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Debt Consolidation vs Bankruptcy for Small Business Owners

Updated on
March 16, 2024

What is Debt Consolidation for Small Businesses?

Debt consolidation is the process of combining multiple business debts into one new loan with one monthly payment. The goal is to simplify repayment by dealing with only one lender instead of many. 

With debt consolidation, a small business takes out a new loan and uses the funds to pay off existing debts. This new consolidated loan ideally has a lower interest rate or better terms, making the overall repayment cheaper.

Some key benefits of debt consolidation for small business owners include:

  • Simplified finances with one single monthly payment instead of multiple bills  
  • Potentially lower interest rate compared to high-rate credit cards or other debt
  • Fixed interest rate provides stability in monthly payments
  • Paying off debts faster by reducing interest fees over time 
  • Lower monthly payments by extending loan terms
  • Improved cash flow from consolidation of high monthly payments
  • Stop collection calls from multiple creditors

Debt consolidation can provide much needed relief for small businesses struggling with debt. By streamlining multiple payments into one and securing better repayment terms, debt consolidation loans can help save money and eliminate debt faster.

What is Business Bankruptcy?

Bankruptcy is a legal process that provides relief for individuals and businesses who cannot repay some or all of their debts. For businesses, the most common types of bankruptcy filings are Chapter 7 and Chapter 13.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy, often called "liquidation bankruptcy," entails liquidating the company's assets to pay off creditors. Any assets that are not exempt from liquidation are sold by the bankruptcy trustee, and the proceeds are used to repay creditors. Common exempt assets include reasonable household goods, clothing, personal vehicles up to a certain value, and tools of trade.

Any remaining unpaid debt is discharged, meaning the business is no longer legally obligated to pay it back. Most small businesses file Chapter 7 bankruptcy.

The Chapter 7 bankruptcy process typically takes 3-6 months from filing to discharge. During this time, creditors cannot attempt to collect on the debts. After discharge, the business owners are protected from any future collections or lawsuits related to the discharged debt. However, any assets the business owns can be seized and liquidated after the discharge if they were used as collateral to secure debt.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy allows small businesses to restructure their debt and repay at least a portion of what is owed over a 3-5 year period. The business owners get to keep their assets by agreeing to a court-approved repayment plan. Monthly payments are made to a bankruptcy trustee who distributes them to creditors.  

Once the repayment plan is completed, the remaining unpaid debt is discharged. While in repayment, creditors cannot sue, foreclose, or attempt to collect beyond the terms of the Chapter 13 plan. This stops harassment from creditors and can allow the business to recover and get back on its feet.

Pros of Debt Consolidation for Small Business

Debt consolidation can offer several benefits for small business owners struggling with high-interest debt:

  1. Lower Interest Rate - Debt consolidation loans typically have much lower interest rates compared to credit cards and other lines of credit. This makes monthly payments more affordable and saves money on interest expenses over the life of the loan.
  1. Simplified Payments - With debt consolidation, you make only one monthly payment to the lender, instead of juggling multiple bills from different creditors. This simplifies payments and makes it easier to stay on top of them.
  1. Stop Collections - The new debt consolidation loan pays off your existing debts, stopping collections and harassment from creditors seeking past due balances. This provides immediate relief and peace of mind.
  1. May Improve Cash Flow - Lower monthly payments free up cash that previously went toward high interest costs. This improved cash flow allows you to better manage operating expenses or invest in growing your business.

Debt consolidation can be an effective way for small business owners to reduce high-interest debt burdens and improve financial stability. The lower interest rate, simplified payments, and other benefits make consolidation loans an option worth exploring.

Cons of Debt Consolidation

  • Taking on a longer repayment term means you may end up paying more total interest over the full loan period, even if the interest rate is lower. Consolidating debt from 2 years of payments into a new 5-year loan saves monthly cash flow but increases the overall interest paid.
  • Secured debt consolidation loans use your business assets as collateral. If you are unable to make payments, you risk losing those assets including equipment, property, accounts receivable or inventory. An unsecured loan does not put your assets at risk.
  • Applying for a new debt consolidation loan requires a hard inquiry on your business credit report, which can cause a temporary dip in your business credit scores. The impact is larger if you have limited credit history. Opening a new account also lowers your business credit utilization ratio which helps improve scores over time.

