit and Loss Forecast (part 1) | |||||||
January | February | March | April | May | June | July | |
Sales Revenue | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 8,000 | 8,000 |
Variable costs | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 |
Gross Profit | 5,500 | 5,500 | 5,500 | 5,500 | 5,500 | 4,400 | 4,400 |
Fixed Costs | |||||||
Rent | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 |
Labor | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 |
Utilities | 100 | 100 | 100 | 100 | 100 | 100 | 100 |
Phone | 30 | 30 | 30 | 30 | 30 | 30 | 30 |
Insurance | 100 | 100 | 100 | 100 | 100 | 100 | 100 |
Advertising | 40 | 40 | 40 | 40 | 40 | 40 | 40 |
Accounting | 130 | 130 | 130 | 130 | 130 | 130 | 130 |
Miscellaneous | 100 | 100 | 100 | 100 | 100 | 100 | 100 |
Total Fixed Costs | 5,500 | 5,500 | 5,500 | 5,500 | 5,500 | 5,500 | 5,500 |
Net Profit (Loss) | 0 | 0 | 0 | 0 | 0 | -1,100 | -1,100 |
Emme's Profit and Loss Forecast (part 2) | |||||
August | September | October | November | December | |
Sales Revenue | 7,000 | 12,000 | 10,000 | 10,000 | 15,000 |
Variable costs | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 |
Gross Profit | 3,850 | 6,600 | 5,500 | 5,500 | 8,250 |
Fixed Costs | |||||
Rent | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 |
Labor | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 |
Utilities | 100 | 100 | 100 | 100 | 100 |
Phone | 30 | 30 | 30 | 30 | 30 |
Insurance | 100 | 100 | 100 | 100 | 100 |
Advertising | 40 | 40 | 40 | 40 | 40 |
Accounting | 130 | 130 | 130 | 130 | 130 |
Miscellaneous | 5,500 | 5,500 | 5,500 | 5,500 | 5,500 |
Total Fixed Costs | 5,500 | 5,500 | 5,500 | 5,500 | 5,500 |
Net Profit (Loss) | -1,650 | 1,100 | 0 | 0 | 2,750 |
Creating this new profit-and-loss forecast lets Emme see that she can't count on taking any extra profits out of the business for the next year. And if her sales estimates are too high, she won't be able to take home $30,000 over the year for living expenses. She needs to think long and hard whether it makes sense to drain her savings account and continue toiling for a year in the hopes the the economy will rebound soon and allow her to make a good living again from the store.
It's also useful to know your gross profit margin. Gross profit margin measures the difference between the costs of producing a product or providing a service and what you're selling it for. In short, it lets you know how profitable your products and services are.
To get your profit margin, divide your estimated average monthly gross profit by your estimated monthly sales.
EXAMPLE: Emme divides her monthly gross profit of $5,500 by her $10,000 of sales, to get a profit margin of 55%. Now she knows she will get to keep, on average, about 55 cents of every sales dollar she takes in (before paying for overhead).
Profit margins can be used in many different ways. Some businesses regularly calculate their profit margin to monitor the profitability of their products or services. A decrease in profit margin over time usually means that variable costs have gone up—costs for raw materials, manufacturing, or labor—which should nudge the company to either look for new suppliers or raise prices.
Other businesses use their anticipated profit margin to help them price products or services (and increase profitability). For example, a business that requires a profit margin of 60% and produces a product that costs $20 to make would set the retail price at around $50 ($20 ÷ (100% - 60%)). (However, some experts disagree with this use of profit margin, recommending instead that businesses start with the price they think customers will pay and then making sure the costs are low enough to make a profit.)
Another way to use profit margins is to screen new products and services to sell. For instance, a retail gift shop might decide to add only new products that can be bought and sold at a price that yields a profit margin of 50%.
What's a good profit margin? The answer varies across industries. For example, most airlines have low profit margins, around 5%; the software industry has traditionally had high profit margins, around 80%-90%; wholesalers' profit margins are somewhere in the middle, between 15% and 35%. But without looking at the costs of a company's overhead, such as marketing and administration, profit margins don't give the whole picture of a company's profitability.
]]>To prepare a cash flow statement, you'll use many of the same figures you use for a profit and loss forecast. The main difference is that you'll include all cash inflows and outflows, not just sales revenue and business expenses. For example, you'll include loans, loan payments, transfers of personal money into and out of the business, taxes, and other money that isn't earned or spent as part of your core business operation.
Also, in your cash flow statement, you'll record costs in the month that you expect to incur them, rather than spreading annual amounts equally over 12 months. This is important because it's easy to show a monthly profit on a spreadsheet but go belly up from lack of cash if you can't pay your bills on time. For example, if you have a $4,000 workers' comp premium and a $3,000 liability insurance premium due each July 1, you'll need to find a way to come up with real dollars then, not later. Plus, if you make sales to some customers on credit (for example, a painter who invoices customers after the job is done rather requiring full payment up front), your cash flow analysis should account for the fact that you won't get paid right away, as well as the fact that you might not collect some of the credit sales at all.
Here are the steps you need to follow to create a cash flow statement like the sample below. Do one month at a time.
For the first month, start your projection with the actual amount of cash your business will have in your bank account.
Fill in all amounts you expect to take in during the month. Include sales revenue that will actually be in hand, collections of previous sales made on credit, transfers of personal money into the business, and any loans coming into the business—basically, every dollar that will flow into your business checking account.
Enter all your projected payments for the month. Include your variable costs (cost of goods), your fixed costs such as rent, tax payments, and any loan payments. Add them to get your monthly total.
Finally, subtract your total monthly cash-outs from your total monthly income; the result will be your cash left at the end of the month. That figure is also your beginning cash balance at the start of the next month. Copy this amount to the top of the next month's column and go through the whole process over again.
EXAMPLE: On January 2 (as a New Year's resolution), Emme starts work on a cash flow projection for the next 12 months. She starts by putting the $5,000 she has in her business bank account in the "Cash at Start of Month" column for January. In her "Cash Coming In" section, she includes her cash sales (which are about 75% of her sales) and her credit sales (about 25% of her sales) on separate lines. She adds in all of the cash sales, but only 80% of her credit sales, because some percentage of her credit customers always take longer than 30 days to pay. In the "Cash Going Out" section, Emme includes her variable and fixed costs, putting the annual insurance premium she's about to pay in the January column rather than spreading it over 12 months.
