Bankruptcy can offer businesses a fresh start but should be a last resort.  It is time consuming, expensive and poses problems for businesses looking for capital in the future.  In most cases, filing for bankruptcy can be avoided by using a debt restructuring firm to negotiate with creditors.  Creditors may prefer to renegotiate the terms of repayment directly rather than have the firm file for bankruptcy since they have little control over the firm once the firm does file. This may make them more willing to renegotiate a loan.  Business debt negotiation often provides the best case scenario for all parties involved.

Source: Orange County Register, May 5, 2011, by Jan Norman

Approximately 2.6% of small businesses have filed for bankruptcy some time in the past seven years, according to a new study for the Office of Advocacy in the U.S. Small Business Administration.

According to American Bankruptcy Institute data, more than 323,000 businesses filed for bankruptcy from 2004 through 2010, more than 39,000 of them in California. This state’s share of all U.S. business bankruptcies has increased from 12.4% in 2007 to 15.7% in 2010, an indication that the recession hit California businesses harder than their counterparts nationwide.

Small businesses can file for bankruptcy protection under Chapter 7 (liquidation), Chapter 11 or 13 (both reorganization) sections of federal bankruptcy law. According to the SBA’s study, which looked at more than 10 years of data and other research, about 70% of businesses that file under any of these sections either emerge as a reorganized business or liquidate and start a new business.

In that sense, bankruptcy does provide small businesses a new start that enables them to contribute again the the U.S. economy and job market, said Chief Counsel of Advocacy Winslow Sargeant.

However, businesses that have a past bankruptcy on their records have a 24% greater likelihood of being denied a loan than those that don’t. Plus, if they get a loan the interest rate will be more than one percentage point higher than lenders charge other businesses, the SBA study found.

“Our results suggest that owners of previously bankrupt firms are less likely to own credit cards and are more likely to look for outside financing from venture capitalists,” said the report written by Aparna Mathur,  a resident scholar at the American Enterprise Institute.

Despite those negative consequences from a bankruptcy filing in the past, the previously bankrupt firms are no more likely than other small businesses to be burdened with poor cash flow, high health insurance costs, excessive taxes.

“That these businesses were still surviving…is testament to the ‘fresh start’ principle (of the purpose of the bankruptcy laws),” the report said. “It suggests that the bankruptcy system goes a long way toward helping businesses recover and resume operations after a bankruptcy filing.”

The study was uncertain whether the data captured businesses that managed to avoid filing for bankruptcy by negotiating with creditors. “In the case of small-business loans, creditors may prefer to renegotiate the terms of repayment directly rather than have the firm file for bankruptcy,” the report said. “Creditors… have little control over the firm once the firm files for bankruptcy. This may make them more willing to renegotiate a loan.”