Pros of Filing for Business Bankruptcy

Filing for bankruptcy can provide much-needed relief for small business owners who are overwhelmed with unsustainable debts. Here are some of the potential benefits of declaring bankruptcy:

  • Eliminates or significantly reduces business debt burden - The primary advantage of bankruptcy is that it can eliminate or greatly reduce the amount of debt owed. In Chapter 7 bankruptcy, most unsecured debts like credit cards, medical bills, and personal loans can be wiped out. In Chapter 13, unsecured debts can be reduced through the repayment plan. This relief allows businesses to restart with a clean slate.
  • Stops collections and seizures - Once a bankruptcy petition is filed, creditors must stop collection efforts immediately. This means an end to harassing phone calls, lawsuits, wage garnishments, bank account levies, property seizures, utility shutoffs, and eviction proceedings. The automatic stay provided by bankruptcy gives businesses breathing room.
  • Allows the business to retain certain assets - Depending on the bankruptcy chapter, small businesses may get to keep necessary assets like commercial vehicles and equipment that are exempt. The exemptions differ by state but allow businesses to continue operations.
  • Discharged in a fixed time period - Chapter 7 bankruptcy is typically discharged within 3-6 months. Chapter 13 bankruptcy ends once the 3-5 year repayment plan is completed. This light at the end of the tunnel allows owners to work toward restarting their business.

Filing for bankruptcy provides permanent solutions that can save small businesses on the brink of financial ruin. By eliminating or reducing debts and stopping collections, it offers a fresh start.

Cons of Filing Business Bankruptcy

Filing for bankruptcy can negatively impact your business in several ways:

  • Damages Credit - Bankruptcy can severely damage your business credit score for years. A bankruptcy will remain on your business credit report for up to 10 years. This makes it very difficult to get approved for financing or loans.
  • Lose Assets - While you may be able to keep certain assets in a personal bankruptcy, this is less likely with a business bankruptcy. The court may require you to liquidate assets to pay off debts. You could lose business equipment, property, and other valuable assets.
  • Costly Legal Fees - The bankruptcy process involves extensive legal fees. Bankruptcy attorney fees average $1,500 to $3,000 for Chapter 7 and $3,000 to $6,000 for Chapter 13 bankruptcies. There are also filing fees and trustee fees.
  • Not All Debts Discharged - With a business bankruptcy, not all your debts will necessarily be wiped out. Taxes, fraud debts, and recent loans may still need to be repaid after bankruptcy. A business bankruptcy discharge also does not protect your personal assets or debts.

Filing business bankruptcy can have lasting negative consequences. Be sure to carefully weigh the pros and cons, and explore all options before making this major financial decision for your company.

How Debt Consolidation and Bankruptcy Affect Your Credit

Debt consolidation and bankruptcy can both negatively impact your business credit scores, but in different ways. 

With debt consolidation, the new loan inquiry will show up on your credit reports and likely lower your scores temporarily. However, making consistent on-time payments on the new consolidated loan can start to rebuild your credit history over time. Just be sure to maintain low credit card balances and keep accounts in good standing.

Filing for bankruptcy has a much more severe and lasting impact on credit. Bankruptcy can damage your credit scores by 100 points or more. The bankruptcy will remain on your credit reports for 7-10 years depending on the chapter you file. 

This can make it difficult to get approved for financing or credit in the years immediately following bankruptcy. Your personal credit is also likely to take a hit if you personally guaranteed any business loans.

Overall, debt consolidation will do less damage to your credit compared to bankruptcy. If you can qualify for a consolidation loan with better terms, it may be a good option to avoid bankruptcy and start rebuilding your credit right away. Consult with a credit counselor or attorney to understand how each option could impact your situation.

