Bankruptcy Basics for Small Business Owners

Understanding Bankruptcy

This guide is for small business owners and managers who want a plain-language explanation of bankruptcy: what it means, how it works, and what to weigh before filing.

Bankruptcy is a legal process. A person or business uses it to tell the court they can’t pay what they owe.

Filing can wipe out, or discharge, much of that debt. But it doesn’t erase everything, and creditors often recover some of what they’re owed by selling off the filer’s non-exempt assets.

What You Need to Know About Filing for Bankruptcy

Contrary to what some people imagine, bankruptcy isn’t simply a result of poor decision-making.

Bankruptcy filings don’t always rise and fall with the economy the way you’d expect. Filings hit nearly 1.6 million around 2010, in the aftermath of the Great Recession. But total U.S. bankruptcy filings actually dropped sharply in 2020, even with a severe pandemic recession and high unemployment, largely because of government stimulus and loan relief programs. Filings have since climbed back up, reaching 574,314 in 2025, an 11% increase from the year before.

Declaring bankruptcy may be the only lifeline left for an individual or business in severe debt. However, you’ll need to select the right one to file a successful case. You’ll also need to meet specific requirements to qualify for each type.

Seeking Professional Help

When someone files for bankruptcy, they seek protection under bankruptcy laws to have their debts discharged and are relieved of the debt they have no way of paying back.

Choosing which is the best option for your situation is where professional help can come into play. You want to find someone who is not trying to sell you a service but looking out for the best route to take for your situation. A professional may advise you not to declare bankruptcy but to go with an alternative.

Bankruptcy Alternatives

If you don’t qualify for bankruptcy, or if you want to consider an alternative, there are options available to you.

Know your rights under debt collection law. The Fair Debt Collection Practices Act already protects you from aggressive collectors — they can’t threaten you, call outside of 8 a.m. to 9 p.m., use obscene language, or contact you at work by phone, fax, or email. Once you tell a collector in writing to stop contacting you, they have to stop.
Stretch your budget by cutting out excessive and unnecessary expenses.
Negotiate better repayment terms from your lenders. This process entails looking for a consolidation loan offering an easier repayment plan.
Increase your income.
Consider debt management by exploring non-profit credit counseling agencies. Some of the benefits include waived fees, lower interest rates, and a workable budget plan as you move forward.

Types of Bankruptcy

If you decide to move forward, you’ll need to choose the chapter that fits your situation:

Chapter 7 — Used when you are prepared to liquidate your non-exempt assets.
Chapter 11 — Used for reorganization.
Chapter 12 — Used for family farms.
Chapter 13 — Used when you want a repayment plan instead of liquidating assets.
Chapter 15 — Used for cases involving foreign proceedings.

Chapter 7 is the most commonly filed type of bankruptcy for individuals in the United States, with Chapter 13 close behind as the second most common.

How to File for Bankruptcy

Filing for bankruptcy isn’t as simple as stating that you cannot pay your debts. You are required to follow several legal procedures and meet set criteria. This is where attorneys come in to advise you on the best way forward.

The first step on your journey before declaring bankruptcy is completing a credit counseling session. This is to obtain a certificate that you will file alongside the bankruptcy plea. Fortunately, you can easily find numerous government-approved credit counseling agencies by visiting or calling a federal bankruptcy court near you.

Since every case is different, the counselor will review your problem individually. They will then present the available solutions, like budget and debt management and other alternatives to bankruptcy.

When filing for bankruptcy, you’ll need to submit a bankruptcy petition and financial statements detailing what you owe, earn, and own. This is followed by a means test, which first compares your income to the median income for a household your size in your state. If your income is at or below that median, you typically qualify for Chapter 7.

If it’s above the median, a second calculation looks at your expenses and what’s left over to decide whether Chapter 13 is required instead. You must also pay a filing fee, which can be waived if you can show you can’t afford it.

Your case will be heard by a bankruptcy judge after the bankruptcy trustee has held a meeting of creditors with the people you owe. If you’re found guilty of hiding assets or fraud, you stand to face criminal charges.

Before your debts are discharged, you’ll have to take a debtor education course to understand budgeting and money management. Once complete, you’ll receive a certificate of participation.

Why Should You Consider Declaring Bankruptcy?

In most cases, people who declare bankruptcy owe far more than they have. Someone could own significant assets and still owe far more than those assets are worth, with no realistic way to pay down the difference.

Before shutting the door to declaring bankruptcy, ask yourself if there’s any way to settle the debt. Realistically consider if it’s possible to pay it off in less than five years. If not, filing may be worth serious consideration. The point of filing for bankruptcy is to provide relief and a second chance to debtors rather than giving them a life sentence.

The alternative is to continue accumulating fines and harassment from your creditors without having any way out of massive debt. Unfortunately, this is not a solution but rather an additional stress factor, especially if the cause of debt was unforeseeable.

Bankruptcy is stressful, and it’s not something any business owner wants to go through. Whether you file or not will affect your finances, your family’s stability, and your overall well-being. When there’s truly no other way out, the benefits of filing can outweigh the drawbacks.

Individual filings far outnumber business filings. Most personal filings involve debt like mortgages, auto loans, student loans, and credit cards.

The Pros of Filing for Bankruptcy

When properly advised, businesses can use Chapter 13 bankruptcy as a financial planning tool. However, this only applies if they have the money to pay creditors by restructuring the payment terms.