Emme's Cash Flow Analysis (part 1) | |||||||
January | February | March | April | May | June | July | |
Cash at Start of Month | 5,000 | 3,340 | 3,080 | 2,220 | 1,960 | 1,700 | –740 |
Cash Coming In | |||||||
Sales Paid (75%) | 7,500 | 7,500 | 7,500 | 7,500 | 7,500 | 6,000 | 6,000 |
Collections of Credit Sales | 2,000 | 2,000 | 2,000 | 2,000 | 2,000 | 1,600 | 1,600 |
Loans & transfers | 0 | 0 | 0 | 0 | 0 | 0 | 0 |
Total Cash In | 9,500 | 9,500 | 9,500 | 9,500 | 9,500 | 7,600 | 7,600 |
Cash Going Out | |||||||
Inventory | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 |
Rent | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 |
Wages | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 |
Utilities | 100 | 100 | 100 | 100 | 100 | 100 | 100 |
Phone | 30 | 30 | 30 | 30 | 30 | 30 | 30 |
Insurance | 1,200 | 0 | 0 | 0 | 0 | 0 | 0 |
Ads | 200 | 0 | 0 | 0 | 0 | 280 | 0 |
Accounting | 130 | 130 | 130 | 130 | 130 | 130 | 130 |
Miscellaneous | 0 | 0 | 600 | 0 | 0 | 0 | 0 |
Loan payments | 0 | 0 | 0 | 0 | 0 | 0 | 0 |
Taxes | |||||||
Total Cash Out | 11,160 | 9,760 | 10,360 | 9,760 | 9,760 | 10,040 | 9,760 |
Cash at End of Month | 3,340 | 3,080 | 2,220 | 1,960 | 1,700 | -740 | -2,900 |
Emme's Cash Flow Analysis (part 2) | |||||
August | September | October | November | December | |
Cash at Start of Month | –2,900 | –6,410 | –4,770 | –5,030 | –5,290 |
Cash Coming In | |||||
Sales Paid (75%) | 5,250 | 9,000 | 7,500 | 7,500 | 11,250 |
Collections of Credit Sales | 1,400 | 2,400 | 2,000 | 2,000 | 3,000 |
Loans & transfers | 0 | 0 | 0 | 0 | 0 |
Total Cash In | 6,650 | 11,400 | 9,500 | 9,500 | 14,250 |
Cash Going Out | |||||
Inventory | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 |
Rent | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 |
Utilities | 100 | 100 | 100 | 100 | 100 |
Phone | 30 | 30 | 30 | 30 | 30 |
Insurance | 0 | 0 | 0 | 0 | 0 |
Ads | 0 | 0 | 0 | 0 | 0 |
Accounting | 130 | 130 | 130 | 130 | 130 |
Miscellaneous | 400 | 0 | 0 | 0 | 200 |
Loan payments | 0 | 0 | 0 | 0 | 0 |
Taxes | |||||
Total Cash Out | 10,160 | 9,760 | 9,760 | 9,760 | 9,960 |
Cash at End of Month | -6,410 | -4,770 | -5,030 | -5,290 | -1,000 |
It's easy to see why a cash flow analysis can give you a more realistic picture of whether your business will have the money to pay its expenses—in other words, sufficient cash flow to stay afloat—than a P&L forecast. This is especially true for companies that make sales on credit, because typically some credit sales are not paid within the expected 30 days (and others not at all). A P&L forecast does not account for late or missing payments, and this is why it's so important to do a cash flow analysis as well.
EXAMPLE: After filling in her cash flow projection, Emme realizes that her account will go significantly negative in the slow summer months. She may not even be back in the black in December, her biggest sales month, because she has estimated that about $500 per month in payments on credit sales will be late. (Though if she eventually gets caught up collecting her accounts receivable, she will be profitable for the year.) But given that some customers will always pay late, she knows that if she can't reduce her costs in some way, she will need some cash to tide herself over in some months, especially during the summer. Because she has already cut her own pay in half and trimmed other expenses to the bone, she'll have to bring in money from extra sales, provide extra services, or get a loan from family, friends, or a bank line of credit.
Despite what your P&L forecast says about your company being profitable or breaking even over the next six to 12 months, if your cash flow is projected to go negative, it means you're not going to be able to pay your bills when they become due, and you'll have to bring in more income or borrow some cash to cover the shortfalls.
EXAMPLE: Going back to her spreadsheet, Emme sees that a loan of $8,000 would cover the shortfall, even accounting for making a small loan payment. After December sales are in, she'd still have a balance of $5,000.
But Emme also sees that even if she gets a loan, it would let her business survive only about 12 to 18 months of lower sales before again going cash-negative the next summer. In short, she needs to make sure that she can boost her sales back to her previous levels within the next 12 to 18 months, or she risks going in the red again before paying back the loan.
Emme's Cash Flow Analysis With $8,000 Loan (part 1) | |||||||
January | February | March | April | May | June | July | |
Cash at Start of Month | 5,000 | 11,180 | 10,760 | 9,740 | 9,320 | 8,900 | 6,300 |
Cash Coming In | |||||||
Sales Paid (75%) | 7,500 | 7,500 | 7,500 | 7,500 | 7,500 | 6,000 | 6,000 |
Collections of Credit Sales | 2,000 | 2,000 | 2,000 | 2,000 | 2,000 | 1,600 | 1,600 |
Loans & Transfers | 8,000 | 0 | 0 | 0 | 0 | 0 | 0 |
Total Cash In | 17,500 | 9,500 | 9,500 | 9,500 | 9,500 | 7,600 | 7,600 |
Cash Going Out | |||||||
Inventory | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 |
Rent | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 |
Wages | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 |
Utilities | 100 | 100 | 100 | 100 | 100 | 100 | 100 |
Phone | 30 | 30 | 30 | 30 | 30 | 30 | 30 |
Insurance | 1,200 | 0 | 0 | 0 | 0 | 0 | 0 |
Advertising | 200 | 0 | 0 | 0 | 0 | 280 | 0 |
Accounting | 130 | 130 | 130 | 130 | 130 | 130 | 130 |
Miscellaneous | 0 | 0 | 600 | 0 | 0 | 0 | 0 |
Loan payments | 160 | 160 | 160 | 160 | 160 | 160 | 160 |
Total Cash Out | 11,320 | 9,920 | 10,520 | 9,920 | 9,920 | 10,200 | 9,920 |
Cash at End of Month | 11,180 | 10,760 | 9,740 | 9,320 | 8,900 | 6,300 | 3,980 |
Emme's Cash Flow Analysis With $8,000 Loan (part 2) | |||||
August | September | October | November | December | |
Cash at Start of Month | 3,980 | 310 | 1,790 | 1,370 | 950 |
Cash Coming In | |||||
Loans & Transfers | 0 | 0 | 0 | 0 | 0 |
Total Cash In | 6,650 | 11,400 | 9,500 | 9,500 | 14,250 |
Cash Going Out | |||||
Inventory | 4,500 | 4,500 | 4,500 | 4,500 | 4,500 |
Rent | 1,000 | 1,000 | 1,000 | 1,000 | 1,000 |
Wages | 4,000 | 4,000 | 4,000 | 4,000 | 4,000 |
Utilities | 100 | 100 | 100 | 100 | 100 |
Phone | 30 | 30 | 30 | 30 | 30 |
Insurance | 0 | 0 | 0 | 0 | 0 |
Advertising | 0 | 0 | 0 | 0 | 0 |
Accounting | 130 | 130 | 130 | 130 | 130 |
Miscellaneous | 400 | 0 | 0 | 0 | 200 |
Loan payments | 160 | 160 | 160 | 160 | 160 |
Total Cash Out | 10,320 | 9,920 | 9,920 | 9,920 | 10,120 |
Cash at End of Month | 310 | 1,790 | 1,370 | 950 | 5,080 |
Emme sets about thinking how to come up with the extra $8,000. Her first thought is having a one-time sale. But even at her usual 55% profit margin, she would need to sell an extra $14,500 in clothes to generate that much gross profit. And discounting prices for a big sale would lower her profit margin, meaning she'd have to sell more. (If she sold her inventory at a 20% discount, her profit margin would be less than 45%, and she'd need to bring in more than $18,000 in additional sales.)
