Bankruptcy is becoming increasingly common among small businesses in America.

• According to the American Bankruptcy Institute, bankruptcy filings under Subchapter V, which is commonly used by small businesses, have surpassed the previous year's rate.
• In 2019, Chapter 11 of the U.S. Bankruptcy Code was amended to streamline the process and reduce costs for small businesses seeking to restructure their debts.
• Not all struggling businesses should choose bankruptcy, whether through Subchapter V or another option.

Small business bankruptcies are on the rise.

Through October, Subchapter V filings have surpassed the number of filings for the entire year in 2022, with 1,659 filings compared to 1,553 for the full year earlier, according to the American Bankruptcy Institute.

The Small Business Reorganization Act of 2019 (SBRA) introduced Subchapter V to Chapter 11 of the U.S. Bankruptcy Code, providing a simpler and more cost-effective way for small companies to reorganize their debts and get back on their feet. As a result, it has become an increasingly popular tool for troubled small businesses. However, determining whether it is the right move for your business can mean the difference between a successful repositioning and an epic failure.

For businesses facing financial difficulties, bankruptcy may not always be the best solution. Here are some alternative steps business owners should consider.

Timing is key in declaring bankruptcy

Seeking professional help is crucial for small businesses before their assets are repossessed or lights are shut off.

James Mohs, an associate professor in the accounting, taxation, and law department at Pompea College of Business at the University of New Haven, stated that while always hoping to find a solution is important, recognizing when it's impossible is crucial.

The first step in resolving your business's financial difficulties is to consult with a bankruptcy attorney who can assess your options and determine the best type of bankruptcy for your situation, according to Mohs.

"After exhausting all other options, the right time to declare bankruptcy is," Mohs stated.

What other options do you have to bring in money without taking on significant risk?

Be wary of short-term funding options

The availability of capital for small businesses is at a low due to the recent Federal Reserve rate hike campaign. Business loans are now being offered at double-digit percentages, which has caused concern among small business owners. A recent survey by Goldman Sachs found that 78% of small business owners are worried about their ability to access capital, and 53% say they cannot afford to take out a loan in the current interest rate environment. Additionally, 21% of small business owners have stated that they would close their business if the credit market does not become less restrictive. The Federal Reserve is not currently planning to consider a rate cut before the middle of next year at the earliest.

Some businesses may be tempted to use merchant cash advances for short-term funding, but it can be a costly mistake.

A merchant cash advance allows business owners to receive a lump sum and repay with future sales, but this can be risky if the business is struggling. Similarly, maxing out credit cards is not a wise financial decision.

Mohs stated that it is crucial to avoid having a business bankruptcy lead to a personal bankruptcy as it can have long-lasting negative consequences.

Protect your assets before it is too late

Even if a bankruptcy is filed after a landlord-tenant action, an eviction may not be stopped, according to Bruce Levitt, a partner with law firm Levitt & Slafkes.

It is advisable to seek counsel before using personal assets, such as retirement funds, to keep a business afloat, as these assets are generally beyond the reach of creditors, according to Levitt.

Debt and the costs of business reorganization

The best bankruptcy filing option for businesses depends on their specific circumstances, such as the severity of their financial troubles, the owner's goals for the future of the business, and other relevant factors.

Businesses with straightforward debts may benefit from Subchapter V, which allows for debt repayment over three to five years. However, there are limitations, such as a maximum aggregate debt level of $7.5 million.

While Subchapter V is a faster and more affordable option for bankruptcy than a traditional Chapter 11, there are still costs involved, as explained by Megan Murray, a founding shareholder of Underwood Murray, a law firm that specializes in commercial bankruptcy. It's important to remember that filing for bankruptcy does not eliminate all legal and administrative fees.

If the bankruptcy has a good chance of success, Levitt said, it's important to consider whether customers have all run for the hills and whether there is little chance of their return. If so, reorganizing the business might not make sense, and a Chapter 7 liquidation may be a better option. On the other hand, if the owner is trying to sell a business as a going concern, a Chapter 11 liquidation may be an option to keep the company open for purposes of sale.

The downsides of bankruptcy

Filing for bankruptcy may seem like a solution for owners facing debt, but it comes with its own set of disadvantages.

A low credit rating due to bankruptcy can make it challenging for you to obtain credit in the future.

Filing for bankruptcy requires businesses to disclose their liabilities, including ongoing litigation, creditors, and financials, which may reveal undesirable information to the public.

Bankruptcy can also serve as a warning sign for customers, vendors, and suppliers.

Use bankruptcy only as a last resort

Donald Swanson, a shareholder at Koley Jessen, has assisted hundreds of businesses in overcoming financial difficulties, but has only filed for bankruptcy for a small number of clients because there are often more effective ways to aid owners in recovery.

The business owner with $12 million in debt and $10 million in property worth owns other assets he doesn't want to sell. If the owner can raise money from friends and family and convince the bank to accept a cash deal, selling the land might be preferable to bankruptcy, leaving the owner with a sizable heap of debt.

Filing for bankruptcy may feel like playing your last card, according to Swanson.