Alternatives to Debt Consolidation & Bankruptcy  

While debt consolidation and bankruptcy may seem like the only options for eliminating or reducing small business debt, there are a few other alternatives to consider first:

Debt Settlement

Debt settlement involves negotiating directly with creditors to pay a lump sum that is less than the total amount owed. Typically you would work with a debt settlement company who will negotiate settlements that forgive a percentage of your debt. This can eliminate debt without the long-term credit damage of bankruptcy. However, it can take several years to settle all accounts and you may get calls and lawsuits in the interim.

Payment Plans  

For some types of debt like taxes and student loans, setting up a payment plan directly with that creditor may be an option. This allows you to pay it down over time without needing debt consolidation. Payment plans don't reduce the debt but can sometimes lower interest rates.

Borrowing From 401K

If your business has a 401K retirement account, you may be able to borrow against it. There are limits and you have to pay it back over 5 years. But the interest goes back into your account versus paying a bank. This should only be done as a last resort however, since it reduces your retirement savings.

Business Loans/Lines of Credit

Depending on your situation, you may be able to qualify for a business loan or line of credit that can be used to pay off existing debts. This adds new debt but may have more favorable repayment terms. It's important to only borrow what you can afford to pay back.

While not as comprehensive as debt consolidation or bankruptcy, these alternatives let you deal with debt without damaging your credit or requiring legal filings. They can be good interim solutions while improving your financial situation.

Questions to Ask When Deciding Between Debt Consolidation and Bankruptcy

When determining if debt consolidation or bankruptcy is the right choice for your small business, ask yourself the following key questions:

Can you afford the monthly payments?

Debt consolidation loans combine multiple debts into one payment, but you need to make sure you can afford the new monthly amount. Calculate the payment based on the loan amount, interest rate, and repayment term to see if it fits your budget.

Will consolidation save you money on interest and time?

Consolidating at a lower rate can reduce the total interest paid over the loan term. And consolidating multiple debts into one may help you pay everything off faster. Crunch the numbers to see if the consolidation option will provide interest and time savings.


Is your financial situation so dire bankruptcy is the only option?

If your business is facing multiple lawsuits, foreclosure, repossessions, or otherwise unable to pay its obligations, bankruptcy may be the only path forward. Debt consolidation is not designed for businesses in truly dire financial straits.


Have you explored alternatives like debt settlement first?

Debt settlement can help negotiate total balances down and create affordable payment plans on the reduced amounts. It may provide relief without the long-term credit damage of bankruptcy.


Can your business survive the bankruptcy process?

Filing business bankruptcy does not necessarily mean closing up shop. In some cases, the protection of bankruptcy can help struggling businesses stay open. Just be prepared for the legal complexities.

Considering these key questions can help you determine if debt consolidation or bankruptcy is truly the right solution for your small business debt crisis. Don't go it alone - talk to professionals to get help choosing the best path forward.

Getting Professional Help

When deciding between debt consolidation or bankruptcy for your small business, it's important to consult professionals who can review your specific situation and provide guidance on the best path forward. Here are some ways to get professional assistance:

Consult Credit Counselors

Meeting with a non-profit credit counseling agency can provide you with free advice on managing debt and understanding all of your options. Credit counselors can discuss programs like debt management plans, negotiate with creditors, and educate you on how different options may impact your credit. They can help assess if consolidation or bankruptcy is right for you.

Meet with Bankruptcy Lawyers

It's wise to meet with a qualified bankruptcy attorney to fully understand if filing for Chapter 7 or Chapter 13 bankruptcy makes sense for your small business. An attorney can evaluate your personal situation, explain what debts can and cannot be discharged through bankruptcy, and inform you of any potential risks or consequences. 

Get Advice to Determine Best Option

Speaking with financial experts like accountants, tax advisors and financial planners can provide additional insight into the pros, cons and feasibility of debt consolidation or bankruptcy. They can also explore alternatives like debt negotiation or restructuring. Their professional advice can help determine the most strategic option for handling your business debt.

Getting guidance from credit and financial professionals is key to making an informed decision on how to best resolve your debt dilemmas. Consult business debt experts here at Cain & Daniels to understand all of your options and put your business on the soundest financial path forward.

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