Small business bankruptcies on the rise

Small business bankruptcies are on the rise, seeing a nearly 30 percent rise in Chapter 11 bankruptcy — which allows the company to reorganize its debts and restructure the company — filings over a 12-month period, according to the American Bankruptcy Institute. Thankfully, small businesses aren’t seeing the same rise in Chapter 7 bankruptcy, which is the type that liquidates assets to pay off business debts.

If you’re considering filing for a small business bankruptcy, consider which type will help your business the most. You should also consider alternatives that may keep you from filing for bankruptcy in the first place.

Small business bankruptcy statistics

Is there a rise in small business bankruptcies?

There is a 16 percent rise in commercial bankruptcy filings from September 2022 to September 2023, according to the American Bankruptcy Institute, and a 29 percent rise in Chapter 11 bankruptcies. But what does the rise in small business bankruptcies mean?

Small businesses may file for bankruptcy for a number of reasons, as they face unique challenges that their large business counterparts don’t face.

According to Greg McBride, “Small businesses are more susceptible to higher interest rates and tighter credit. Many are also tied more closely to the fortunes of Main Street, so increasing financial strain among consumers can weigh disproportionately on a small business that doesn’t have the broader geographic diversification of a large, national or multi-national competitor.”

Types of business bankruptcies

As a small business, you can file for bankruptcy in a number of ways. Which chapter of bankruptcy works best for you will depend on your financial state and whether or not your business can reorganize itself to pay off debts.

You can work with a bankruptcy lawyer, a debt relief credit counselor or a commercial financial advisor to determine the best route for your business.

Alternatives to business bankruptcy

Before you nosedive into a business bankruptcy, understand that you do have options to help keep your business running even when you or your business is in poor financial condition. Those options include:

• Credit counselor or financial advisor. Seek advice from a debt relief counselor or financial advisor to go over your business finances and revenue. These experts can help you come up with a plan that doesn’t involve filing for bankruptcy.
• Debt consolidation loans. You can take out a business debt consolidation loan to pay off multiple debts. Then, you can focus on the one debt consolidation repayment. You may be able to lower your monthly debt obligations if the debt consolidation loan offers longer terms than your previous loans.
• Restructuring the business. Do a cash flow analysis and analysis of the value-add for different areas of your business. Then, you can decide where to cut spending, which may involve tough decisions like letting employees go or discontinuing products or services.
• Alternative business funding. To give yourself a runway that allows you to turn a profit, you can apply for business grants, which don’t require you to repay the funding. You can also start a crowdfunding campaign, either to raise money that you wouldn’t repay or to raise capital from individual investors that you would repay.
• Discovering new sources of revenue. You could think of this timing as an opportunity to create a new product or offer a new service that would diversify and bring in new revenue.
• Running the business as a side business. If the business needs time to recover, you could become employed elsewhere and run your business on the side. You may decide to forgo a salary to allow the business time to turn a profit. This is a common strategy for many startup business owners.

What happens when a business files for bankruptcy?

The exact order of events when a business files for bankruptcy will depend on which type of bankruptcy your business files for, but most include the following steps:

1. File a petition with the bankruptcy court. First, you’ll file a petition with the bankruptcy court that’s in your district. The district is based on your business’s address.
2. Submit any documentation. You may be required to file business financial statements or a debt and business reorganization plan. You’ll file the documentation requested either by the court or your trustee.
3. Receive credit counseling. In some cases, you will receive credit counseling either from a certified credit counselor or through working closely with a U.S. trustee providing oversight to your reorganization plan.
4. Attend meetings. You’ll be required to attend meetings with the court, your trustee or a credit counselor.
5. Liquidate assets or commit to a payment plan. Finally, you or a trustee will carry out the bankruptcy plan. That could mean selling your assets or simply running your business and sticking with a new debt repayment plan.

What happens to personal assets when a business goes bankrupt?

What happens to a business owner’s or partner’s personal assets will depend on the type of bankruptcy filed and what type of business entity was formed. In a sole proprietorship or partnership, business and personal assets may be seized to pay back debts.

For incorporated businesses, there is a more established separation between the business and business owners or partners. Business owners shouldn’t have their personal assets seized, although they may lose money on stocks held with the company.

What happens when a business owner goes bankrupt?

A business owner going bankrupt may affect the business if the business is a sole proprietorship, as there isn’t a separation between the business and the individual’s finances. Both business and personal assets — like a home or car — may be considered when liquidating or restructuring debt repayments.

A business owner going bankrupt may not affect an incorporated business as long as the business itself is on solid financial footing.

Can a business file for bankruptcy and still stay open?

Yes, a business can file for Chapter 11 bankruptcy and stay open. Your business will restructure itself and/or reorganize and negotiate debt repayments to help manage the repayment plan. To keep your business open, you’ll need to follow this reorganization plan closely and submit any required ongoing documentation.

You may also stay open if you file a Chapter 13 bankruptcy as an individual, which involves reorganizing personal debts and making a plan to repay them. If you’re a sole proprietor, you’ll need to make sure your business is sustainable, so you have the income needed to repay your debts. If not, you may need to look for employment elsewhere.

Bottom line

Small business bankruptcies are on a steep rise, with a nearly 30 percent increase in Chapter 11 filings, according to the American Bankruptcy Institute. Yet bankruptcies aren’t your only course of action if your business is in poor financial condition. With a little forethought or the help of an expert, you can discover ways to avoid bankruptcy, such as consolidating your debt, cutting expenses, bringing in new revenue or negotiating your debts.

If you do need to file for bankruptcy, you can consider a Chapter 11 bankruptcy, which could help you remain open while working out a plan to repay debt. Chapter 7 bankruptcies are typically used as a last resort and involve liquidating your assets to pay off debts, which can lead to closing your business. Be sure to consult with a financial expert and understand all of your options to make the best decision for your business.

Frequently asked questions

• What causes most bankruptcies in businesses?

  The main cause of businesses failing is poor cash flow management, according to SCORE. Here are the top five most common reasons that SCORE states businesses fail:<br /><br />

  • Cash flow problems (82%)
  • No market need for products or services (42%)
  • Run out of cash (29%)
  • Don’t have the right teams (23%)
  • Outcompeted by other businesses (19%)

• What should you do if your business closes and owes you money?

  Unfortunately, if you have to close your business and the business still owes you money, you may have to take a loss. As an alternative, you could offer your product or service as a side business and continue to pay yourself as the business profits until the money that’s owed is fully repaid.

• Did businesses struggle in 2023?

  Yes, the nearly 30 percent rise in Chapter 11 small business bankruptcies indicates that small businesses struggled more than usual in 2023 than they have in past years.<br /><br />Greg McBride states, “The U.S. economy is expected to slow further, and interest rates will remain at high levels for some time to come. Even if the broader economy skirts a recession, there will be communities or lines of business that feel the brunt to a greater extent and the smaller businesses will be most impacted by that.”