Bankruptcy for small business owners starts with one question: whose debt is it? A debt owed only by your LLC or corporation is treated very differently from a debt you personally signed for, and a sole proprietor's business debts are simply personal debts. Sorting that out first tells you whether Chapter 7, Chapter 13 or closing the business makes sense.
If creditors are already calling you personally about business accounts, call (415) 754-0115 to arrange a free consultation, or reach us online, before you move money, sign new agreements or shut the doors. The order in which things happen can matter.
Step one: map every debt to the right person
Pull every statement, lease, loan document and credit application and put each debt into one of three columns. This exercise does more to clarify options than anything else a business owner can do before meeting an attorney.
Debts only the business owes
If your company is a properly maintained LLC or corporation and you never signed personally, vendors, suppliers and some lenders can usually look only to the company's assets. If the business closes, those claims may simply go unpaid, without any bankruptcy at all.
Debts you personally signed for
Most small business lenders, equipment lessors and commercial landlords ask owners to sign a personal guaranty. Business credit cards often carry personal liability too. These debts follow you even if the company is dissolved, which is why they are frequently the real reason an owner considers bankruptcy.
Debts the law puts on you regardless
Some obligations reach owners personally even without a signature. The most important is payroll tax that was withheld from employees but not paid over: the IRS can assess the Trust Fund Recovery Penalty against the responsible people, and California agencies have similar tools for withheld payroll and collected sales tax. These are usually not dischargeable, so they need a separate strategy.
How bankruptcy for small business owners works under Chapter 7
How Chapter 7 plays out depends on your business structure.
If you are a sole proprietor
You file one personal case that covers both household and business debts. The Chapter 7 trustee looks at business assets, such as equipment, inventory, receivables and bank balances, and can sell what is not protected by a California exemption. In practice, an operating business with employees or significant inventory is usually wound down. A service business run from a laptop and a truck sometimes continues, because tools of the trade and other exemptions may protect what the owner needs to keep working.
If you own an LLC or corporation
You can file a personal Chapter 7 to wipe out guaranties and other personal debts while the entity itself is handled separately. The company can also file its own Chapter 7, but a business entity does not receive a discharge, so that filing is really an orderly liquidation. If you are weighing negotiation against a filing, our comparison of debt settlement and bankruptcy sets out the differences.
The means test and business debt
Whatever your structure, the Chapter 7 means test applies only when your debts are primarily consumer debts. If most of what you owe arises from the business, you may not have to pass the means test at all, which can open Chapter 7 to owners whose income would otherwise be too high.
Keeping a business alive with Chapter 13
Chapter 13 is available to individuals, including sole proprietors, who have regular income and debts within the statutory limits. It lets you keep operating and keep business property while paying creditors through a three- to five-year plan. It can also be used by an owner of an LLC or corporation to deal with personal guaranties and personal tax debt while the company keeps trading.
The trade-off is paperwork. Business debtors typically file monthly operating reports or detailed income statements and must keep business and personal money strictly separate. The plan must also pay unsecured creditors at least what they would receive if non-exempt business assets were liquidated.
Larger business reorganizations happen under Chapter 11, including its small business track. That is a different process, and an attorney can explain whether your situation calls for it or whether personal Chapter 7, Chapter 13 or negotiation is the better fit.
Closing the business without filing for the company
Many owners do not need a company bankruptcy at all. A typical wind-down includes:
- Stopping new credit and collecting receivables.
- Selling equipment and inventory at fair value, with records of every sale.
- Paying employee wages and trust fund taxes first where possible.
- Filing final returns and dissolution paperwork with the California Secretary of State.
- Deciding separately how to handle any personal guaranties, which may be negotiated or resolved in a personal case.
What to avoid: paying back a loan from a relative or yourself ahead of other creditors, transferring equipment to family, or letting assets disappear without documentation. A trustee in a later personal bankruptcy can undo preferential and fraudulent transfers.
The Somal Law Firm represents individuals and small businesses in Pleasanton and throughout the Tri-Valley and East Bay in bankruptcy, debt settlement and IRS disputes. Because guaranty debt can sometimes be negotiated rather than discharged, a consultation can cover settlement with creditors alongside the bankruptcy options.
Frequently asked questions
Will filing personally shut down my LLC?
Not automatically. Your ownership interest becomes part of your bankruptcy estate, and the trustee will look at its value, but a company with little value is often left alone.
Does the automatic stay protect my business if only I file?
Generally no. The stay protects the person or entity that filed. Creditors of your LLC can usually still pursue the LLC, and a creditor holding your guaranty is stopped only from pursuing you.
Can I discharge an SBA loan I signed a personal guaranty for?
A personal guaranty is typically a dischargeable unsecured debt in a personal case, though any collateral you pledged remains subject to the lender's lien.
What about business taxes?
Trust fund taxes are generally not dischargeable. Other business-related income taxes follow the usual tax discharge rules.
Business debt feels personal because, very often, it is. To separate what is yours from what belongs to the company and see which path fits, call Bob Somal at (415) 754-0115 or schedule a free consultation. Bring your entity documents, any guaranties you signed and your most recent tax returns.
Attorney Advertising. This article is general legal information for Bay Area residents, not legal advice, and does not create an attorney–client relationship. Every situation is different — please consult a licensed attorney about your specific circumstances.