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Managing a Business in Financial Distress Prior to Closing

Cash flow is your No. 1 priority if you own a small business. Any interruption in your cash flow may be a sign of financial distress. If your business is having financial issues, there may be a temptation to shut down to avoid any personal liability. Even if you set your business up to avoid personal liability, you may be on the hook for taxes or lawsuits.

Dissolving your business because of financial stress may be an option, but don't let your emotions run away with you. Take time to get legal advice about other options before rushing into dissolution.

Your business plan should address possible financial challenges. However, some challenges, such as the COVID-19 pandemic, are unforeseeable. If your business is in trouble, here are some tips for handling financial distress, avoiding liability, and protecting your business assets in case you must shut down.

Managing Financial Stress

Your debts will not vanish if you shut down your business. Creditors, vendors, and employees can still sue for breach of contract or unpaid bank loans. Take the time to audit your books and review state laws regarding employee and creditor notification when your business is in trouble.

  • Keep your taxes current. The Internal Revenue Service (IRS) can hold corporate officers personally liable for unpaid taxes. Be sure you pay all employment withholding taxes promptly. If you plan to close your business, the IRS and state tax offices have tax forms designed for a business's last year of operations.
  • Use caution when transferring assets, applying for small business loans, or paying creditors. If you must file for bankruptcy or dissolve your business, you must avoid any appearance of concealing assets. Keep your personal funds away from your business funds. Do not try to keep the business solvent by lending your personal money to the business.
  • Protect your bank account. Some loans may allow creditors to withdraw assets from a linked account if the payor falls behind in payments. You may want to transfer to a different bank if you have such an account. Again, be cautious. You don't want to appear as if you're hiding money from your creditors.

Before you decide to shut things down for good, consider some ways of keeping things running in the short term.

Financing Options and Prioritizing Operations

Some cash flow emergencies are due to things beyond your control. Sometimes, they're due to a small business growing faster than you realized. You might be able to reallocate your resources — "retrenchment" in business language — enough to survive the financial crisis.

  • Update your business records and financial statements. Small-business owners sometimes fall behind in assessing their finances and cash flow. Look at where the money is coming from and where it's going before you do anything else.
  • List your business debts and assets. Whether you keep going or close down, you must know who still owes you money, who you must pay, and how much from each. Prioritize your creditors as to who gets paid first — oldest accounts or oldest customers. Do the same with your accounts receivable.
  • Contact a bankruptcy attorney. There are important differences between Chapter 7, Chapter 11, and Chapter 13. Your options here depend on whether you want to continue business operations and the structure of your business.

If You Want To Continue Operations

The Small Business Association (SBA) provides loans and assistance to startups and small businesses. If you are in financial straits and need help, the SBA has resources for small-business owners.

Consider new financing options. Thinking outside the box and using the power of social media can keep your business afloat long enough for things to stabilize.

  • "Angel investors" are high-net-worth investors and entrepreneurs who provide financing or bridge loans in exchange for a percentage of equity or ownership in the business. The downside is these lenders may charge high interest rates, so do your due diligence.
  • Crowdfunding using social media sites like Kickstarter generates funds by asking online users to donate small sums of money for new businesses or worthy causes. If your business has a community following, crowdfunding might help.
  • Debt collection is unpleasant, but if your financial review shows that unpaid bills cause your cash flow problems, having an agency collect your outstanding accounts may help tremendously.

Other operations maintenance methods include reducing expenditures, liquidating some assets, and downsizing. All these have downsides, and you should discuss them with your partners and business associates.

If You Plan To Shut Down

If winding down your business is the better option, be sure you do everything right. It takes time to close a business down legally. Don't make the mistake of locking the doors and walking away. A string of lawsuits will follow you.

The SBA provides guidance for closing your business legally. It's also a good idea to consult a business attorney to ensure you've followed state and federal law on reporting business debt, paying your final taxes, and paying your employees.

About Bankruptcy

Business bankruptcy and personal bankruptcy have almost nothing in common. Only sole proprietorship bankruptcies resemble personal bankruptcies in court.

  • Chapter 7 bankruptcy liquidates all assets, pays off creditors, and may result in closing the business. If the business is a sole proprietorship or a partnership, the owner's personal finances and real estate may be included in the liquidity. An LLC or corporation of any size does not receive a debt discharge from a Chapter 7 bankruptcy.
  • Chapter 11 bankruptcy (restructuring) requires an attorney. Businesses remain open during the process. The payment terms of outstanding debts are renegotiated, and the business must make monthly payments based on the business finances. Missed payments can result in the termination of the restructuring.
  • Chapter 13 is an individual restructuring. It is unavailable for partnerships, LLCs, or corporations of any size. A business owner may opt for Chapter 13 to help the business's bottom line. In that case, the business value becomes part of the owner's assets, increasing the monthly payments.

Filing a business bankruptcy is not the same as a personal bankruptcy. Corporations don't get a clean slate and a chance to start over. You must still pay off your creditors and employees. The liquidation process could leave you with much less than you started with and a bad business credit rating.

No matter your financial status, you must still cope with the day-to-day business operations. Talk to a legal professional before decision-making becomes too overwhelming.

Need Help With a Struggling Business? Contact a Business Lawyer

Stop and think if you're shutting down your business for financial reasons. Closing up shop and walking away can have disastrous consequences. Creditors, customers, employees, and other stakeholders are part of the process. Before you make any major decisions, discuss your situation with a licensed business and commercial law attorney near you.

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