We all know the odds when it comes to starting a small or independent business. About 1 in 5 won’t make it past the first year, and less than half make it past the five-year mark. After ten years, fewer than a third of small businesses are still going.


And the two-thirds that don’t make it account for plenty of bankruptcies.


The numbers don’t tell the whole story, of course. Just because a business is gone doesn’t mean it folded. Owners decide to close up for personal reasons, or go off on search of a new business adventure, or sell to a larger concern. And businesses that fold don’t necessarily go bankrupt—nor do businesses that go bankrupt necessarily fold.


But bankruptcy is where a decent number of small businesses (or their owners) end up after a while. Planning for that eventuality—even as you work to avoid it—can help smooth out the bumps in the entrepreneurial road.


Strategically Planning Debts and Assets


As I’ve written before, while it’s generally best to separate your business and personal financial assets, there can be advantages to certain entanglements when you hit the bankruptcy stage. Namely, a variety of personal assets are protected during a bankruptcy. In addition, certain debts are dischargeable (i.e. can be cancelled by paying only a fraction of the debt owed, or even none at all) in a bankruptcy, where others are non-dischargeable.


Then, whether a debt is secured (i.e. attached to a specific piece of property or equipment, like a car loan that allows the lender to repossess the car) or unsecured can affect how it’s treated in a bankruptcy. And to complicate things further, some debts—both secured and unsecured—may or may not relate to protected assets and may or may not be dischargeable.


To take one straightforward example, a house with a mortgage on it is a secured debt. But if that house is your personal residence, the asset typically can’t be taken in a personal bankruptcy. Moreover, your mortgage debt may be discharged without the need for you to pay the full amount. In contrast, a student loan is an unsecured debt that often cannot be discharged even in a bankruptcy. If you paid off your house but let your student loans linger, then you’ve lost a lot of protection a bankruptcy can offer.


This barely scratches the service of personal bankruptcy planning. Add business assets and obligations to the mix, and the possible debt-and-asset combinations grow exponentially.


The end result is that two businesses, and two business owners, who seem to be in relatively similar financial positions, may emerge from bankruptcy in drastically different situations depending on how they’ve structured their debts, what specific assets they hold, whether those debts and assets are held by a business entity or by the owner in their personal capacity, and whether each debt is secured or unsecured, dischargeable or non-dischargeable.


Bankruptcy is, to put it simply, anything but simple.


Look Ahead Before You See Red


You might be thinking it isn’t worth the headache to plan for bankruptcy at the outset of your business venture, or any time things are going well. After all, these are issues you’ll tackle with your bankruptcy lawyer should the need ever arise, right?


Not exactly.


Yes, your bankruptcy lawyer will likely discuss these issues with you. But when a bankruptcy is looming on the horizon, it is likely too late to make many of the changes you would need to take full advantage of a bankruptcy. Most importantly, trying to make these changes because you anticipate a bankruptcy and are trying to aggressively protect assets could easily backfire, hitting you with penalties and potentially eliminating bankruptcy protection.


In extreme cases, you could find yourself facing fraud charges. That’s not an ordeal you (or your lawyer) want to encounter.


That’s why up-front planning is essential. To make your bankruptcy work best for you, you need to have things set up correctly long before you’re entertaining the notion of a bankruptcy at all.


Talk to your account, and to an attorney, about the best way to maximize your borrowing, how your assets are held, your personal as well as your business situation, and the specific risks facing your business. A potential bankruptcy won’t be your only consideration in these discussions, but it should be among them.


I’m not saying you need to panic, or run your business with a doom-and-gloom mentality. Hope for the best, take risks, do all the scary-but-necessary things to make your small business work. 


Meanwhile, be prepared just in case things turn south.