Published On: Sat, Dec 3rd, 2016

5 Things Creditors Should Understand about Business Bankruptcies

Many people feel they have a fairly good understanding of the way bankruptcy works. However, this understanding can often be faulty, especially when it comes to business bankruptcy cases. Small investors often rely on their understanding of personal bankruptcy laws when making business decisions. If you’re considering investing in a business that has filed for bankruptcy in the past, or are considering loaning money to a business owner in a high-risk area or industry, there are several issues to make sure you understand.

  1. Chapter 7 and Chapter 11 bankruptcies have different purposes and different legal regulations. As a general rule, Chapter 7 bankruptcies are for companies that plan to liquidate and Chapter 11 bankruptcies are for companies that plan to restructure. Investing in a person or company with a history of Chapter 11 bankruptcies makes more financial sense than investing in a business owner with a history of Chapter 7 bankruptcies.
  2. Creditors can request an involuntary bankruptcy for a business. Technically, involuntary bankruptcies can also be requested for individuals, but it is extremely rare. If you are owed money by a business, and you believe the business has assets with which it could pay you, you can file a petition with the bankruptcy court. Obviously, this is not a step to take lightly or without legal help. However, if you find yourself owed money by a business that can pay, an involuntary bankruptcy petition may be worth investigating.
  3. State bankruptcy rates are often misleading. When evaluating a business opportunity you may wish to look at the numbers of business bankruptcies in the area. However, as a recent study has shown, because these rankings are based solely on the number of bankruptcies in an area, and do not consider other factors such as the area’s economy, they are often misleading.
  4. Partnerships can put your personal assets at risk. Anyone with a little extra money to invest has had a friend or relative approach him about a great partnership idea. Although the decision to loan money to a loved one may be made emotionally, the decision to enter in to a legal partnership should not be. If you are a legal partner in a business that goes bankrupt, your personal assets could be put at risk. No matter how close you are to the person proposing a partnership, make sure you fully understand any documents and have your personal assets protected.
  5. Some people actually invest in bankrupt companies. It sounds ridiculous to think that buying stock in a company that has declared bankruptcy is a good idea, but every once in a while it pays off. When a company declares Chapter 11, secured lenders get paid before unsecured creditors and stockholders are the last to get paid. Usually, there’s nothing left for stockholders. But, occasionally, under a reorganization or buyout, shareholders either get shares of the new company, or shares in the buying company. This is an extremely risky investment move and is not recommended by most experts.

Even in the best of circumstances, investing in a business is risky. However, having a thorough understanding of the risk you are undertaking can help you feel better about your choices.

Author: Lolita Di

photo via Flickr stockmonkeys.com

photo via Flickr stockmonkeys.com

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