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Between Enron and WorldCom, bankruptcy news has all but dominated headlines in recent months. But roughly 80% of the 9,000 businesses nationwide that sought Chapter 11 bankruptcy protection in 2000 were small businesses, according to the National Bankruptcy Conference, a nonpartisan group of academicians, judges, and lawyers.
When a small business owner decides to file for bankruptcy, there are a few things the entrepreneur should keep in mind. Small business owners have two filing choices: Chapter 7, which requires a complete company liquidation where all assets are sold and proceeds are used to pay off creditors, or Chapter 11, a “reorganization” that holds creditors at bay for a specified length of time.
To those business owners considering bankruptcy, Claude Montgomery, a partner with Salans Hertzfeld & Heilbronn in New York City, advises taking action sooner rather than later. “Every small business owner thinking about bankruptcy should do it when they have cash, not when they’ve run out of cash,” says Montgomery. “If you file when you’ve run out of cash, your options will be limited because it will be harder to obtain financing or even operate.”
After filing for bankruptcy with the local clerk of courts, forms detailing all properties, sources of income, and all debts involved with the company will have to be filled out. From there, a court’s clerk notifies those creditors about the bankruptcy filing, and creditors and debtors meet in court with a trustee and talk about repayments, seizure, or debt dissolution. About 30 to 40 days after filing the bankruptcy petition, a hearing called a “First Meeting of Creditors” will be held and presided over by a bankruptcy trustee.
As these events unfold, small business owners may find it hard to concentrate on both running their companies and handling paperwork and court dates. During this busy time, Marcus A. Tompkins, an associate with Los Angeles-based Sulmeyer, Kupetz, Baumann & Rothman, advises business owners to:
- Hire a skilled bankruptcy attorney who can lead you through the process.
- Avoid firing your accounting personnel. They are indispensable during a financial crisis (assuming, of course, they are not suspected of fraud or incompetence).
- Maintain a good relationship with your creditors and employees by giving them correct and accurate financial information rather than keeping them in the dark. This will help employees and outside business partners understand what’s going on and keep the rumor mill at a minimum.
- Set aside as much cash as you can. “You’ll need it to run your business once your financial situation becomes public knowledge,” says Tompkins.
- Another important step is to realize that there could be tax and legal implications during the bankruptcy process. For example, the business owner won’t be able to use bankruptcy to erase or reorganize tax debts. Furthermore, business owners may alienate key suppliers (turned creditors during bankruptcy proceedings) if they aren’t satisfied with the reorganized or minimized payments that the court approves.
“Choose which vendors and other trade creditors are less critical and reduce or stop payments to them, but don’t fail to pay anyone that could shut
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