Realizing that she doesn't have a realistic chance of selling that much inventory, she goes looking for a loan. When family, friends, and the bank turn her down, her last resort is to take out a $8,000 home equity line of credit. This will allow her to dip into it as needed to tide her over. In the meantime, she gets to work on a clever marketing plan to boost sales until better times are here.
Now it's time for the next step, which is to focus on your current cash position with an eye to improving it. If cash is flowing out of your business significantly faster than it's coming in, you need to examine three aspects of your cash flow:
To fix your cash flow, you need more money coming into your business (increase sales, collect past-due accounts receivable), less money going out of your business (reduce costs of goods and labor), and less money tied up in your business (reduce inventory and leased equipment). Many of these things will raise your profit margin. For more information, see our article on profit and loss forecast and gross profit margin.
]]>When a business runs short of cash, it's common for the owners to start paying bills late—sometimes even federal and state taxes.
First, you should know that skirting tax obligations is an absolute no-no and a sign that you may be at (or past) the point where you should close down. But if you're unconvinced, see our article on prioritizing your debt payments, which explains why shortchanging the IRS is a terrible idea.
Even paying garden-variety bills late is almost always a poor approach, for all the reasons discussed below.
What about the argument some small business commentators make that by keeping accounts current you are paying out money before you absolutely have to—something you can't afford to do in tough times? Sorry, in the real world of small business this may not make sense for six reasons.
The cost of paying on time is low as compared to almost anything else you can do to maintain a good reputation in your business community. When you pay late, you kick your cash problem down the road a few months at great cost to your credibility, something that is crucial to preserve in tough economic times. To survive, your business will eventually have to pay its debts, so by putting them off a few months you gain nothing but risk losing your good reputation.
Paying early can get you discounts that net you more cash then you could earn in interest by holding onto the money longer. Don't be shy about asking for deeper discounts than your vendors initially offer. Especially if you have the cash to pay early, you should be able to achieve reductions as high as 10% to 15%.
EXAMPLE: A few months after the recession hit and new construction plummeted, Solar Supply LLC's bank threatened to pull its line of credit. This was avoided when the company's founders loaned Solar Supply a substantial sum. Now with both the loan money and line of credit to draw on, Solar Supply had adequate cash, but no profits. So after making lots of money-saving cutbacks, Solar Supply called its ten largest vendors with a simple proposition: For the next six months, Solar Supply will pay on delivery for all orders, in exchange for a 15% discount. Five vendors—themselves short of cash—immediately agreed, and two more said yes when it became clear they would otherwise lose the business. The three holdouts were easily replaced by companies that realized that when times are tough, everyone has to give a little.
Every working day, you (and every other small entrepreneur on Earth) form judgments about the businesses you come into contact with, judgments that are particularly crucial at a time when many businesses are in financial trouble. For example, you likely have thoughts like these on a regular basis:
When these thoughts run through your head, you'll doubtless question whether you ever want to deal with business D, E, or F again. And if you had to choose one of these less-than-stellar outfits to head your blacklist, we bet it would be Business F. That just makes good sense. Tough as it is to cope with late deliveries, unreturned phone calls, inexperienced workers, or even poor quality products or services, it's far harder to survive without being paid. This is doubly true for a business in a field where payment isn't due until after goods or services are provided. Here, if payments are substantially late, a business can actually fail even though its bottom line shows it to be profitable.
You want to be a company that other companies want to do business with. For example, if your business suddenly needs to ask a print shop to turn around a flyer in a few hours, you'll have a much better chance of getting them to say yes if you paid your last bill the day it was due.
Keep in mind that it's not just your satisfied customers (people who pay you money) who tell others about your business. All the people who work for and with you can also be powerful recommenders. This includes everyone you cut a check to, from your landlord and insurance broker to the owner of the restaurant down the street that occasionally caters your meetings. If they feel positive about your business—something that is greatly aided when you pay their bills promptly—each can become a significant marketing ally.
EXAMPLE: Doug, an insurance broker, goes to great lengths to help Bluebelle Web Design find an insurance company willing to customize a standard business policy to meet Bluebelle's special needs. Joan, Bluebelle's president, is so impressed with Doug that after the policy is finally in place and Bluebelle is billed, she ignores the ten-day payment terms and immediately mails the premium check, along with a note of thanks. Now it's Doug's turn to be pleased. Later that week, when he attends a service club meeting and the subject of small business websites comes up, he favorably mentions Bluebelle to what amounts to a roomful of potential customers. As a result, Joan picks up two excellent new accounts.
If your business is new and tiny, you might assume the rest of the commercial world doesn't even know you exist. Not so. Almost from day one your small business will leave tracks in the commercial sands. For example, if you incorporate, form an LLC, hire employees, or apply for a bank loan, credit card, or trade credit, you'll quickly appear on the radar screen of Dun & Bradstreet and similar data collection organizations. These outfits gather and sell credit information about virtually every American business. Among other things, they note what your business does, how many employees it has, who owns it, and, probably most important, its credit and bill-paying history. In short, your bill-paying profile is available to anyone who pays a modest fee.
Who would buy such a report? Especially when economic times are tough and many businesses are losing money, the answer is: Virtually all of your creditors and potential creditors, including banks that are considering lending you money, companies reviewing your application to lease equipment, and suppliers, wholesalers, and other businesses from which you have requested credit. True, an excellent payment record alone won't guarantee that you'll receive a bundle of commercial credit or a particular loan; other information is also important. But if Dun & Bradstreet reports that you habitually pay late, your credit application is sure to raise a red flag and greatly increase the likelihood that you'll have to pay cash up front.
Paying on time acts as an effective rainy day fund if and when you face a serious reverse like losing a major client, having a horrible sales month, or dealing with the bankruptcy of someone who owes you a lot of money. That's because in case of emergency, you'll have a payment cushion of several months: If you've paid promptly over the years, you'll have built up a substantial reservoir of goodwill and respect with creditors. They are likely to support you when you can't pay on time if you can show them a convincing plan to solve your temporary cash problem.
