Navigating the financial world after bankruptcy can be difficult, especially if you need to secure a small business loan. However, it’s not impossible. Despite common misconceptions, acquiring a small business loan post-bankruptcy is achievable, though you’ll need to prepare before doing so.
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What Is Bankruptcy?
Bankruptcy is a legal status that a person or entity can enter when they can’t repay their debts. It’s a process usually initiated by the debtor and imposed by a court order.
There are various types of bankruptcy outlined under U.S. law, most commonly Chapter 7, Chapter 11 and Chapter 13. Bankruptcy relieves the debtor from the overwhelming pressure of financial liabilities, but it also inflicts severe damage to their creditworthiness, making it difficult to secure loans or credit in the future.
Types of Business Bankruptcy
There are two main types of bankruptcy businesses can file for in the United States: Chapter 7 and Chapter 11. However, small business owners and sole proprietors may also use Chapter 13 bankruptcy to pay off their debts over time.
- Chapter 7 bankruptcy. Chapter 7—or liquidation bankruptcy—is a common choice for small businesses that can’t make regular payments toward their debts. In this process, the company ceases operations and a trustee is appointed to liquidate its assets. The proceeds from this liquidation are used to pay off the business’s creditors. While it provides a fresh start, it results in dissolving the business.
- Chapter 11 bankruptcy. This form of bankruptcy, also called reorganization bankruptcy, allows a business to continue operating while restructuring its debts and obligations. Businesses typically choose Chapter 11 if they believe they can become profitable again after restructuring. The business, or debtor, typically keeps control of the business operations as a debtor in possession but remains subject to the oversight and jurisdiction of the court.
- Chapter 13 bankruptcy. Although Chapter 13 bankruptcies are commonly associated with individual debtors, they can be a viable option for sole proprietorships. This form of bankruptcy allows a debtor to keep their property and pay debts over three or five years, depending on their debts, income and location. Chapter 13 bankruptcy provides a good choice for businesses that can pay off their debts within the applicable commitment period.
The Result of Business Bankruptcy
Bankruptcy has long-lasting consequences on a business’s ability to operate and secure future financing. Post-bankruptcy, the debtor’s credit report shows the bankruptcy filing for up to seven or 10 years, depending on the type of bankruptcy. This significantly decreases the business’s creditworthiness, making it extremely difficult to secure the best small business loans, credit cards and other forms of credit.
Business bankruptcy can lead to lost control of the business, especially in the case of Chapter 7 and Chapter 11. In Chapter 7, the business typically ceases operations entirely, while in Chapter 11, the court may appoint a trustee to oversee the business’s reorganization and debt repayment plan.
How To Get a Business Loan After Bankruptcy
Securing a business loan after filing for bankruptcy can be challenging, but it’s not impossible. Lenders often perceive bankrupt businesses as high-risk borrowers due to their financial history and this perception can result in higher interest rates and more stringent loan terms.
However, several strategies can improve the likelihood of securing a loan post-bankruptcy. Here’s how to get a business loan after bankruptcy:
1. Give It Time
Time is crucial in increasing your chances of securing a business loan after bankruptcy. As bankruptcy filings stay on your credit report for up to 10 years, waiting allows the negative marks on your credit to lessen over time. The more time has passed since your bankruptcy, the less weight lenders will give it in their decision-making process.
Putting time between you and your bankruptcy also lets you rebuild your credit history and demonstrate financial responsibility, making your business a more attractive proposition for lenders in the future.
2. Build Credit
A robust credit score can make a significant difference in how lenders perceive your financial stability post-bankruptcy. You can start by getting a secured credit card or a small installment loan. As you regularly make payments on these debts, you’ll show your ability to manage debt responsibly, gradually improving your credit score.
You can also consider self-reporting your payment histories to business credit bureaus. Positive payment histories can enhance your business credit profile, making you more attractive to lenders. While you’re rebuilding your credit, it’s crucial to keep your credit utilization low and to avoid any late payments or defaults on existing credit.
