What Happens When a Small Business Files for Bankruptcy?
December 19th, 2022 by Crystal Buhler | CPA, CGA, CIRP
Over 2,400 Canadian businesses filed for bankruptcy in 20211. Although that may seem like a large number of businesses going under, keep in mind there are 1.2 million small to medium-sized businesses operating in Canada.
However, the government is no longer offering pandemic funding for business owners, and bankruptcies are rising. If your business is struggling, you may wonder how does business bankruptcy work and if it’s right for your business.
If you’re searching for solutions, we can help!
Here’s what you should know about what happens when a small business files for bankruptcy.
When Should You File for Bankruptcy As A Business?
Is your business struggling to bring in revenue and make a profit? If so, it’s a difficult place to be in. You have to consider whether filing for bankruptcy is the best option.
Some things to consider include:
Are you experiencing a prolonged downturn in your industry?
Consider whether people are interested in what you have to offer or if what you’re selling has been replaced by new or more advanced products.
Most recessions in Canada last a year or two. You may be able to wait out a lag in the economy and avoid filing for bankruptcy.
However, if the town’s economy revolves around a business such as a factory or a mill that’s struggling, it can cripple small businesses in the area.
High Debt or Limited Cash Flow
In business, you may need to take on debt to pay for new equipment, technology, or construction.
If you’re not bringing in enough revenue or have the cash flow to cover your debts, things can go downhill quickly.
Reliance on Credit Cards or Loans
If you’re relying on personal credit cards to carry your business through the month or you’re needing to take out loans to meet your expenses, your business is in trouble. When you can’t generate the income to cover business costs, bankruptcy may be the next logical step.
One financial challenge may not necessarily lead to bankruptcy. If you’re facing multiple financial challenges and feel like the ship is sinking, it’s time to consider a consultation with a Licensed Insolvency Trustee.
In Canada, you can declare bankruptcy if you meet the following criteria:
- You’re a Canadian resident
- You owe over $1,000 to creditors
- You cannot meet your financial obligations on time
To file for bankruptcy, you must use a Licensed Insolvency Trustee. They can help you understand the process and determine the best plan moving forward for your business.
Although bankruptcy is typically considered a last resort, it’s often the only viable option for a struggling business.
Partnerships and Sole Proprietorships
If the structure of your business is a partnership or sole proprietorship, you may need to file for personal bankruptcy, since the business is not separate from your personal financial situation.
In these types of businesses, the person who operates the business and the business itself aren’t considered legally separate, your personal and business liabilities and assets aren’t separate either.
If your company is incorporated, your business is a separate entity from you personally. In this case, you don’t need to file personal bankruptcy, only business bankruptcy.
Your trustee will sell certain assets owned by your incorporated business, and distribute those funds to your creditors. In business bankruptcies, there may be certain creditor classes that receive preferential treatment, such as employees or suppliers.
Are You Liable for Your Small Business Debts?
Any business debt you’ve personally guaranteed can be included in your bankruptcy process.
Creditors may attempt to come after you for debts you’ve guaranteed. If this happens, you may also need to file for bankruptcy.
Do I Need a Licensed Insolvency Trustee?
Bankruptcy is a legal process, and you must file it through a Licensed Insolvency Trustee (LIT). In Canada, LITs are the only professionals permitted to assist you with filing bankruptcy.
Although bankruptcy is a viable option for some business owners, careful consideration should be given before filing. Your LIT can work with you to evaluate your financial picture and help you make the right decision.
The LIT will help you understand your options and help position you for better days and future success. They will also work to ensure your creditors are treated fairly so they can continue serving other businesses in the future.
Considerations Regarding Business Bankruptcy
If your business isn’t financially viable, it may be time to unload the burden of overwhelming debt. On the other hand, if your financial difficulties are temporary, there are other options to consider. These include:
- A Consumer Proposal is an option if your debt is below $250,000
- A Division I Proposal is an option if you owe more than $250,000
Both options have some similarities to bankruptcy, including:
- Debt collection stops
- Your company retains its assets
- You can reuse your debt substantially
- Once conditions are met, it may be easier to rebuild credit
A Division I Proposal requires your LIT to project cash flows and meet with creditors. This process allows a business to restructure. A majority of the creditors in number, and two-thirds of your creditors in value must accept the proposal or it moves to automatic bankruptcy.
Talk to your trustee about the options and types of bankruptcy and what might be the best course of action for you.
How Does Business Bankruptcy Work?
If your business is struggling under mounting debt, you may be wondering how does business bankruptcy work and if it could it be a solution for you. For many business owners, bankruptcy is a viable option.
The goal of bankruptcy is to save your business, allowing it to continue to operate. If you’re considering it, it’s a big decision for the future of your business.
At Bankruptcy Canada, our Licensed Insolvency Trustees and Consumer Proposal Administrators work together to provide our clients with up-to-date, comprehensive information on Bankruptcy and Consumer Proposals.
Contact Bankruptcy Canada today to schedule a consultation.
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