EXAMPLE: Frank's Marine Services, a long-term customer of your engine repair business, faces a difficult business patch because a charter company went bankrupt owing it $40,000. Frank has always paid you early or on time, so chances are you will be as accommodating as possible—certainly far more generous than you would be if Benji's Boat Repair, your most feckless customer, asked for similar help.
Sometimes, despite your best efforts, you might not be able to pay all your bills on time. For example, you might be forced to delay some bills a month or two while you deal with a one-time problem like a lost line of credit, a tax lien, or closing a money-losing part of your business.
In this situation, your best strategy can be stated in three words: communicate, communicate, communicate. Don't wait until you receive a third dun letter to talk to the people whose check is not in the mail; pick up the phone as soon as you know you have a problem. Talk to the person who has real authority to manage accounts receivable to briefly explain what the problem is, how you're solving it, and when you expect to be able to pay. If you can make an immediate partial payment, even a small one, it's absolutely essential that you do so. As the old saying goes, it always pays to put your money where your mouth is.
Don't overdramatize your business problems. Occasionally, people who can't pay a bill on time are tempted to detail every miserable thing that prevents them from doing so. Better to briefly explain a good reason for the holdup and focus on when you will be able to send a check. Otherwise, you risk convincing the creditor that things are so bad they should immediately cut off future credit.
For information on which bills you should pay first (to reduce your liability), see Nolo's article on Prioritizing Which Business Debts to Pay.
]]>Business expense reduction, of course, is easier said than done. Here are five creative, cost-cutting business ideas to help you spend less without crippling your business.
If you find you need professional help as you cut costs, you should reach out to a business lawyer. They can help you renegotiate contracts, manage employees, and settle debts.
If you’re planning on painting your building, buying new equipment, or hiring additional employees, wait. You should only move forward with expenses that are essential to carrying out a crucial marketing or diversification plan. In virtually every other instance, just close your checkbook.
Even if you've made a contractual commitment to spend money, you can try to negotiate your way out of it. If you’re willing to pay a reasonable buyout fee, ending an unfinished contract is legal and honorable. After all, once clued into your financial problems, the other side might be happy to accept a partial payment from you rather than risk your business failing and receiving no payment at all.
You can't do the planning or take the action that will be needed to turn around a recession-battered business unless you fully understand your business's key numbers. Prepare a current profit-and-loss statement and cash-flow analysis.
When times are good, it's easy to commit to buying or leasing expensive equipment. Think big purchases like:
Take a hard look at everything you own, especially items you're still paying for. Sell everything you don't need.
Even if you sell a vehicle for less than you owe and must make up the difference to pay off the loan, you'll often net large cash savings over time. If you used your vehicle as collateral to secure a loan for it—that is, you agreed that the lender can take the vehicle if you fall behind on loan payments—you can try to use the collateral to satisfy the loan. Ask the lender if surrendering the collateral will cover what you owe on the loan. If it doesn’t—for instance, you owe $10,000 but the collateral is only worth $8,000—see if the lender will forgive the difference (or the “deficiency”).
And if you still need the item from time to time—for instance, your job needs an extra bulldozer this time—you can probably rent it by the day for far less.
Don't forget leased equipment. If you’re leasing equipment you don't absolutely need, ask the leasing company to renegotiate payments or cancel the lease in exchange for them taking back the equipment.
If no one takes your requests seriously, don't be afraid to involve a lawyer, who should be experienced in explaining that without quick cooperation, your business might fail. Especially if the leasing company believes you might close down and file for bankruptcy, it’ll likely make you a better offer or take the equipment back. For any money you still owe on a vehicle or equipment you own, an attorney might also be able to convince the lender to dismiss the debt entirely if you hand over the collateral, even if there’s still a deficiency.
When sales drop, you need to increase your marketing outreach. But it's not usually cost-effective to expand outreach by paying for expensive advertising or other high-cost techniques.
Instead, your cash preservation strategy should usually direct you to cut conventional marketing costs and instead rely on low-cost guerilla marketing efforts. For instance, you can enlist your loyal customers to help rescue your business by having them post promotional content on social media or by bringing two friends to a weekend sale. (See more on low-cost and effective marketing.)
Assuming your business still does a significant amount of travel, cut it at least in half. Just committing to this will force you to focus on eliminating the least profitable half.
Faced with tough economic times, the last thing you want to do is eliminate essential insurance coverage for fire, theft, and liability. But by increasing deductibles and canceling less essential coverage for things like business interruption or the death of a key employee, you might be able to reduce your overall payments.
It makes more sense to scrimp on insurance if your business is organized as an LLC or corporation than it does if you’re a sole proprietor or partner and therefore personally liable for business losses. If you’re faced with a lawsuit, they usually can’t come after you personally if you have an LLC or corporation. The lawsuit could sink your business—if your insurance coverage isn’t the best—but you’d likely walk away without owing any money personally.
If you’re a sole proprietor or partner, it’s more important to at least have some kind of insurance because someone could come after you personally in a lawsuit against your business.
Also, if your business is co-owned and you’ve established a buy-sell agreement to allow surviving owners to buy out the deceased owner's inheritors, you might’ve also bought a life insurance policy to provide funds for the purchase. If so, consider canceling this policy, and if you’ve had it for a while, pull out its cash value, if any.
All businesses buy things. It should go without saying that buying in smaller quantities and negotiating lower prices will help preserve cash. But given that prices usually go down when volume goes up, getting better prices for smaller quantities might seem impossible.
But when times are tough and suppliers are hungry for business (especially from companies that pay on time), you'll be surprised at how many will lower prices, if you ask and don't take no for an answer.
Don't overlook basic expenditures, such as:
Even for smaller purchases, often it's best to ask for bids (prices) from a number of suppliers, including your old standbys. And don't sign a long-term contract with the first vendor who offers you a better deal. If someone eager to get your business offers you a lower price, the vendor you use now will probably try to keep your business by going lower still.
If you take credit cards, chances are that you pay your processor too much, giving up cash you desperately need. Because many banks quote a complicated menu of charges to handle different types of credit cards, comparing prices can be confusing and time-consuming. (The complicated process is deliberately calculated to give bank sales reps a huge advantage over often extremely busy merchants.)
As a general rule, if you solicit a number of bids and buy your own processing equipment, you'll save a significant amount. But because getting several bids might take time you don't have, here are a couple of shortcut ideas:
Handing out money at $300 per hour is no way to save your business. Reconsider the money you’re spending on lawyers, accountants, and other professionals because these fees can add up quickly. Try these tips based on your business needs:
Every business we've ever seen prints far too many copies of far too many pieces of paper with much of the paper ending up in the trash. Consistently printing too much isn't the only money-eater; lots of businesses pay far too much even when they print exactly what they need.
