Considering Bankruptcy for Your Small Business? Here Is What You Need to Know
Starting a small business involves inherent risk. Entrepreneurs trade the predictability of a regular paycheck for the opportunity to build financial independence and create economic value. According to data from the U.S. Bureau of Labor Statistics, approximately 20.4% of businesses fail within their first year, about 49.4% fail by their fifth year, and roughly 65.3% fail by their tenth year, with survival rates varying by industry (https://www.bls.gov/bdm/us_age_naics_00_table7.txt). These figures underscore a consistent reality: sustaining a business over the long term remains challenging for many owners.
While the reasons for small business failure vary, financial distress is a common thread. When a business can no longer meet its obligations, the U.S. Bankruptcy Code provides tools to either discharge debt in an orderly fashion or restructure liabilities while continuing operations. Although the word “bankruptcy” carries stigma for many entrepreneurs, bankruptcy can, in appropriate circumstances, offer a structured path to regain control and achieve a financial reset.
Small Business Bankruptcy Trends
Business bankruptcy filings have increased in recent years following a period of historically low activity during and immediately after the COVID-19 pandemic. According to the Administrative Office of the U.S. Courts, business bankruptcy filings increased approximately 5.6% during the twelve-month period ending September 30, 2025, rising to just over 24,000 total filings nationwide (https://www.uscourts.gov/data-news/judiciary-news/2025/11/24/bankruptcy-filings-increase-106-percent).
This upward trend reflects broader economic pressures, including higher interest rates, tighter credit markets, persistent inflation, and rising operating costs. While many small businesses still close informally without filing bankruptcy, the growing use of bankruptcy reflects increased financial strain across multiple sectors (https://www.abi.org/newsroom/bankruptcy-statistics).
Subchapter V of Chapter 11—designed specifically for small business debtors, has continued to play a significant role. Filings under Subchapter V reached their highest annual totals to date in 2024–2025, reflecting increased awareness and use of streamlined reorganization options for closely held businesses (https://www.abi.org/newsroom/small-business-reorganization-act).
Reasons for Small Business Bankruptcy
Small business owners face well-documented failure rates: roughly one in five businesses fail within the first year, one in two fail within five years, and only about one-third survive beyond ten years (https://www.bls.gov/bdm/us_age_naics_00_table7.txt).
Common causes of small business bankruptcy include:
Undercapitalization
Poor or unrealistic planning
Adverse business conditions (competition, rising costs, reduced demand)
Management or operational mistakes
Trade credit disruptions
Loss of major customers or contracts
Tax liabilities and compliance failures
Creditor disputes, including lawsuits and foreclosures
Personal crises such as illness, divorce, or family emergencies
Calamities such as fraud, theft, accidents, or natural disasters
Insurance gaps also play a role. Industry studies show that many small businesses lack adequate insurance coverage to defend lawsuits or absorb catastrophic losses, increasing the likelihood of insolvency when unexpected events occur (https://www.insureon.com/small-business-insurance/statistics).
Bankruptcy Options for Small Businesses
The U.S. Bankruptcy Code contains six chapters, but Chapter 7, Chapter 11, and Chapter 13 are most commonly used by businesses and business owners (https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics).
Chapter 7 Bankruptcy
Chapter 7, commonly known as liquidation bankruptcy, involves the sale of non-exempt assets by a bankruptcy trustee, with proceeds distributed to creditors. For sole proprietors, many remaining debts are dischargeable, subject to exceptions such as certain taxes and domestic support obligations. For corporations and LLCs, debts are not technically discharged, but the entity typically ceases to exist after liquidation (https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics).
Chapter 7 does not necessarily end a sole proprietorship. Many service-based businesses can retain exempt tools of the trade, allowing the owner to continue earning income after the case concludes.
Chapter 11 Bankruptcy
Chapter 11 allows businesses to continue operating while restructuring debt under court supervision. The debtor proposes a reorganization plan—generally within 120 days—detailing how creditors will be paid or modified. Chapter 11 can preserve enterprise value but is often complex, time-consuming, and costly, with no guarantee of plan confirmation or future profitability (https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics).
Small businesses may also qualify for Subchapter V of Chapter 11, which simplifies procedures, reduces costs, and allows owners to retain equity without full creditor consent in certain circumstances (https://www.abi.org/abi-journal/subchapter-v-the-small-business-debtors-best-friend).
Chapter 13 Bankruptcy
Chapter 13 is available only to individuals, including sole proprietors, and involves repayment of debts over a three- to five-year plan. It is typically less expensive than Chapter 11 but requires sufficient disposable income to fund the plan. A trustee is appointed to distribute payments to creditors, and all disposable income may be committed during the repayment period (https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-13-bankruptcy-basics).
Talk to Our Lawyers About Your Situation
Bankruptcy is not a decision to make lightly. It can have long-term consequences for both business and personal finances. Before proceeding, business owners should consult experienced counsel to evaluate available options, assess risks, and develop a strategy aligned with long-term goals.
To discuss your situation with our attorneys, contact us to schedule an appointment.