The global pandemic is certainly taking a toll on the economy and a lot of people and small businesses are suffering the consequences.
Bankruptcy happens when a business can no longer pay its debts or doesn’t have enough assets to cover its liabilities. As cash flow and market demand can shift dramatically in a short period of time, small businesses are usually the ones that struggle the most during these difficult times.
And even if talking about bankruptcy is something no one wants to do, it is necessary to understand how it happens and what to do.
For businesses, there are typically two types of bankruptcies:
In this case, the business owner turns everything over to a bankruptcy trustee and walks away. The trustee will liquidate the assets and pay its creditors.
In this case, the owner runs the company and gets the job done. There might be times in which a court-appointed trustee takes place, but this happens only if the owner or manager is suspected of being dishonest or not doing a good job. During the reorganization, the debtor will define a new business plan and seek approval from creditors.
Filing for bankruptcy is usually considered a failure, but it doesn’t have to be that way. Before you get to that point, there are certain red flags that, if detected on time, will mitigate the disaster. Follow these steps:
Recognize the signs
Warning signs are usually on the records. Check your cash flow reports, as financial statements are the key to reading your business and detecting problems at an early stage. These statements will help you see where the money is coming from and where the money is going. If you can see this early enough, you might be able to make the necessary adjustments and correct the problem.
Detect the root of the problem
You need to take the time to seriously determine what is causing the problem and whether it is something you can control or not. Avoid personal liability issues at this stage. Failing to make payments will only make things worse because not only will you still have to deal with it later, but also you will have to pay penalties.
Contact your lawyer
Find an attorney with expertise in bankruptcy and turnaround strategies. Ideally, it should be someone with experience in your own industry.
As soon as you start noticing warning signs, it is a good idea to get professional help before things get really bad. Preparing yourself for a potential bankruptcy when things go bad doesn't mean you need to file for one.
Actually, filing is not the solution as it is usually expensive, time-consuming and complicated, let alone the emotional weight it carries as well.
Even in these situations, you can still plan for success. Approach your creditors with a tailored financial plan that gives you credibility. If your business is failing for the first time, most banks appreciate you coming to them early enough to let them know what the situation is and how you plan to deal with it.
Bankruptcy doesn't happen overnight. It is a long process with different stages and in many of them, you can still manage to save the ship. And even if there is no way of doing it, you need to acknowledge the situation and plan for a wind-down bankruptcy, as challenging as it seems.
Is filing for bankruptcy a good option?
Filing for bankruptcy could stop a foreclosure or car repossession, protect your wages from garnishment, or keep your utilities from being turned off, but it will affect your credit score. How long does it stay on your credit report?
Your credit score will take a hit after bankruptcy, but it won't hurt your credit score forever. Eventually, the bankruptcy will fall off your credit report and will have no future impact on your score. Here's how long it takes for that to happen.
How long does bankruptcy stay on your credit report?
Bankruptcy typically stays on your credit report for a minimum of seven years and a maximum of 10 years.
While there are many types of bankruptcy, two of the most common types are Chapter 7 and Chapter 13. A Chapter 7 bankruptcy can stay on your credit report for up to 10 years and all eligible debts are discharged immediately. A Chapter 13 bankruptcy can stay on your credit report for up to seven years and you agree to a three- to five-year repayment plan to partially or fully repay your debts.
Each delinquent account included in the bankruptcy will also remain on your credit report for up to seven years. But the seven-year clock for delinquent accounts begins when they were first reported as late, not when you filed for bankruptcy.
So if some of the accounts included in your bankruptcy were already delinquent before you filed, they will fall off your credit report before the bankruptcy does. Any accounts that were current until you filed, however, will be removed from your report at the same time as the bankruptcy.
Is bankruptcy your best option?
Bankruptcy is just one of the various debt relief options. Depending on your situation, there may be other alternatives you may want to explore first, like taking out a debt consolidation loan or trying to work out a repayment plan with your creditor on your own or with the help of a credit counselor.
In some cases, you may find that a different debt relief strategy would save you money while also having less of a negative impact on your credit score, but if you do decide to file for bankruptcy remember that the damage to your credit score will be temporary.
How to rebuild your score after bankruptcy
If you are struggling with debts, bankruptcy may be a way out of your financial distress. Even though your credit score will take a hit after this, there are steps that you can take to build a positive credit history again.
If you are overwhelmed by debt and can’t seem to be able to work yourself out of it, bankruptcy is a legal process that could help you find relief. The disadvantage of this is that this will affect your credit. A Chapter 13 bankruptcy can stay on your credit report for up to seven years, while a Chapter 7 bankruptcy can remain for a maximum of 10 years.
Credit scores can drop by 100 points or more after bankruptcy is added to a credit report and damaged credit can make it more difficult to get approved for a line of credit in the future, but there are ways to rebuild your credit.
Follow these steps:
1. Continue on-time payments
If there are any credit accounts that weren't included in your bankruptcy, make sure that you continue to make punctual payments on them each month.
2. Apply for a secured credit card
This can be one of your best options for rebuilding your score. Since these cards require a security deposit, which limits the issuer's risk, they're easier to qualify for with poor or damaged credit.
Payment history on secured cards is reported to the credit bureaus just like regular credit cards. So making consistent on-time payments on a secured card can improve your score over time which can open up more credit opportunities for you down the road.
Before you apply for a secured card, check to make sure that it reports cardholder payment activity to all three major credit bureaus. And to see the biggest positive impact on your score, try to keep the credit utilization rate on your secured card below 30%.
Ultimately, the biggest cure to your bankruptcy-related credit score ailments will be time. If you're patient and commit to following good credit habits, your credit score will slowly but surely rise.