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What Happens When a Business Files for Bankruptcy?

business files bankruptcy

No one wants to think about the possibility of bankruptcy, but there are times when it is the best solution for a struggling or failing business. Whether you’re a business owner or an investor, it’s important to understand how this sometimes-complex process works so that you can protect yourself and hopefully have the best outcome possible.

There are a range of factors to consider when bankruptcy is the best option, including what type to utilize and how it will impact both business owners and investors. This overview will help you get a greater breadth of knowledge so that you can protect yourself or your organization, should bankruptcy be part of your future.

Bankruptcy Basics

In general terms, bankruptcy is a legal proceeding filed by organizations that are unable to meet their financial obligations and are dealing with severe financial difficulties. Bankruptcy proceedings are always handled by a federal court under federal laws. When this takes place, it gives companies the opportunity to either reorganize their debts and restructure their business or liquidate their assets to pay back creditors and investors. Basically, a bankruptcy can either help a company liquidate and close its business or help it restructure and recover from financial difficulty.

All bankruptcies are unique, and as such, the chances that a company will recover or that creditors and investors will get their money back depends on each individual bankruptcy proceeding.

What Are the Different Types of Bankruptcy?

There are two basic types of bankruptcy available for a struggling business. Which type is right for an organization depends on whether there is a chance for any type of recovery. If a business is too financially compromised for any real chance of recovery and liquidation is needed, Chapter 7 is the best option. If restructuring and reorganization can help, then many businesses go with a Chapter 11. There is also a less expensive option under 11 U.S. Code Subchapter V that applies to certain small business debtors.

Chapter 11 Bankruptcy

When a company files for Chapter 11 bankruptcy, it’s likely due to financial trouble that may result in business failure, without some type of intervening financial protection or restructuring. Recovery is possible with expert guidance, discipline, hard work and careful steps to get back into the black.

Organizational restructuring is an important aspect of Chapter 11 bankruptcy that can help a business by reorganizing its debt. This may involve negotiating with creditors outside of court or litigating in a federal court. Often, organizations work with financial professionals experienced in successful organizational restructuring. However, debt and equity restructuring may not always work out, and in some cases a full, Chapter 7 liquidation may be required.

Chapter 7 Bankruptcy

For a business with no hope of turning things around, Chapter 7 bankruptcy may be the only option. The company must stop business completely and a court-appointed trustee is put in charge to help with the liquidation of assets and distribution of funds to creditors or investors.

The repayment of debt must be performed in a certain order, with secured creditors getting paid first, followed by unsecured creditors getting a portion of whatever is left. Secured creditors typically loan money to a business with collateral, such as liens on a company’s mortgage or property. Unsecured creditors don’t have collateral or guarantees on their loans to the company and may include bondholders.

Can Investors Get Out of Bankruptcies?

If you’re an investor, you’re probably wondering if it is even possible to get out of a bankruptcy with any of the money that you invested. This will all depend on the type of investment and the type of bankruptcy the company is filing.

The first thing you should do when invested in a company facing bankruptcy is to file a claim. This does not guarantee that you’ll get your investment back, but it does put you in line with other secured and unsecured creditors so that you may be able to receive repayment when it’s your turn.

Takeaways

Whether you are a business owner or an investor, bankruptcy can feel like the end of the road. Remember, Chapter 11 bankruptcy is designed to help companies come back from the brink. There are times when nothing can be done to save a failing company—sometimes bankruptcy is exactly what an organization needs to get back on track towards success. Companies with strong operations but a balance sheet in need of restructuring may be the best candidates.

If it seems like filing for bankruptcy is the next step for your company, contact Rocky Mountain Advisory. Our team of experienced professionals can help you find competent legal counsel to assist you through the process and we can provide the necessary financial advisory services to help you emerge successfully.

     

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