Tests For Financially Troubled Small Business

Considering business bankruptcy

The hardest question for the owner of a small business considering bankruptcy is whether the business has a future or not.

To chart a path forward, you have to pin down some facts:

  • What has caused the problems the business now faces?
  • Are there prospects for change?
  • Can filing bankruptcy effect change?

Limits to reorganization

Reorganization can’t create a market; increase gross revenue, or make up for a poor fit between the skills available and the skills required to run the business.

Reorganization could free up cash from servicing the old debt to fund current operations;  permit rejection of leases or contracts that are no longer advantageous (an expensive facility lease or improvident equipment purchase); or prevent the loss of vital assets or cash to creditor collection actions.

Bankruptcy for an orderly sale

A reorganization in Chapter 13 or Chapter 11 could provide a breathing space for the owners to sell the business as a going concern or or its assets in something other than a fire sale.

The resulting proceeds could pay taxes or unpaid salaries.  The sale of the business could provide ongoing jobs for the work force under new ownership.

The bankruptcy could then be converted to Chapter 7 or dismissed if bankruptcy protection is no longer needed.  The court will probably condition dismissal of the case on payment to creditors of the sale proceeds.

Considering reorganizing

Does management have the resources and desire to engage in the reorganization process?

Bankruptcy reorganization in Chapter 11 requires significant time on the part of the owners and managers to comply with the requirements of the bankruptcy system.

The “bankruptcy bargain” is that, in exchange for the protection of the automatic stay and other bankruptcy protections, the debtor provides full disclosure of its financial condition to creditors and the court, both at the beginning of the case and on a monthly basis thereafter,  and operates as a fiduciary for its creditors while the bankruptcy is ongoing.

Legal expenses are significant.  Most reorganizations fail, usually for lack of a real plan to solve the problems.

Is the business one that the owners could start up again after a liquidation of the current business?

Businesses that require little capital, have few assets, or are really just extensions of the owner’s skills and personality are ones that it may not pay to reorganize.  The owners may be better off liquidating the business, in or out of bankruptcy, and starting over in a fresh entity.

This can be a complex issue and requires good professional advice to do correctly.  Thoughts on finding a bankruptcy lawyer.

When Chapter 7 is best

A Chapter 7, whether for the individual or a corporation, may be the best choice when

  • the business has no future,
  • it has no substantial assets or qualities that cannot be reproduced,  or
  • the debts are so overwhelming that restructuring them is not feasible.

Individuals can get a discharge of the dischargeable debts and a chance to start over.

Corporations don’t get discharges in bankruptcy, but a Chapter 7 can provide an orderly liquidation under the direction of the trustee and at no expense to the debtor.

Creditors are assured that they will be paid to the extent of the assets available and the priority of their claim.

Former management is assured that the assets that are available go (after the expenses of the Chapter 7) to pay taxes for which the individuals may be liable.

More on business issues

Winding down a small business, step by step

Business bankruptcy FAQ

Separating the business from the owners

Image courtesy of @boetter

About the Author
Northern California bankruptcy lawyer Cathy is a 30+ year veteran of bankruptcy practice in the Silicon Valley. She is known for energetic representation of clients and her command of bankruptcy law.