Establishing a sole proprietorship is a cost-effective and straightforward way to set up a business. However, the legal ease of having no legal separation between you and your company also brings a significant financial risk.
Sole proprietors bear personal responsibility for business debt, risking creditor claims to their savings and personal property. This particular challenge can factor greatly into decisions when filing for bankruptcy.
Sole proprietors and other small business owners facing debt typically choose between two options:
- liquidating in Chapter 7 bankruptcy
- restructuring their debt through Chapter 13 bankruptcy
While most businesses avoid Chapter 7 since it often leads to ceasing business operations, service-based sole proprietors enjoy several exemptions that make it an attractive choice.
Chapter 7 benefits for sole proprietors
In Chapter 7, you settle qualifying personal or business debt by liquidating or selling your assets to pay your creditors. To file for Chapter 7 in Ohio, a sole proprietor must pass a means test. It requires a household income below the state’s median.
Service-based sole proprietors may want to opt for Chapter 7 because they can:
- Wipe out or discharge both personal and business debts in a single Chapter 7 filing
- Get exempted from the means test if their business debts exceed their personal obligations
- Avoid losing equipment to bankruptcy due to the tools of the trade exemption, which exempts $2,550 worth of items used to make a living from seizure
- Continue their business since the bankruptcy trustee can’t sell their ability to perform the service
- Get a relatively quick, fresh start since it typically only takes four to six months from filing to discharge
When to take extra caution
While Chapter 7 can be the most beneficial option for some sole proprietors, it may not be the case for all. Sole proprietors with large estates or significant business assets necessary to keep the business running stand to lose more in the process. Exploring a Chapter 13 payment plan may be more practical in these cases.
Identifying whether you should file for bankruptcy and which type to file may be challenging. Consulting an experienced bankruptcy attorney is advisable to decide what’s best for your business and ensure you meet all legal requirements.