For example, if you're printing 3,000 copies of a four-color catalog at a printer down the street, chances are you can cut your bill in half by using two colors and getting bids from half a dozen area printers. When the lowest bid comes in, ask how they can cut it further, possibly by using a slightly unusual type of paper left over from another job or waiting a few days until their equipment is idle.
Whether you rent or own your office building, you have a few cost-saving options to consider. If you rent, then your priority should be to save the most money, even if only in the short term. If you own, your priority should be to make money as quickly as possible while you still have your valuable real estate asset.
Renegotiating an ongoing business lease to get a lower rate is rarely easy. But if the economy has caused tenants in your area to be thin on the ground and your lease will be up for renewal soon, chances are good that if pushed, your landlord will give you a better deal.
Even if you have a long-term lease, try to renegotiate. If properties are empty around you and you open your books and show your landlord that without a reduction in rent your business won't survive, they might be willing to accommodate you. One possibility is to propose a significantly lower rent for the next year, with a built-in increase to kick in when and if your sales return to normal levels.
Be careful not to trade a short-term rent reduction for a significantly longer time commitment because you can't know for sure that this adjustment will be sufficient to keep you going. Also beware that in exchange for your requested rent reduction, your landlord might ask for your personal guarantee (even if you’re organized as an LLC). A personal guarantee will make you personally liable for the business loan, and giving it could imperil your personal credit and assets.
Unless you have a personal relationship with your landlord, it can often help to let someone else do the negotiating. A lawyer will know how to reassure the landlord that your business can survive if you resolutely reduce expenses, while at the same time suggesting that if you can't quickly reduce expenses, bankruptcy might be your only option. Landlords typically know that they might not get paid—or if they do, then they won’t be paid for many months—if you file for bankruptcy. So they’ll be more motivated to work with you to prevent your filing.
If your business is losing money, your real estate might now be your most valuable asset—make sure it's producing every penny of income it can. If you own, then renting out extra space can help you make your mortgage payments or even make you some extra money.
If you rent, then you can save money by splitting the rent. If your business downsizes, rent out unused space if your lease allows it (you might need to obtain your landlord's consent beforehand). You might even want to look at moving your business to another location and renting out your entire building.
You might conclude that it would be impossible to find a subtenant because other businesses also have surplus space. But it can put real dollars in your pocket to think again. List your vacancy online and canvass your area for a subtenant who can no longer afford space of its own.
Be creative. Even formerly fiercely competitive retailers might survive by operating out of the same space or combining offices, warehouses, or even small manufacturing operations.
Companies spend on salaries, benefits, and perks to keep workers happy and operations running. But you have several opportunities—for instance, cutting hours and pay—to reduce costs without laying any employees off. The more you already offer employees, the more you can save by cutting those extras and shifting around schedules.
When making these cost-cutting decisions, check that you’re complying with employment laws, especially if you’re planning to lay off employees. An employment law attorney can also help you make sure you’re following all state and federal laws.
Your business can and should cancel any extra perks, including:
After you’ve canceled extras, examine every other check your business writes. Even when cuts are more symbolic than significant—such as no longer buying pizza for meetings or renting parking spaces for employees—working hard to chop every possible expense sends an important message to everyone associated with your business that you’re determined to do what it takes to survive.
Benefits should be the next place you look to cut employee costs.
For example, if your business matches your employees' contributions to a 401(k) plan up to $1,000 per year or it has other generous benefits such as paying health club memberships, alternative wellness programs, or a pricey dental plan, seriously consider eliminating them. Although painful, when times are tough it's better to cut most benefits rather than to lay off people.
The one big exception is your medical plan. If you provide one, do your best to keep it, even if you have to cut your premiums by raising employee contributions and co-pays. For most people, health insurance is an essential part of their personal safety net, and if you don't provide it, they’ll look for an employer that does.
Payroll is the biggest expense for many small businesses. If this is true for your enterprise, it follows that cutting other expenditures alone is unlikely to produce the savings your troubled business needs. Sooner or later—and the sooner the better—you'll need to reduce the size of your payroll.
In bad economic times, when jobs are scarce, it's usually possible to cut pay by a small percentage and not lose employees. When deciding whose salary to cut first, you should follow your company’s hierarchy:
This cut-from-the-top approach usually makes sense for several reasons. First, it should help you save money without losing essential employees. Second, and perhaps more importantly, it sends a message to everyone connected to your company that you and other managers take personal responsibility for coping with tough times.
But before you cut anyone’s pay, look at your state’s wage and hour laws and review the Fair Labor Standards Act. Researching state and federal laws can save you down the line if an aggrieved employee sues. You can also run any employment law questions by an attorney first before you make any pay cuts or other decisions that affect your workforce.
Another way to spread the economic pain while saving jobs is to cut the work week.
For example, going to a four-and-a-half day work week saves 10% of payroll; a four-day week saves 20%. Similarly, putting a freeze on overtime hours will save you money.
If your employees are highly motivated to see your business through to better times (and appreciate the fact that the cuts avoid or reduce layoffs), the change won't significantly reduce productivity. People will realize that to keep your enterprise afloat they need to work a little harder and smarter to accomplish the same amount of work in less time.
A few employees might quit, but in a poor economy, most will be disposed to hang on to what they have.
Cutting jobs and showing loyal employees the door is never a pleasant prospect. But for many businesses where payroll is the biggest cost, it's the only realistic way to achieve needed savings. You’ll need to decide quickly how and when to make layoffs.
In the big business world, a CEO can order 10,000 job cuts without ever meeting anyone who gets laid off. But reducing a small workplace entails the excruciating task of laying off people you know well and are on friendly terms with. It's so hard that some businesspeople watch their business fail rather than wield the axe.
But to survive, you must accept the proposition that your duty to your employees is limited by economic reality. Remember, you hired employees in an effort to make a profit, not to pay them in all circumstances forever.
Always cut jobs, not people. Things are likely to go downhill further and faster if you base your cuts on the personal needs of the people who work for you, sparing those who have the most sympathetic personal problems. If you keep them, then it means you'll be cutting those who are more efficient or needed. Far better to look at the tasks that need doing and the people who can do them best.
In a very small enterprise, it’ll fall to you to decide which jobs must go. But if you depend on others to help with management decisions, it's extremely important to solicit their help in deciding who you should lay off, unless of course, you’ve decided that the manager must also go.
Managers, not you, probably have the best frontline knowledge of which tasks are essential and which are expendable. And because managers are the ones who’ll be responsible for accomplishing the essential work with a smaller staff, they’re likely to be highly motivated to hold onto the most talented workers who can do the most for the company.
If you’re far behind on your bills, and especially if you think you might have to close down because it will be impossible to catch up, consider asking your creditors to write off a portion of your debt. Negotiating with your creditors to lessen your debt might be just what you need to get your business through difficult times.
Your pitch should normally be along these lines: "Our company can't survive the economic downturn with its current debt load. But following our new frugal business plan, we can survive and prove to be a good long-term customer if our debts can be reduced on a one-time basis."
