Here's What Happens When Your Small Business Files for Bankruptcy

It's happening. The balance sheet is coming up red, and there's no shoving it back into the filing cabinet. Things are looking grim. You consulted with stakeholders and a qualified bankruptcy attorney, and together, you decided your small business would file for bankruptcy.

Though bankruptcy numbers fell post-pandemic, they've climbed back up again. Year over year, bankruptcies have risen by 18%, according to the American Bankruptcy Institute (ABI) and Epiq Bankruptcy. Fed rate hikes may be partly responsible (debt has become costlier).

Declaring bankruptcy is no small thing. There are two major types of bankruptcy: Chapter 7 and Chapter 11. Here's what happens when your small business files for bankruptcy.

Chapter 7

Small business owners who see no path to profitability may file for Chapter 7 bankruptcy, which liquidates (shuts down) the business completely to settle debt.

Once you decide to move forward with Chapter 7, you may be required to undergo a means test comparing income and expenses. Individual proprietors (not corporations) may need credit counseling 180 days before filing.

Once that's handled, you can petition the bankruptcy courts.

What happens after you file

1. Debtors can no longer contact you to collect debt.
2. A court-appointed trustee takes control of your assets and sells them to settle debt.
3. Remaining debt is discharged, meaning you're no longer on the hook.

After your debt is discharged, your business shuts down, and the court case ends. The bankruptcy is effectively over and done. You must deal with the consequences of filing for bankruptcy, but most, if not all, debt is settled (there are exceptions).

Chapter 11

Small business owners who see a potential path to profitability may file for Chapter 11 bankruptcy, which reorganizes debt to make it payable.

Once you decide to move forward with Chapter 11, you may be required to undergo credit counseling. You'll want the accounting books handy, because the courts will require detailed financial records of your business operations.

Once you're ready to file, you can do so in bankruptcy courts.

What happens after you file

1. Debtors can no longer contact you to collect debt.
2. You must develop and submit a plan for profitability.
3. Creditors and courts must approve your plan.
4. You must follow through and make progress reports.

Once your plan is successful, your small business can shed its bankrupt status, and the case is closed. Ideally, your business is healthy and better-organized post-restructure. You will likely have paid thousands in fees to get to this point.

How much does it cost?

It depends on a few factors, including your hired attorney, the complexity of your case, and the type of bankruptcy you're filing. For reference, debt.org provides a few total cost estimates:

• Chapter 7 bankruptcy is estimated to cost $1,788, most of which is attorney fees. It's typically the cheapest form of bankruptcy filing because the business doesn't need to be reorganized.
• Chapter 11 bankruptcy is estimated to cost $19,738, the vast majority of that going to attorney fees. Should you need an accountant to organize your finances, prices could go way up.

Alternatives to declaring bankruptcy

Bankruptcy has clear perks -- no more debt! -- but it can be lengthy, expensive, and complicated. Not always, but often. Before filing, small business owners may want to exhaust other options.

Debt settlement is an option. You can negotiate down debt with debtors if you can convince them you're unable to pay their loans as planned. They may prefer to lighten your load if the alternative is getting paid nothing at all.

A debt consolidation loan is another option. You can consolidate your debt so it's easier to pay. For example, you could combine two $10,000 loans with interest rates of 10% into a single $20,000 loan with an 8% rate, shrinking your total interest payments.

Definitely consider consulting a bankruptcy attorney before filing. It'll cost you to hire one, but it may be worth the payment to settle debt or save your business from going under. Speak to an attorney to ensure bankruptcy has minimal impact on your credit score.

>> More: What happens when individuals file for bankruptcy?