Does Declaring Bankruptcy Really Give a Business a Fresh Start? Yes…and No

By Maria Valdez Haubrich

What effects does a prior bankruptcy filing have on a small business’s chances of recovering and thriving once again? A new study recently released by the Small Business Administration’s Office of Advocacy has some surprising news about the longer-term effects of business bankruptcy.

First, the good news: Small businesses that have filed for bankruptcy in the past aren’t any more burdened than other small companies by cash flow problems, excessive taxes or high health insurance costs; they also end up growing to similar sizes as the average firm, the study found.

Now, the bad news: Companies that previously declared bankruptcies have approximately a 24 percent higher chance of being denied a business loan. When they do obtain loans, they are charged interest rates at least 1 percent higher than the average company.

And the really bad news: Companies owned by African Americans or and Hispanic Americans were even more likely to have their loan applications denied and to be charged higher interest rates when they did get loans.

“Small businesses filing for bankruptcy have an opportunity for a new start,” said Chief Counsel for Advocacy Winslow Sargeant in announcing the study. “[But when] this new start is hampered by the challenges of obtaining new loans, this can impede innovation and job creation.”

The study, Beyond Bankruptcy: Does the Bankruptcy Code Provide A Fresh Start to Entrepreneurs? by Aparna Mathur, found that owners of 2.6 percent of firms had filed for bankruptcy at some point in the previous seven years. (The study used data from the Federal Reserve Board’s Survey of Small Business Finances.)

The businesses’ ability to survive after filing bankruptcy was positive, Mathur noted in the study. However, “a bankruptcy on a firm’s credit record negatively affects a firm’s ability to obtain loans, especially at reasonable interest rates, even controlling for credit scores,” Mathur noted. What’s more, bankruptcy affected all types of credit—including trade credit, which is more crucial than loans to many small businesses.

“While the bankruptcy code does help certain businesses get back on their feet,” Mathur concludes, “the persistence of credit access issues after bankruptcy suggests that the promise of the ‘fresh start’ has not been fully realized.”

The full report is available on the Office of Advocacy’s website.

Image by Flickr user Nicholas Copernicus (Creative Commons)

This entry was posted on Tuesday, May 3rd, 2011 at 6:00 am and is filed under Business Law, Compliance, Small Business. You can follow any responses to this entry through the RSS 2.0 feed.


You can leave a response, or trackback from your own site.