Handling Business Debts: Your Options

Bankruptcy, workouts, and other strategies for dealing with business debts.

These days, many small business owners have fallen deep into debt, so you're not alone. Perhaps sales have dropped off, expansion plans didn't pan out, or customers and clients are taking longer to pay their bills. No matter the reasons for your business's debt, take heart: You have options. The strategies available to you will depend on whether you are personally liable for the debts and whether you want to continue in business.

If your business is a corporation or limited liability company, and you have not personally guaranteed or otherwise taken legal responsibility for its debts, the business is responsible for paying its own debts. Creditors cannot come after your home, car, personal bank accounts, or other personal property, but instead must look to the business for repayment. (For help figuring out whether you might be on the hook debt-wise, see Nolo's article Are You Personally Liable for Business Debts?)

If, however, your business is a sole proprietorship or partnership -- or if you are legally responsible for its debt for other reasons (see the article above) -- your personal assets are at risk. In this situation, your options for dealing with debt depend on whether you want to close your business's doors or keep them open. A walk through both scenarios follows below.

If You Want to Close the Business

If you're going to close your business's doors, you have several options for handling your personal liability for the debt your business has accumulated. You may:

  • Do nothing and see what happens. One option that some business owners take -- often as a result of sheer exhaustion rather than careful planning -- is to just wait and see what happens with their outstanding debt. Some creditors, perhaps realizing that the debtor has nothing valuable to take, will give up their collection efforts after sending a threatening letter or two. On the other hand, some creditors will sue, get a judgment, and try to take your personal assets to satisfy your debt. If you have nothing worth taking now, these creditors may simply wait and hope you get a job or acquire some valuable property in the future, when they'll come back to collect.
  • File for Chapter 7 personal bankruptcy. Chapter 7 bankruptcy wipes out your personal liability for most common business debts -- including credit card debt, lawsuit judgments, and money owed to suppliers, consultants, and professionals. In exchange, you will likely have to give up any valuable business assets you own (and perhaps some of your personal property) to pay down your unsecured debt. You will probably also have to close down your business, at least while your bankruptcy case is proceeding. For more information on Chapter 7 bankruptcy for small business debts, see Nolo's article Can Chapter 7 Bankruptcy Solve Your Business Debt Problems?
  • Sell your business. Another option is to sell your business as a going concern and use the proceeds to pay off its debts, to the extent possible. But even in the best of times, it can be difficult to sell a profitable small business. When times are tough and a business is losing money, it can be nearly impossible to arrange even a bargain-basement sale. But there are exceptions. A business with a great reputation, market position, or location might find a buyer (perhaps a competitor) even when profits have disappeared. Businesses that have been historically profitable usually retain at least some value, even when they stop making money. A local business broker can help you determine whether this strategy is viable.
  • Liquidate your business. Rather than trying to sell their business as a going concern, some business owners close the business down, sell its assets, and then use the proceeds (perhaps along with some personal assets) to negotiate settlements with their creditors, often for a fraction of what they owe. Creditors may be willing to accept pennies on the dollar because it makes better financial sense than suing you and trying to chase down your remaining assets while hoping you don't file for bankruptcy (which probably would leave your creditors with nothing). By liquidating your business on your own rather than allowing the bankruptcy trustee to do it, you will likely get more money for your assets (and therefore, have more money to pay your creditors) than a bankruptcy trustee could get, and you won't have a bankruptcy on your credit report.

If You Want to Stay in Business

Some business owners will want to continue operations after getting some relief from their debts. This is most common when the owner believes the business could succeed once one or two missteps are corrected. For example, perhaps the underlying business could be profitable if not for debts resulting from an ill-timed expansion.

If you file for Chapter 7 personal bankruptcy, you will probably have to close down. And if your business has significant assets, you may have to give them up in Chapter 7 bankruptcy so they can be sold for the benefit of your creditors. Once the bankruptcy process is over, you may be able to start a similar business, but the business you have now will likely be gone for good.

If you have significant business assets and/or want to keep operating your business without interruption, you'll have to file for another type of bankruptcy or try to negotiate and settle your debts through a "workout": an agreement you reach with all of your creditors to settle your business's debts outside of court. Here are some things to keep in mind when you're weighing these options:

  • Chapter 13 bankruptcy. In Chapter 13 bankruptcy, you don't necessarily lose any property. Instead, you use a portion of your future income to pay some or all of what you owe your creditors, over a three to five year time period. If you make all of the payments required by the plan, most remaining debts are discharged when the plan ends. Unfortunately, Chapter 13 bankruptcy isn't a good solution for many small business owners. If you continue your business during your Chapter 13 plan, you'll be operating under the scrutiny of the bankruptcy trustee and devoting all of your money to paying off the business's debts -- often an impossible task for an enterprise that's already struggling to stay afloat.
  • Chapter 11 bankruptcy. In Chapter 11 bankruptcy, a company uses a set of procedural rules in the bankruptcy code to come up with a plan under which it will be able to continue its operations. Any business entering Chapter 11 must be represented by an attorney, who prepares a complicated set of disclosures and meets and negotiates with various creditor groups. All of the creditor groups must agree to the Chapter 11 plan proposed by the debtor business through its attorney, or the judge can approve the plan in spite of any creditor objections if the plan generally meets the best interests of the creditors overall. Once the plan is approved, it governs the business's future relationships with its creditors. Many Chapter 11 bankruptcies fail -- and attorney fees are often the reason: A Chapter 11 case can easily cost $50,000 to $100,000 in fees alone. Because of the cost and complexity, Chapter 11 is rarely a good solution for any but the largest businesses.
  • Negotiate a workout. A workout is sort of like a Chapter 13 repayment plan, without the bankruptcy court. In a workout, you negotiate with all of your business's creditors to settle the business's debts out of court. You make an offer to each of your creditors, asking them to take less than the full amount you owe to help you stay in business. But making a workout work isn't easy, primarily because you'll have to come up with at least some money for your creditors. Because your business probably doesn't have the cash available to pay off your creditors in a lump sum, you would need to get a loan, attract new equity investment, or pay your creditors regular installments from your business's income. All of these options are fairly difficult for a struggling business to pull off. Most businesses need the help of a savvy business lawyer to negotiate a workout.

Next Steps

If you're ready to wipe out your business debts with a Chapter 7 personal bankruptcy, get step-by-step instructions with Bankruptcy for Small Business Owners: How to File Chapter 7, by attorneys Stephen Elias and Bethany K. Laurence (Nolo).

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