This is the ninth edition of my New Regular series, dedicated to helping small businesses cope with the one-two punch of the coronavirus pandemic and associated economic constraints. Normal was just sighted in a homeless shelter in the north of France.
The subject today is a serious and troublesome one. No amount of lipstick will make the bankruptcy pig pretty. But as we roll into the post-pandemic era, we should improve our understanding of it.
You can be technically bankrupt without being legally bankrupt. At some time in their existence, most businesses will experience an upside-down state of negative net worth, where liabilities exceed assets. It’s likely that such a condition will pass unnoticed, possibly even by the owner, because the business might not be insolvent.
Insolvency is a pre-bankruptcy state of financial distress when near-term payment obligations exceed cash-generating ability. This condition is not only noticed, it’s consuming. If you dig yourself out of insolvency and avoid bankruptcy, that becomes a badge of honor. Yes, your humble correspondent knows something about that.
Blasingame’s 2nd Law of Small Business states: “It’s redundant to say undercapitalized small business.” With limited financial resources and surrounded by risks ranging from annoying to existential, the potential for bankruptcy is always hard by to small business owners as they push their chips to the middle of the table almost every day.
To gain a better understanding, let’s look at some bankruptcy numbers, facts and, believe it or not, even a little lipstick.
U.S. business bankruptcies over the past five years have averaged 23,000 annually. Since small firms represent over 95% of the business sector, you can do the math on the break-out.
In 2020, we’re suffering the wages of the coronavirus shutdown(s), causing various industries to report staggering permanent closure numbers. And since bankruptcy can include legal protection for the personal assets of a debtor, no doubt thousands of Main Street business owners will seek it over the next 12 months.
Consider these two references to frame that projection.
- In 2009, the first full operating year following the September 2008 financial collapse – our last comparable experience with a national economic crisis – business bankruptcies tripled that five-year average at over 60,000.
- In our recent online poll, we asked small business owners what they knew about bankruptcy law reforms benefiting small businesses. Half of our respondents allowed that they might need to know more. A year ago, that number would have been less than 25%.
Here’s the essence of the three business bankruptcy options:
Chapter 13 is the reorganization option for individuals, which includes sole proprietors, contractors, and freelancers, whose businesses, by definition, have not been formed as a legal entity separate from the owner. This option combines protection of certain assets with a re-payment plan established by the court.
Chapter 11 allows legally formed business entities, such as a corporation, a Limited Liability Company (LLC), or a partnership, to reorganize while continuing to operate, and if successful, eventually “exit” bankruptcy. Historically, this has not been a feasible option for most small firms.
Chapter 7 is the extreme option for individuals and businesses – asset liquidation. All assets are sold, and the court doles out the cash to debtors, after which there is no further obligation or contact between debtor and creditor.
If there is such a thing as bankruptcy good news, here it is: This year, there’s new bankruptcy lipstick serendipitously available just as the pandemic hit. As a result of the 2020 Small Business Reorganization Act, that reorganization feasibility issue for small businesses has been reformed. The new law makes it easier, quicker, less expensive, and less risky for small businesses (remember, reorganization means you keep your company).
Chapter 11, Subchapter V now includes, but is not limited to these improvements:
- It reduces the risk of a creditor forcing the company into Chapter 7.
- Shareholder equity is less in jeopardy.
- A petitioner (debtor) can “cram down” a reorganization plan over the objections of creditors.
- The process is faster, thus cutting expenses and allowing the debtor to focus on successful reorganization and live to fight another day.
Consequently, small businesses finally have the same reorganization ability large businesses have had, like GM, Chrysler, several banks, most of the airlines, and dozens of large retailers.
As in 2008-09, through no fault of the petitioner, the coronavirus shutdown will result in a spike in business and personal bankruptcies in the coming months. But even though pretty isn’t an option, America’s bankruptcy laws were created to be more about second chances and less about shame.
One of the reasons Europe is less entrepreneurial than the U.S. is because every risk taken there comes with the burden that failure by the parent accrues to the children. But part of the foundation of America’s greatness is something these famous people learned about the entrepreneurial alloy forged from risk and redemption: Abraham Lincoln (1830s), R.H. Macy (1855), Henry Ford (1901), and Walt Disney (1923). Of course, we knew about them after they filed for bankruptcy.
You can recover from bankruptcy – in time. But make no mistake. Taking bankruptcy is an extreme legal and financial step that should not be taken lightly – it will always be part of your record.
If you think you’re in financial trouble, you probably are. Don’t wait too long to contact an attorney about your asset protection rights and reorganization options under the law (don’t trust this make-up artist). Because the only thing worse than taking bankruptcy is being forced into it.
Write this on a rock … Information is power even when – especially when – you’re up against it.