Bankruptcy Basics: What Happens When a Business Files?

Bankruptcy Basics: What Happens When a Business Files?

In the business world, bankruptcy is a bad word. No one wants to think about it, and it’s certainly not an option that small business owners take lightly. Unfortunately, bankruptcy is fairly common; it’s a process used by struggling or failing businesses to meet their financial obligations and save face with investors, as much as that is possible. 

When considering bankruptcy for your business, it’s important to understand what bankruptcy is, what it isn’t and which type is right for your specific needs. The following overview should give you a better idea of what to expect if it seems that bankruptcy is in your business’ future. 

What Is Bankruptcy?

In its most basic sense, bankruptcy is a legal proceeding that struggling or failing organizations file in hopes of either salvaging their business by restructuring or minimizing financial loss by closing completely. All bankruptcy cases are handled by federal courts following federal laws. 

When a business files for bankruptcy, it has the option of either restructuring the business and reorganizing its debts or liquidating all its assets in order to repay investors and creditors. A company considering bankruptcy determines the best option for their situation, as well as factors unique to their organization; each bankruptcy proceeding is different. 

Different Types of Bankruptcy

There are two types of bankruptcy that a struggling company may choose. This also depends on whether there is any chance for recovery or whether closing up shop is the only option. These two options are Chapter 7 and Chapter 11. 

Chapter 7 Bankruptcy

Chapter 7 bankruptcy is for businesses that are too deep in debt or financial struggles for the possibility of recovery. If there is no hope of turning things around, an organization’s best bet is to liquidate all assets in an attempt to repay debtors and investors. 

During a Chapter 7 proceeding, the company is required to stop business and a trustee appointed by the court is tasked with liquidating the assets and distributing funds. Funds are distributed to secured creditors first, such as those who loaned money with collateral, with whatever is left going to unsecured creditors, or those who did not have collateral on their loans. This usually includes bondholders. 

Chapter 11 Bankruptcy

Businesses that utilize Chapter 11 bankruptcy are those that have the possibility for recovery. Taking advantage of the proceeding to restructure the business and reorganize their debts may lead to getting back into the black.

Chapter 11 bankruptcy puts more control into the hands of the company, as it can continue to stay in business and trade stocks and bonds. However, unless the organization can restructure its debt and improve its financial stability, it may still have to resort to complete liquidation. 

Getting Help

Filing for bankruptcy is a serious and important step for failing businesses. However, it doesn’t have to be the end of the road. With professional help and guidance through the process, many companies are able to bounce back.