Below are five points outlining the benefits of declaring bankruptcy:

1. Instant relief from debt

Although restrictions apply to each case, successful cases can liquidate their assets and get a fresh start.

2. Relief from bill collectors

Many people get frustrated and overwhelmed with the never-ending bills and constant phone calls from creditors. However, your creditors won’t continue to seek payment from you after filing successfully, thanks to the “Automatic Stay.”

3. Emotional relief

Having a massive debt with no possible payment plan can cause emotional stress. Declaring bankruptcy, therefore, allows people to lower their stress levels so they can figure things out.

4. Fresh start

Although filing for bankruptcy will affect your credit score, the benefit is that you can work towards rebuilding it progressively.

5. When there’s no way out – There is

When you have no other option, the law gives you a way out by filing for bankruptcy.

Bankruptcy protection also plays a role before things ever get that far. Research on debtor-friendly bankruptcy laws has found that entrepreneurs take more risks, and start more businesses, in places where failure doesn’t mean permanent ruin.

Bankruptcy isn’t meant for someone who plans to fail and declare bankruptcy as an easy way out. It’s better understood as a safety net: something that lets a business owner try again instead of losing everything for good.

The Cons of Filing for Bankruptcy

Below are five points related to the cons of declaring bankruptcy:

1. Credit Report

It’s crucial to understand that although filing for bankruptcy gives you a chance to start over, it will hurt your credit score and your ability to borrow money for a while. A Chapter 7 case typically takes about four months to complete, and it stays on your credit report for 10 years from your filing date. A Chapter 13 case runs three to five years, matching your repayment plan, and stays on your credit report for 7 years.

2. Affects credibility

As mentioned, bankruptcy affects your credibility. Even after getting a fresh start, you may have a challenging time getting any loan or mortgage approval. And if you’re lucky to get one, the interest rates will likely be steep.

3. Other debt

Despite getting debt relief, not all your debt is cleared. Student loans, alimony, back taxes, and government fines are some of the outstanding debts that you’ll still have to pay.

4. Losing non-exempt property

There’s always the possibility of losing your non-exempt property, including vehicles, houses, bonds, stocks, and cash.

5. Costly

Filing for bankruptcy can quickly become a costly legal process. You’ll need to pay the attorneys, credit counseling service providers, trustees, etc.

Key Points and Facts About Bankruptcy

U.S. bankruptcy filings totaled 574,314 in 2025, an 11% increase from 517,308 in 2024.
Business filings make up only a small share of total U.S. bankruptcy cases — the vast majority are filed by individuals.
Chapter 7 is the most commonly filed type of bankruptcy for individuals, with Chapter 13 the second most common.
A Chapter 7 case typically takes about four months to complete, while a Chapter 13 repayment plan runs three to five years.
A Chapter 7 filing stays on a credit report for 10 years from the filing date; a Chapter 13 filing stays for 7 years.

Action Steps for Filing for Bankruptcy

Talk to a Credit Counselor First

Find a government-approved credit counseling agency.
Discuss alternatives to bankruptcy before deciding to file.
Keep your certificate of completion — you’ll need it to file.

Decide Which Chapter Fits Your Situation

Compare your income to your state’s median income.
Talk to an attorney about whether Chapter 7 or Chapter 13 makes more sense.
Ask about Chapter 12 if you run a family farm.

Gather Your Financial Records

List out your debts, income, and assets.
Pull together recent tax returns and pay stubs.
Note any property you believe should be exempt.

Work With a Bankruptcy Attorney

Get help completing the petition and required forms.
Understand what property you’re allowed to keep.
Know your rights during the meeting of creditors and beyond.

Checklist for Filing for Bankruptcy

Complete credit counseling
- Do this within 180 days before filing.
- Use a government-approved agency.
- Keep your certificate for the filing.
File your petition and financial statements
- List your debts, income, and assets.
- Pay the filing fee or request a waiver.
Take the means test, if required
- Compare your income to your state’s median.
- Complete the extended calculation if your income is above median.
Attend the meeting of creditors
- Answer the trustee’s questions honestly.
- Bring ID and proof of income if requested.
Complete a debtor education course
- This is required before your debts can be discharged.
- Keep your certificate of completion.
Receive your discharge
- Chapter 7: usually 90 to 120 days after filing.
- Chapter 13: after you complete your repayment plan.

FAQ: Bankruptcy

What does it mean to file for bankruptcy?

It means telling the court, through a legal process, that you can’t pay what you owe. In exchange, the court can discharge much of that debt, though not all of it, and non-exempt assets may be sold to repay creditors.

How long does bankruptcy stay on my credit report?

A Chapter 7 filing stays on your credit report for 10 years from the filing date. A Chapter 13 filing stays for 7 years.

Will bankruptcy erase all my debt?

No. Debts like student loans, alimony, back taxes, and certain government fines typically survive bankruptcy and still have to be paid.

What’s the difference between Chapter 7 and Chapter 13?

Chapter 7 involves liquidating non-exempt assets to pay creditors. Chapter 13 involves a court-approved repayment plan, usually over three to five years, without liquidating your property.

How long does the bankruptcy process take?

A Chapter 7 case typically takes about four months. A Chapter 13 case runs the length of the repayment plan, usually three to five years.

Are there alternatives to filing for bankruptcy?

Yes. Options include negotiating new repayment terms with lenders, working with a non-profit credit counseling agency, cutting expenses, or increasing income.

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