The creditor might be willing to accept as little as 40 to 60 cents on the dollar, especially if it believes you could go bankrupt without help—or if you’ve found a new source of income to tide you over (perhaps a hard-headed investor who will invest only if you reduce your debt load).
If you don't have cash to pay off a portion of your debt, you'll have a lot less leverage when it comes to trying to convince a creditor to write off part of it. As an alternative, you might be able to convince a creditor to instead convert your debt to a term loan with low initial payments. (Again, agreeing to sign a personal guarantee is probably unwise, especially if you have valuable personal assets and your business might fail anyway.)
Or if your creditor really believes in your future, you could offer them to trade your debt for an equity stake in your corporation or LLC.
Creditors will be far more likely to support your survival plan by writing off a portion of your debt if they really believe you’re taking the hard steps necessary to return your business to profit; consider opening your books to show them your business plan.
Because it can be difficult to beg for debt forgiveness while promising that your business can operate in the black if you receive it, it usually makes sense to involve a small business consultant or a business lawyer with debt settlement and bankruptcy experience. You can try to settle your debt with your creditors on your own first, and if that doesn’t work, hiring an attorney can be a great next step.
A call from a lawyer might be just what a creditor needs to realize that your offer is far better than a notice of your bankruptcy filing.
]]>But if employees who’ve already seen mass layoffs or pay cuts fear that your business might fail or that more layoffs are likely, they'll be quick to jump to any job that looks more secure. If your post-layoff workplace is poorly functioning, tense, and joyless, they are likely to leave even faster.
So how do you keep productive employees working for you as long as possible when your business is shrinking and you might even have imposed pay cuts? Start with a simple fact: If your employees feel fairly treated under the circumstances and believe you have set a course to outlast the economic downturn, they’re far more likely to stick by you.
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In good times or bad, your business will suffer if you don't keep the loyalty of your best employees. Just as it takes many small business owners three to five years to really hit their stride, top-notch employees—even those who can do skilled work from their first day—become more valuable every month they work for you.
Long-term workers build a valuable mental database of useful information about your products or services, customers, coworkers, and suppliers. If they move on, you lose everything they know.
To fully appreciate how valuable it is to keep good employees for as long as possible—especially during hard times when you have no time to train replacements—think about your own relationships with local businesses. If you've been dealing with the same competent person year after year, it's frustrating when that familiar face (or even familiar voice) is replaced by a less experienced one.
The decision to make layoffs challenges the employer-employee relationship and you, as the business owner, need to respond delicately to keep your remaining employees’ loyalty. So be fair, communicate, and listen.
"Fairness" is the best one-word prescription for keeping employees loyal to your business.
Workers who believe your business can be trusted to treat them equitably are likely to be loyal; those who feel they’re in untrustworthy hands are almost sure to move on. This feeling goes double when times are tough, unemployment is high, and your business is obviously struggling.
Basically, your business should use objective criteria—not whim or emotion—to hand out rewards and punishments. Put another way, it means that your business establishes and follows a set of employment policies that are understandable, consistent, and evenhanded.
For example, if you lay off a long-term, experienced employee but keep your lazy cousin, you risk convincing everyone in the company that despite your rhetoric about fairness, you can't be trusted. But if you adopt a merit-based system of promotion and stick to it—even though it means your cousin is let go—you go far toward reassuring all employees that they’ll be treated fairly. True, your aunt might snub you at the next family gathering, but that's a small price to pay to run a business that your employees will respect and stick by.
When it comes to wages, most employees use three factors to judge whether they’re being fairly treated:
It’s important to grasp just how essential it is even for employers with just a handful of employees to create logical, understandable, and defensible pay policies.
While it might make sense to reevaluate your company’s policies during layoffs, for some, it might not be the right time. Some companies might find it useful to consider how staff cuts might affect their overall pay policies. But others might choose not to add the difficult task to their already lengthy, post-layoff to-do list. Regardless of layoffs, it’s a good idea to review and update your pay policies on an annual or periodic basis.
When you create and reevaluate your company’s pay policies, consider consulting a human resources specialist. They can help you identify the changes needed, notify employees of the changes, and provide additional resources to both you and employees.
If a change in employment law has triggered a policy change, it could be a good idea to also reach out to an employment lawyer for guidance.
When people have been laid off (or if employees expect them to be), many of your employees will be fearful. It's no secret that if allowed to fester, these kinds of worries can have a seriously negative effect on your business. Productivity drops when people are distracted and anxious (or spend work time on online job sites), and your best employees could leave for what they perceive to be greener pastures.
To counter decreased productivity and early exits from employees, you need to honestly communicate how the business is doing, whether the news is good or bad, and do so quickly and often.
You can follow these steps to navigate the choppy waters of communicating layoffs to your remaining employees once your laid-off employees have been informed:
Once you’ve informed everyone about the layoffs and have fielded initial questions, it’s time to open the floor to ideas and suggestions for how your business can grow stronger. As the business owner, your job is to lead the discussion, not to control or monopolize it.
Everyone associated with your enterprise will be happier and your business more productive if you’re a frugal, hardworking leader, not a privileged dominator. At all levels of our society, leaders who work hard and are in touch with ordinary people command loyalty and respect.
If your employees regard you as a decent human—and not just the big boss—they’ll be far more willing to share their thoughts about how to improve the business, something that can be crucial to your survival in a severe downturn. No doubt some ideas will be more helpful than others, but you’re likely to find a few good ones mixed in with the less sensible ones.
To make employees feel comfortable sharing their thoughts and to capture the best ideas, you need to:
When implementing new ideas, be sure you include key employees in the process. New policies and procedures carried out with the input of the people who’ll have to cope with them day to day are not only likely to be more successful—but they’re far less prone to be sabotaged. Remember, employees who don't buy into new ways of doing things can always find ways to subvert them.
Far better to run your enterprise with a strong purposeful center at the same time you invite and respect employees' opinions, and treat them with dignity.
When employees are on edge and morale is low after layoffs, it’s more important than ever to invest in workplace climate. Show employees that you appreciate their hard work and recognize their achievements. If you encourage a positive work environment, employees will want to show up every day and give their all to a company they respect and enjoy.
It's simple, really: Employees strive to do better when they know their hard work and creative contributions are noticed. Showing appreciation is even more important when business is grim and you’re asking everyone for a little extra. Those employees whose good work isn't acknowledged are likely to conclude that there’s no point in busting their butts.
So whether you have five, 55, or 105 employees, develop an employee appreciation program. To make sure your program will be welcomed by your employees, it's best to create it with their input. If you don't, you risk adopting a plan that’ll be ignored or resented.
For example, if your well-meaning plan to pay bonuses to salespeople who bring in new business is regarded as a cynical ploy to make your overworked employees put in extra hours, you're unlikely to achieve your objective.
