When Bankruptcy is Best

Know when to consider Chapter 11 protection

wealth-gap2Chrysler and General Motors have done what was previously unthinkable – filed for bankruptcy. Even for your small business, there may be circumstances where bankruptcy is your best option. Chapter 11 bankruptcy protection is a tool that can be used to help a struggling company survive bad times.

Three types of measurements give a profile of a small business’ financial health, says Jack Williams, the American Bankruptcy Institute’s resident scholar and a bankruptcy professor at Georgia State University in Atlanta. These three yardsticks size up if an owner needs to reach out for help:

Income Statement. Check out your revenue. Compare the revenue you’re generating now to the revenue you were generating a year ago. Is it increasing, decreasing or static? Decreasing revenue is a bad sign. Always keep a close eye on your month-over-month and year-over-year revenue.

Cash Statement. Assess your liquidity needs and whether you’re meeting those in the short term. Your cash position is the ability to take your revenue and convert it into actual dollars. Are you able to pay your debts as they become due?

Balance Sheet. Look at the capital structure of your business. What percentage of your business’ capital can be attributed to equity, and what percentage can be attributed to debt? Even if you are able to pay debts that become due now, certain loans may be coming due in the future that would be a substantial drag on your cash flow.

“The idea is that once you see signs of financial distress, you can’t ignore them. They are not going to go away. They’re usually a symptom of a deeper concern. Businesses oftentimes recognize the signs, but they don’t do anything about it, and hope that if they just redouble their efforts, they will work themselves out of it. That usually is not the appropriate response,” says Prof. Williams, a lawyer who does a lot of pro-bono work in Atlanta’s vibrant black small business community.

For a company that is in serious financial distress, filing for Chapter 11 bankruptcy may be a reasonable option. It affords the firm protection from its creditors. It allows the firm time to reorganize itself so it can stay in business, get back on its feet and emerge stronger. But because small business owners tend to wait too long before they seek relief, bankruptcy is unsuccessful more often than it is successful, warns Williams.

The great irony is that just when a small business doesn’t have a lot of money, Chapter 11 bankruptcy relief is expensive. For a “microbusiness” with under $1 million in revenue, a bankruptcy may cost $15,000 to $25,000 — if that business is well-operated, but has too much debt. Chapter 11 fees increase for larger small businesses. Prof. Williams says typical costs for small business bankruptcies are in the $25,000 to $50,000 range, provided the financially distressed companies react to warning signals in a timely way.

Where does that money go? There are filing fees and a quarterly United States Trustee fee to be in bankruptcy, but the bulk of those fees go to attorneys and other professionals, like bankruptcy accountants.

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