What Is the Meaning of Insolvency?

When you start your own small business, you do so with the intention of it being a success. No one sets out with the expectation that their business will fail. Unfortunately, even some of the most brilliant business ideas end up not being financially viable.

If you’re struggling in your business, you’ve probably heard the term “insolvency” thrown around here and there. What is the meaning of insolvency? What are your options when it happens?

Read on for a deep dive into this important topic.

What Is the Meaning of Insolvency?

As a business owner, you know undoubtedly have a number of financial obligations. At a minimum, you have to pay the rent or mortgage on your business space, you have to pay your employees, and you have to pay taxes. The goal of owning a business is to bring in enough money in profits to meet your financial obligations and have money left over to pay yourself.

Despite many business owners’ best intentions, they might find themselves unable to meet their financial obligations. When someone cannot make ends meet, then they are considered to be insolvent. 

It’s important to note that an insolvent business doesn’t necessarily mean that they are bankrupt. Bankruptcy is a legal process to restructure or discharge debts, while insolvency is a state of being. Therefore, not all insolvent businesses are bankrupt, but all bankrupt businesses are insolvent.

What Are Your Options?

You’ve gone over the numbers, and you’ve come to the conclusion that your business is insolvent. Reaching that conclusion might make you feel like you’re a failure, but it’s actually a relatively common phenomenon in business. In fact, 65 percent of businesses fail within the first ten years of business.

Though the statistics are grim, that doesn’t mean you have to resign yourself to failure. There are steps you can take to keep your business’s doors open.

The first thing you should consider is finding an investor, especially if your business is still in its infancy. A lot of businesses spend some time in the red when they first open, in fact, it’s expected. Savvy business owners seek out investors to help make ends meet while they get things up and running.

If you’ve exhausted your options with investors and venture capital firms, then your next option is to consider a business loan to help bridge the gap. This is a good option for business owners who have incorporated their business as a limited liability company (LLC). In general, incorporating as an LLC protects business owners from being held personally liable for debts incurred by their business.

Bankruptcy

Another common option for insolvent businesses is bankruptcy. If you don’t have a lot of familiarity with the bankruptcy process, then the word probably sends a chill down your spine. Businesses that file for bankruptcy close down, don’t they? 

That’s not always the case. There are a number of different routes to take with bankruptcy. Some involve liquidating assets, while others involve restructuring your debts.

Most importantly, filing for bankruptcy is not a guaranteed death sentence for your business.

Chapter 7

Chapter 7 is a form of bankruptcy whereby a business liquidates its assets and has its debts discharged. Chapter 7 is a pretty common practice among sole proprietors.

Sole proprietors can file for Chapter 7 in order to discharge all business and personal debt. When you file, a trustee determines how much you have in assets and collects those funds in order to pay your creditors. If your assets cannot pay off the full amount of your debts, then the remainder of your debt is discharged.

It’s important to note that bankruptcy cannot discharge things like tax debt and student loans.

Business owners who are part of a partnership or an LLC can file for Chapter 7, but it’s ineffective because their business’s debts are not discharged. It also makes them vulnerable to personal liability if a creditor files a lawsuit to pierce the corporate veil.

Chapter 11

Want to keep your doors open? Then filing for Chapter 11 bankruptcy might be more your speed.

Chapter 11 is known as a form of bankruptcy that reorganizes your debts, assets, and business affairs. As the debtor, you have the ability to suggest a reorganization plan that is in the best interest of your creditors. If you decline to suggest a plan, then your creditors may create the plan.

Chapter 11 essentially allows you to start fresh, downsize, and keep your business going. The only downside to filing for Chapter 11 bankruptcy is that is complex and expensive. 

Chapter 13

Chapter 13 operates similarly to Chapter 11, but it is only available to individuals and sole proprietorships.

Chapter 13 allows eligible business owners to keep their assets and pay back their debts based on a repayment plan. Most payment plans last up to five years. Once you complete your payment plan, then you’ll be in the clear.

One thing to note is that Chapter 13 only clears your personal liability for business debts. Your business will still be liable for paying off its debts. For this reason, Chapter 13 is the least ideal option.

Insolvency Abroad

If you’ve taken your business international, then that adds an extra layer of complication. You need to familiarize yourself with local laws regarding insolvency in order to determine your next steps.

For example, businesses in the UK have a process called company administration that closes down an insolvent business and helps pay back their debts. If you have an insolvent business in the UK, then you should absolutely be thinking about company administration. It helps you get more money for your business than you would otherwise be able to do on your own, leaving you in a better financial position.

Now’s the Time to Get Your Finances Back on Track

It’s normal for businesses to go through financial stress from time to time. If your business is really hurting, then it’s time to take some steps to get back on track. Learning the meaning of insolvency is the first step toward financial recovery for your business.

It’ll take hard work, but it is possible to get your business out of the red. 

Are you interested in learning more about being a successful business owner? We can help you out with that. Check out the rest of our blog for loads of content that’ll get you on the road to success. 

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