Finally, during tough economic times when everyone is forced to pinch pennies, it's best to keep your appreciation efforts simple, sincere, and cheap. Many rewards programs are designed (or at least seem designed) to influence or even manipulate employees' future behavior, rather than to simply acknowledge their good work.
Even if you don’t create a formal appreciation program, you can show your appreciation in a few simple ways:
Hogging credit for the business's achievements is a huge and common faux pas of small business owners. Just as professors are sometimes guilty of putting only their names on research done largely by their graduate students, owners of small enterprises are far too prone to act as if they alone made the business a success. Few things are more disappointing and insulting to employees who’ve worked hard and creatively to help build the company.
Try to foster a culture in which leaders go out of the way to acknowledge everyone's contributions. If those efforts mean that your company meetings sometimes sound like a roll call of every employee's achievements, so much the better. People work more creatively when they know their efforts are acknowledged and appreciated—especially when, in a recession, they’re asked to work harder for less pay and benefits.
Here are just a few ways to foster this attitude:
It's crucially important to encourage a culture of "we," not "me." If, when the limelight goes on, you can learn to step aside and nudge someone else forward, that's a good start. But to really help people feel appreciated, you'll need to go beyond fancy words and empty "employee of the month"-type programs to show people you really do value them.
In addition to paying decently, rewarding superior work, and providing good benefits (especially health care for all employees), adopting a simple stock option or other employee ownership plan can be the best way to literally put your money where your mouth is. That way your employees really do know that your business is about them, not just you.
When money is short and you’re chewing the insides of your cheeks with worry, it's easy to transfer your grim mood to your employees. If you do, your employees are in turn likely to transfer it to your customers—never a wise move when you desperately need customers to purchase more.
To avoid creating business-killing gloom, it’s important to understand how actually encouraging workers to enjoy themselves can be a powerful motivator.
Because workplace environments vary so much, the best advice is to find simple ways to let employees enjoy themselves, and then get out of the way and let it happen. Start by loosening up a bit yourself. For example, if, on Halloween, you plan a costume party and bring in some spooky treats to share, people will likely get the idea.
Once you’ve cut staff, all eyes will be on you. Your employees will look to you for direction and reassurance. And in their understandable unease, employees will also look closely at your behavior to make sure they can trust you—and subsequently, the business they work for—moving forward.
You’ve made the difficult decision to cut your workforce, and you need to make it count. If you were living extravagantly before the layoffs, it’s time to cut back and to put your business—and its aspirations—first. Be a role model and remind your employees why they got into their line of work in the first place.
Your employees and those who do business with you pay attention to how you spend money, especially when the business experiencing cutbacks is footing the bill. If you wear designer clothes, drive the biggest Beemer, and have your business pay your country club dues, you'll find yourself short of loyal employees.
You could also risk offending your banker, key suppliers, and customers, who sooner or later are likely to figure out that they’re paying for all those perks. The more ostentatious you are, the more harshly you’re likely to be judged.
You might not need to sell your beloved sports car or cancel your club membership. But be aware that if your business is facing financial difficulty and you’re asking others to make sacrifices, your employees likely don’t want to hear about your vehicle upgrades or upscale, members-only lunches.
Employees of successful small businesses are almost always imbued with a strong sense of purpose. It doesn't matter if you make or sell booties, bibles, or bagpipes—the key is to instill your company with a commitment to excellence, something that is especially important to maintain when a business is struggling financially.
There are several tried-and-true methods to help your employees believe in the value of their work. But no amount of cheerleading will work unless they really see that you run a high-quality operation.
For example, if you claim your café serves the freshest baked goods in town, but now that sales are down you occasionally slip a few day-old muffins in with today's batch, you'll begin to alienate your own employees.
If you do run a quality operation, helping your employees create and participate in a larger vision will go far toward cementing their loyalty. No question it can be tough to stick to the bigger picture when you’re fighting for every dollar, but it's not impossible.
Once your cash flow has stabilized and some revenue has returned, you might be tempted to quickly reverse the cutbacks you made, like hiring back employees you had to lay off. But before you think about increasing expenditures, your business not only needs to return to profitability, but also to dig itself out of its financial hole.
In many instances, instead of restoring benefits or hiring more employees, it might make sense to invest your money in other business needs, such as:
For example, if you borrowed $50,000, deferred the purchase of $25,000 worth of new equipment, and failed to repaint your tatty-looking building, you've got lots to spend money on before adding to your payroll expense.
A second reason not to restore jobs and pay too quickly is to avoid the possibility of a double dip. If, after a couple of months, your business again underperforms, it’ll be emotionally devastating to you and your staff to have to reimpose cuts.
To say your credibility as a leader will be shot is an understatement. Besides, if you did a good job with your layoffs—cutting your least important functions and your most inefficient people—it might not make sense to reverse these decisions, no matter how much business prospects improve.
Layoffs are messy and come with their own stack of paperwork. Before you deliver any layoff notices, it might be a good idea to speak with an HR specialist or even an employment lawyer. An HR specialist can help you with the layoff procedure while an employment lawyer can give you clarity on your employees’ rights.
If you’re in the post-layoff phase, it can still be useful to seek guidance. You can run any workplace changes by an HR professional. For bigger legal shifts in policy, talk to an employment law attorney.
]]>Late-paying customers usually fall into three categories:
For the first two categories, there is hope. You may be able to manage these debts and convince the debtors to make partial or full payment. As for the last category, you need to recognize this type as quickly as possible and take serious action -- perhaps turning the account over to a collections agency, discussed below.
Whatever collections efforts you make, one rule always applies: Get busy as soon as possible and stay on the account until you're paid. Send bills promptly and re-bill monthly. There's no need to wait for the end of the month. Send past due notices promptly once an account is overdue. For more information on sending notices and collecting debts, see Running a Side Business: How to Create a Second Income, by Richard Stim and Lisa Guerin (Nolo).
Here are some more tips:
For a clear explanation of the practical and legal information you need to run your business, read Legal Guide for Starting & Running a Small Business, by Fred Steingold (Nolo).
]]>Business debts that you share with another person—a spouse, partner, or cosigner—can raise some legal issues if you can't pay them, especially if you eventually consider filing personal bankruptcy to get rid of your business debt.
Whether you are liable for your spouse's business debts, or your spouse is liable for yours, depends mostly on where you live.
In "community property" states, including California and Texas, generally any debt incurred by one spouse during marriage (but before separation) is owed by both spouses. Likewise, in these community property states, all income made by either spouse during marriage, as well as property bought with that income, is community property, owned equally by husband and wife. This means that the business creditors of one spouse can go after the assets and income of the community (the married couple) to make good on that spouse's debt. (It follows that if that if only one spouse were to file for Chapter 7 bankruptcy in a community property state, all of the eligible debts of both spouses would be discharged.)
