Several times a week, I will have someone contact our office, telling me they need to file a business bankruptcy. Sometimes, they are right. However, most of the time, a business does not actually need to file for bankruptcy. In this blog post, we’ll discuss when it does and doesn’t make sense for your business to file for bankruptcy.
The first thing to consider is whether your business needs to file bankruptcy, you personally need to file bankruptcy, or a combination of the two.
If you don’t plan to operate the business in the future and did not personally guarantee the debt, depending on the types of debts your business has, neither you nor the business may need to file bankruptcy. Instead, you can potentially let creditors for the business liquidate any assets the business has, and you and the business can walk away. Since there are no assets in the business, other creditors won’t have much to go after to collect from the business. If you didn’t personally guarantee the debt, then they can’t go after you.
If you’ve decided to shut down the business or stop operating it and you’ve personally guaranteed business debts, the business may not need to file a bankruptcy, but it may (and usually does) make sense for you to file a personal bankruptcy to protect your property from business creditors. Many times, a business owner will think they have not personally guaranteed debt when, in actuality, they have. It’s very important to check your loan agreements to see if there is a personal guarantee on the debts.
If you hope to continue operating the business, your bankruptcy options become a bit more limited. You may still want to consider a personal bankruptcy to limit or remove your personal liability for business debts.
So, let’s discuss more situations where it may make sense for a business to consider filing bankruptcy.
Warning Signs That Your Business May Need to File for Bankruptcy
Running a business is tough—and sometimes, financial trouble becomes more than just a temporary cash flow issue. But how do you know if your business is beyond repair and might need to file for bankruptcy?
Here are a few warning signs to watch out for:
Missed Payroll and Vendor Payments
If you’re struggling to make payroll or are months behind on paying suppliers, it could be a sign that your business isn’t generating enough revenue to stay afloat.
Growing Debt With No Relief
Constantly borrowing to stay open or maxing out credit cards to keep the lights on may mean you’re in over your head. When your liabilities consistently outweigh your income, that’s a red flag.
Lawsuits or Collection Actions
If creditors are suing your business or threatening legal action, bankruptcy may help stop those actions and give you time to regroup.
Dipping Into Personal Finances
When business owners repeatedly use personal savings or retirement funds to cover business expenses, it’s often a sign the company is in serious trouble.
If you’re facing any of these issues, it might be time to ask if filing for bankruptcy is worth considering. Learn more about what’s required when a business owner files personally and how that impacts the business in this guide on what is needed for your business if you file personal bankruptcy.
Understanding the Types of Business Bankruptcy
Once you realize your business is in financial trouble, the next step is figuring out what kind of bankruptcy might be right for you. The U.S. Bankruptcy Code offers several options depending on how your business is structured and your goals.
Chapter 7 – Liquidation
This type of bankruptcy is best for businesses that don’t plan to continue operating. Under Chapter 7:
- The business stops all operations.
- A court-appointed trustee sells off assets.
- The money is used to pay creditors as much as possible.
A Chapter 7 bankruptcy is common for sole proprietors and small businesses with few assets. Remember, you may need to include business assets if you’re filing a personal bankruptcy as well. This guide on listing business assets in personal bankruptcy offers more on that.
Chapter 11 – Reorganization
Chapter 11 is designed for businesses that want to stay open while restructuring their debt. It:
- Allows time to create a repayment plan.
- Keeps the business running under court oversight.
- Can be complex and expensive.
A Chapter 11 is typically used by larger businesses or those with multiple income streams.
Chapter 13 – Repayment Plan (for Sole Proprietors)
If you operate as a sole proprietor, Chapter 13 may be an option. It lets you:
- Repay debt over 3 to 5 years.
- Keep personal and business property.
- Avoid liquidation and keep running your business.
Understanding which chapter fits your situation depends on your business structure and financial goals. For deeper guidance, check out the U.S. Courts’ Bankruptcy Basics.
Personal Liability and Business Debt
What happens if your business can’t pay its debts—but you’re personally on the hook? That depends on how your business is set up.
Sole Proprietors Are Personally Liable
If your business is a sole proprietorship, there’s no legal separation between you and your business. That means:
- Creditors can come after your personal assets.
- You may need to file for personal bankruptcy.
- Personal and business debts are treated the same.
LLCs and Corporations May Offer Protection (But Usually Don’t)
You’re generally not personally liable for business debts if your business is structured as an LLC or corporation. These legal entities are designed to shield your personal assets from business liabilities.
However, most business loans and credit lines require a personal guarantee in today’s lending environment. This means:
- You are personally on the hook for the debt, even if the business fails.
- Lenders often ask for personal guarantees unless the business has significant collateral that isn’t already tied up with liens.
- Your personal credit and assets could be impacted even if your business is a separate legal entity.
So, even if you’re incorporated, check your loan agreements carefully. If you personally guaranteed any business debts, you might still need to consider personal bankruptcy protection.
To understand this better in the context of business taxes, see whether you’re personally responsible for taxes owed on your business.
IRS Debt and Bankruptcy
Owing taxes complicates things. The IRS has its own rules, and some tax debts might not be eliminated in bankruptcy. Their bankruptcy tax guide outlines what to expect if you owe taxes when filing.
Bankruptcy Alternatives to Consider First
Before you file for bankruptcy, explore other options that might help you get back on track without the legal and financial impact.
SBA Loans and Government Programs
The U.S. Small Business Administration (SBA) offers resources and financing to help businesses in distress. Some SBA-backed loans can refinance existing debt or help with cash flow issues. Learn more from the SBA’s guide to closing or selling a business.
Debt Settlement or Consolidation
You may be able to:
- Negotiate lower payoff amounts with creditors.
- Combine high-interest debts into one manageable payment.
- Work with a credit counselor to develop a plan.
Creditor Negotiations
If your financial troubles are temporary, some creditors may agree to:
- Reduce your monthly payments
- Extend your repayment timeline
- Waive late fees
For more non-bankruptcy options, this guide outlines helpful alternatives for filing bankruptcy.
What Happens After You Decide to File?
If you’ve decided to move forward with filing bankruptcy, it’s essential to understand the immediate and long-term effects.
The Automatic Stay
As soon as you file, an automatic stay goes into effect. This legal protection:
- Stops all debt collection efforts.
- Pauses lawsuits and foreclosures.
- Gives you time to reorganize or liquidate.
Read more about how the automatic stay can help protect your business while filing.
Informing Creditors
Some business owners ask: Should I tell my creditors I’m filing? In many cases, it’s best to wait until the automatic stay is active. However, if you’re negotiating a deal or payment plan, it may be worth a conversation.
Here’s a helpful post on talking to creditors before filing bankruptcy.
Legal Support and Representation
Filing for bankruptcy is complex, with paperwork, deadlines, and legal terms. Working with a bankruptcy attorney ensures:
- You choose the right chapter.
- You protect your personal and business assets.
- You meet all filing requirements.
Do you need a lawyer? This post explains why it’s important to hire a bankruptcy attorney.
Bankruptcy’s Long-Term Impact
Rebuilding or Closing Down
After bankruptcy, you’ll need to decide whether to:
- Shut down the business permanently
- Start fresh under a new entity
- Continue operating with a restructured debt plan
Impact on Credit and Future Loans
Bankruptcy will affect your credit. Depending on the chapter filed, it may stay on your credit report for 7 to 10 years. While it doesn’t mean you can’t borrow again, lenders may be more cautious.
If you’re worried about how bankruptcy may affect your ability to secure financial help for future opportunities, this guide offers key insights into the impact of bankruptcy on getting financial aid.
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