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Chapter 11 vs Chapter 7: What Small Biz Owners Should Know

Entrepreneurs are optimists by nature -- no one starts their own business to see it fail. And the last thing most small business owners are thinking about when they're starting up is declaring bankruptcy. But failure is a fact of life, and not all businesses make it.

That said, declaring bankruptcy doesn't necessarily mean your small business is a failure. Plenty of big businesses have declared bankruptcy only to rebound stronger than before. But what happens to your business after declaring bankruptcy will depend on the type of bankruptcy you file. Chapter 7 and Chapter 11 are two of the most-filed types of bankruptcies for small businesses, so let's see how they stack up.

Lucky Number 7

Chapter 7 bankruptcy, also referred to as liquidation, is pretty much what it sounds like. Your small business' assets will be liquidated in order to remove all debt in exchange for a lasting mark on the business' credit. While it may seem tragic to contemplate the end of the road for your small business, Chapter 7 bankruptcy can be a decent option for sole proprietors and small business owners who don't mind closing up shop for good.

For those more optimistic, it may be possible to file for Chapter 7 bankruptcy and then get a second chance to salvage the business. If your small business assets put up for sale by the bankruptcy go unsold, you may have the opportunity to buy them back.

In order to qualify for Chapter 7 bankruptcy, however, you must be under a certain median income, so your small business may need to consider Chapter 11.

11 a Side

If your small business is too big to qualify for Chapter 7 or you're not ready to close up shop just yet, Chapter 11 bankruptcy may provide the opportunity to hold off creditors while you form a new plan to pay off your debts. Chapter 11 is generally used by larger corporations who are able to prove to a bankruptcy court that they can become profitable post-bankruptcy, but your small businesses may still be able to qualify for reorganization.

If your business has fewer than 500 employees and less than $2.19 million in debt, you can file a petition for bankruptcy protection with the U.S. Bankruptcy Court. Soon after filing, you'll normally have a "341 meeting" with your small business' creditors in order to discuss the company's finances and consider a reorganization plan. This plan will outline exactly how the business will typically divide your creditors into classes and prioritize a repayment plan. Just one caveat: your creditors will have a say. Under Chapter 11, creditors can vote on the reorganization plan and each class of creditors must approve the plan before it can be finalized.

Choosing a form of bankruptcy might be the last thing you want to do, but finding one that fits your needs as a small business owner can give your business a second chance, or at least leave some doors open for your next business venture. If you need help figuring out which type of bankruptcy is best for your company, contact an experienced bankruptcy lawyer near you.

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