Community and Common Law Property States |
||
Community Property |
Common Law |
|
Alaska* | Nevada | Everywhere else |
Arizona | New Mexico | |
California** | Texas | |
Idaho | Washington | |
Louisiana | Wisconsin | |
*In Alaska, couples can elect to treat their property as community property | ||
**In California, community property laws also apply to registered domestic partners. |
EXAMPLE: Linda runs a fabric store in Houston, Texas; her husband is a local bank executive. Over the last few years, Linda's store has been suffering from poor sales, but the recession is the final nail in the coffin, as people all but stop spending money on customizing their houses. Linda closes her doors owing $35,000 to suppliers, $15,000 to her landlord, and $10,000 in other invoices.
Because Linda and her husband live in a community property state, these creditors can sue both Linda and her husband personally to collect the money owed. Linda no longer has an income to take, but her husband's is significant, and her creditors are able to garnish $5,000 of her husband's income per month until the debts are paid off.
You can agree to keep property separate. Couples in community property states can sign an agreement with each other to have their debts and income treated separately. This can prevent your spouse from being liable for your business debts. Signing an agreement now won't help your spouse escape personal liability for business debts that you already owe, but signing an agreement now (and then scrupulously keeping your assets separate) can protect your spouse from future business debts. See a lawyer with experience in postnuptial agreements for help in drafting this type of agreement.
In states that don't have "community property" laws (sometimes called "common law" property states), business debts incurred by one spouse are that spouse's debts alone. Debts are jointly owed only if 1) the debt was jointly undertaken—for example, if both spouses signed a contract requiring them to make payments—or 2) if the debt benefits the marriage (for example, the debt was for food, clothing, child care, or necessary household items).
Otherwise, business creditors of one spouse cannot legally reach the other spouse's money, property, or wages to repay a spouse's separate debt. However, if both spouses' income has been put into one joint account, a creditor may have the right to take at least 50% of the money from the joint account to pay a separate debt. In addition, the law of some common law states also provides that if you and your spouse jointly own property, such as a house, but a business debt is yours alone, the creditor cannot force a sale of the property by attaching a lien to it. (As to bankruptcy, if you alone (not your spouse) were to file for Chapter 7 bankruptcy in a common law state, only your separate debts and your joint debts will be discharged; your spouse's separate debts would not be discharged.)
EXAMPLE: Will Horton, the sole owner of Horton Rental, rents construction equipment and party furniture and supplies in Albany, New York. His wife Amanda is an independent jewelry appraiser who makes a good living. After a few years of strong construction rentals, Will's business drops off steeply as housing starts disappear. Will markets his party rentals heavily to help tide him over and tries to lower his debt costs by selling some of the construction equipment that is sitting idle. But after not being able to pay some of his bills for several months, a creditor is threatening to sue the Hortons.
Fortunately, because the Hortons don't live in a community property state, the creditor can't sue Amanda and garnish her income. And because the Hortons hold title to their house in "tenancy by the entirety" and live in New York, a creditor cannot put a lien on the house and force its sale as long as Amanda is alive. If Amanda and Will were to sell the house, however, the creditor would have to be paid off with Will's half of the proceeds.
Keep what's separate, separate. If you live in a common law state, you absolutely don't want to have your spouse personally guarantee your business debts. Unless your spouse cosigns a loan or personal guarantee, your spouse can not be held liable for your business debts if you keep your income separate (in a common law state).
All partners are personally responsible for all of a general partnership's debts. And because each partner has the legal power to obligate the partnership, creditors can come after your personal assets to collect on a debt even if another partner signed the deal and you did not. What does this mean for bankruptcy? If you were to file for individual Chapter 7 bankruptcy, you could get rid of your personal liability for the partnership debts, but the remaining partners would still be on the hook for 100% of the partnership's debts, unless they too filed for bankruptcy.
EXAMPLE: Adam and Steve, acquaintances from a Master's program in geology, form a partnership to assess and repair damage to California streams. They take out a $40,000 equipment loan, which Steve's parents cosign. Over a few years, they build a successful business by getting contracts from state and federal agencies.
But when the state suffers economic woes, payouts are frozen for three months, and 75% of Adam and Steve's jobs are cancelled. They try to continue business as usual, fearing they'll lose their employees forever if they lay them off. But after the money isn't unfrozen in month four, they begin to cut payroll, sell equipment, and sublet unused office space. Unfortunately, they are so far in the red by now that they can't make their loan payments or pay suppliers. With their backs to the wall, they decide to lay off their entire workforce and hibernate the business until the government is paying again.
As business partners, Adam and Steve are each personally liable for all of the business debts. Their main supplier sues over a $40,000 debt, and because there is no money left in the business, goes after Adam and Steve (and Pam, Steve's wife) personally to pay the debt. Steve has no income now, but Pam does, and the supplier can go after it because they live in a community property state and Pam is equally liable for the debt. After getting a court judgment against Adam, Steve, and Pam, the supplier garnishes 25% of Pam's paycheck.
Steve and Pam decide to file for Chapter 7 bankruptcy, meaning both spouses' debts will be discharged and Pam's paycheck will no longer be garnished. Most important, they can keep their house, since they have only $75,000 in equity in it, the amount exempt from creditors in their state. (See Nolo's article What Can Creditors Do If You Don't Pay?) After Steve and Pam's bankruptcy, Adam is still 100% liable for the supplier's debt. Because he owns assets that are not exempt and that creditors may take, including a vacation house, he takes out a second mortgage on the vacation house and pays the supplier.
The partners also default on the $40,000 equipment loan, but Steve's liability for it was discharged in bankruptcy, making Adam 100% liable for it, along with Steve's parents, who cosigned the loan. Adam refuses to pay, claiming that since he made good on the supplier's debt, he considers his half of the partnership debt paid. Eventually Steve's parents, the cosigners, pay off the loan rather than risk being sued and losing their house (but if they hadn't, the equipment lessors could have sued either Adam or Steve's parents or both).
Cosigners and guarantors legally guarantee that they will make debt or loan payments if you or your business don't pay off its oan. Because the cosigner or guarantor signed a personal guarantees, it makes no difference whether your business is organized as a sole proprietorship, partnership, LLC, or corporation -- the cosigner or guarantor has to pay the business's debt.
Unfortunately, even if you, the business owner, were to get out of paying a debt—say you file for Chapter 7 bankruptcy and get your liability wiped out by the court—your consignor or guarantor would still be legally on the hook to pay it. If this were to happen, you might not want to stick the cosigner or guarantor with the debt you just escaped (many close relationships have been ruined this way).
Inatead, you could legally "reaffirm" the debt in bankruptcy—basically, promise to repay it—and keep making payments after bankruptcy. Another option would be to make an informal arrangement with the cosigner or guarantor to eventually repay any amount they pay your creditor. Or you could file for Chapter 13 (repayment) bankruptcy instead; in that case, the cosigner would not be called to account until you completed your repayment plan, three to five years down the road.
Learn more about personal liability for business debts.
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