File Business Bankruptcy Now or Later? 5 Signs the Timing Has Arrived

Most entrepreneurs think the choice to file business bankruptcy is a black or white decision. They either choose to file if the business is irretrievably damaged or not to file if there is any hope to save it. Choosing the right time to file bankruptcy is rarely simple, but a typical scenario would be if the business still has value worth saving, the pressure from creditors is making further attempts to negotiate unrealistic, and all out-of-court options have been explored and tried. Earlier in the process may be too soon, when there still is room to negotiate; filing too late may make the business worth far less, by losing customers and assets. From outside, an observer might assume an owner would never file until the situation seemed hopeless, the last ditch option, the final nail in the coffin of the business, the end. For a surprising number of businesses, this is exactly the wrong time to file. These five signs indicate it is time to file.

Signs of a Crisis

First, if the trend of your monthly numbers is negative - for example, profit, income, or sales dropping - and/or if the number of overdue accounts receivable or outstanding invoices is increasing, this indicates that your business is in crisis mode, perhaps long-term. Hitting a mid- or short-term low point is sometimes recoverable, but getting into long-term distress can be a sign of irreversible trouble. If a significant customer or inventory sale that was going to save the business, for example, suddenly looks less likely, it is a warning sign of a crisis. If your finances are showing no sign of hitting rock bottom and nothing is changing for the better, it is a good time to consider bankruptcy.

Before creditors start calling, check your balance sheet ratios to see if you might be headed toward insolvency, and your monthly statements to see if your cash flow is negative. Nonpayment or late payment of important bills, negative net cash flow, or a current ratio below 1.0 are signs of a crisis. Keeping cash below your short-term debts is a warning sign, particularly if your cash flow has been negative for more than a few quarters in a row. Why would you file bankruptcy when your assets are still more than your liabilities? The reasons are very pragmatic: you want to file when the assets still have value and are more likely to save part of the business.

Second, lawsuits and liens against your property mean creditors are fed up with waiting, and are likely fed up with your partial payments or excuses. If these lawsuits and your overdue accounts start to pile up, it may be time to file, before things get even more serious and you are dealing with foreclosures, and even post-judgment creditors’ remedies such as sheriff’s levies. It’s possible that filing for bankruptcy could at least temporarily get your business out of this situation. Know your options, including filing for bankruptcy protection sooner rather than later. That can start an automatic stay that stops most collection actions without a court order. Some actions aren’t covered, and the stay can be shorter than expected. After a sheriff’s levy or foreclosure sale, it may be too late to get the money back. Filing even a few days earlier may help you avoid these dire consequences, and save you some assets.

Third, many lenders will come to their own conclusions about your financial situation, in spite of your assurances. Some lenders will only negotiate a few times or give so many modifications before they give up. If any or all of your lenders and creditors refuse to talk with you or consider the possibility of an agreement, bankruptcy might be the only way to get those assets out from under crushing debt. If creditors no longer believe in you, but you still have a viable business or have plans to turn one around, filing for bankruptcy protection might be a worthwhile next step.

Fourth, some owners go so far as dipping into their own savings or retirement accounts to keep the business afloat. If this is an unsuccessful attempt to keep the business afloat, it can leave you in even worse personal shape than before. But if you’ve already tapped your personal savings or taken out personal loans, and still need to do so to run the business, bankruptcy might be something you want to think about sooner rather than later. Watch out for claw-back rules. Any payments of a certain size to some creditors too close to bankruptcy can be undone. The bankruptcy trustee may claw back some payments made within a year to insiders such as relatives or owners, or up to 90 days to other creditors. The longer a business waits, the more it risks a lender enforcing a personal guarantee. Pay the payroll taxes first. Using withheld tax money to pay vendors or loans can make you 100% liable for the trust fund taxes.

Fifth, some owners or managers wait and wait until their cash runs out, thinking they’ll get through on the last of their cash flow and then apply for bankruptcy protection, in the hope of saving some assets, usually as a Chapter 11, as a last-ditch maneuver. They hope it’s the solution to keep the ship afloat and the company running after all else fails, a sort of parachute out of the death spiral. But for many businesses, it does not work out this way, and may leave the owner with nothing to show for all their effort. Bankruptcy is expensive; there are court filing fees, many other costs and fees, and, for Chapter 11, not always inexpensive bankruptcy attorneys’ fees. And you must generally be able to at least pay these costs from the outset. It’s $1,738 to file Chapter 11 for now, in addition to lawyers’ fees. Subchapter V, a short-cut option for businesses of up to $3,424,000 total debt, skips the U.S. Trustee’s mandatory quarterly fees.

Filing too early can be as bad as filing too late. Bankruptcy is a public court proceeding, and becomes public knowledge. Alerting your customers and suppliers too soon may risk them bolting, cutting you off, or demanding payment up front. In Chapter 11 you will still need the court’s approval for anything out of the ordinary course of business. Filing for Chapter 11 protection from creditors without a plan can end in the dismissal of your bankruptcy or a conversion to Chapter 7, and the loss of what you came for.

In case of no viable future, Chapter 7 is an option. The trustee sells assets in Chapter 7. A company gets no discharge of any debts or taxes; only people get that. There is a $338 fee to file Chapter 7.

Legal and Financial Advisors

When you see the signs, bring in legal and financial advisors. Have financial statements, cash flow projections and tax returns ready for them. Collect all leases and contracts. Delay too long and you can lose any chance at saving your business.