Building credit is a slow process, but these efforts can significantly improve your chance of securing a business loan—even after bankruptcy.
3. Write a Solid Business Plan
A well-structured and convincing business plan can significantly improve your chances of securing a small business loan after bankruptcy. The business plan should clearly articulate your business model, market analysis, operational strategies, financial projections and a detailed plan for using the loan funds.
This gives the lender confidence in your vision and strategic direction and also demonstrates your commitment to responsible financial management.
4. Demonstrate Consistent Income
Lenders want to see that your business is generating reliable, steady revenue that can cover your loan repayments and other business expenses. Consistent income from customers, investments and other sources shows lenders that your business is viable and can make on-time loan payments.
Note, however, that businesses emerging from bankruptcy may have difficulty proving consistent income due to their financial situation prior to filing for bankruptcy. To mitigate this concern, be prepared to share relevant documents like historical financial statements or tax returns to demonstrate your financial health.
5. Be Prepared To Explain the Bankruptcy
Explaining the circumstances surrounding the bankruptcy can reassure lenders that your bankruptcy resulted from circumstances beyond your control rather than poor fiscal management. Start by drafting a detailed bankruptcy statement that provides a clear explanation of the factors that led to the bankruptcy.
This statement should be honest and straightforward and highlight any unique or unexpected circumstances that contributed to your business being unable to repay debts—such as an unforeseen market change or a global event like a pandemic.
6. Keep Your Debt Low
Maintain a low level of debt following bankruptcy by budgeting and spending carefully. Avoid taking on more debt unless it’s absolutely necessary and focus on paying off any existing obligations. If appropriate, consider consolidating your debt or negotiating with creditors for lower interest rates or extended payment plans.
Keeping your debt low not only helps in managing your finances more effectively but also boosts your credit score, which is a key factor lenders consider when evaluating a loan application. Lower debts also mean a lower debt-to-income ratio, which lenders often see as a sign of financial stability.
7. Find a Co-Signer
A co-signer is someone who agrees to take on the responsibility of your loan if you’re unable to make the repayments. This reduces the risk for lenders and can make them more inclined to approve your loan application. A co-signer with a strong credit history can also help you get better loan terms, like lower interest rates.
When applying for a loan with a co-signer, remember they will be legally liable for the loan repayment if you default. Consider the co-signer’s financial situation and have a clear and open discussion about the risks and responsibilities involved before entering into this type of relationship.
8. Put Up Collateral
Offering collateral can significantly boost your chances of securing a business loan after bankruptcy. Collateral is typically an asset you pledge as a guarantee to the lender, serving as a backup in case you default on the loan. This can include personal and business assets, such as real estate, vehicles, equipment, inventory or accounts receivable.
Secured loans with collateral are perceived as less risky by lenders, since they can seize and sell the assets if you fail to repay the loan. Even with a bankruptcy in your financial history, providing collateral can reassure lenders of your commitment to repay and improve your eligibility for a loan.
9. Consider Alternative Funding Options
Following bankruptcy, alternative funding options might be more feasible and accessible than traditional small business loans. These lenders are often more willing to extend loans to bankrupt businesses and may be more lenient with the terms and requirements than traditional banks. Some options worth considering include:
- Crowdfunding. Crowdfunding involves raising small amounts of money from numerous people, typically via online platforms.
- Peer-to-peer lending. Peer-to-peer business loans connect borrowers directly with investors through online platforms without going through a traditional financial institution.
- Venture capital and angel investors. Venture capitalists and angel investors are individuals or firms that provide capital to startups or small businesses in exchange for equity. In addition to their financial investment, VCs may bring valuable guidance and connections to your business.
- Grants. Depending on your industry, you may be eligible for small business grants that don’t need to be repaid. Governments, foundations, and organizations offer various grant opportunities, especially if your business is involved in research and development or if it aligns with specific social or economic objectives.
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