Is bankruptcy the answer to pandemic business troubles?

It's no secret that COVID-19 has had a profound impact on businesses large and small. Headlines regularly report pandemic-related, high-profile bankruptcy filings for well-known companies, including J.C. Penney, Pier 1, and J. Crew.

In fact, S&P Global Market Intelligence reports that 509 companies went bankrupt in the first nine months of 2020, which is more than any other year since 2010.

If your business is struggling because of the global pandemic, you might be exploring options. Is bankruptcy the answer to your problems? Maybe, but maybe not.

Here's what you need to know about business bankruptcy—and some alternatives.

Understanding bankruptcy

Business bankruptcy is a legal proceeding used by a company that's in debt beyond its means. “Bankruptcy is all about two things: breaking contracts and reducing stress," says small business bankruptcy attorney, Dai Rosenblum.

The goal in most cases is to liberate your business from debt while giving creditors an opportunity to collect at least part of what's owed to them. The three most common types of bankruptcy are:

• Chapter 7: Dissolves and liquidates the business, and proceeds go to creditors.
• Chapter 11: Reorganizes the company and establishes a realistic debt repayment plan so the company can continue operating. Normally complicated and costly, the Chapter 11 process for small businesses is now faster and less expensive, thanks to Subchapter V of the Small Business Reorganization Act of 2019.
• Chapter 13: Available only to individuals and sole proprietors, it allows you to repay debt over time.

Bankruptcy pros and cons

Filing for bankruptcy can buy you time to reorganize your operation.

“The main pro of filing for bankruptcy is that it initiates an automatic stay, which means that creditors and debt collectors are no longer allowed to contact you," says Gary Zhou, founder of Colored Contacts, who previously filed for bankruptcy with co-owners of another business. “An automatic stay also delays foreclosures and repossessions."

On the other hand, the process is expensive, time-consuming, and distracting. “In general, the litigation involved in filing bankruptcy is never something that people should willingly pursue unless there is no other viable option," says Jeremiah Foster, founder and president of business advisory firm Resolute.

In addition, depending on the circumstances, bankruptcy could hurt your credit score.

Rosenblum adds that there's no need to be embarrassed, though. “There is virtually no stigma anymore over filing bankruptcy," she says.

Bankruptcy alternatives

Bankruptcy isn't always the answer. For example, if you have a cash flow problem because customers aren't paying, you have other options.

According to data from Invoiced, an accounts receivable automation platform, the number of “days sales outstanding," a key accounts receivable metric, jumped nearly 500% between January and September 2020.

If sales are reasonably strong, but you aren't collecting soon enough, Invoiced CEO Jared King recommends making payment “as frictionless as possible. That means rapidly shifting gears from paper billing and waiting for check delivery to offering online payments via credit or debit card, direct debit, PayPal, and more."

King also recommends offering early payment discounts, installment plans, autopay, and, for larger overdue balances, payoff incentives.

Ken Yager, who works with distressed small businesses as founder and president of Newpoint Advisors Corporation, recommends negotiating with creditors out of court whenever possible. As with bankruptcy proceedings, such an agreement requires a payment plan with an extended timeline. “The most important part of a plan is being able to deliver on results, no matter how weak they are," he says.

Liquidating through a process known as "assignment for the benefit of creditors" is another option. “This is when an insolvent entity transfers legal title, custody, and control of its property to a third party in trust to apply the proceeds of the sale of assets to creditors," Foster says.

Consult With a Professional

You might not be in the best position to determine whether your business is still viable or if it's possible to negotiate or restructure debt. A bankruptcy attorney or otherwise qualified business adviser can help you explore options and determine the best path for your business.