When the Startup Dream Goes Bust: the Basics of Filing for Bankruptcy

A wise adage that many successful entrepreneurs heed is “expect the best, but prepare for the worst.” Yet even the most down-to-earth or outright cynical and pessimistic entrepreneur out there might be forgiven for not predicting that a bankruptcy might be their future.

However, although it’s a topic that most people don’t want to dwell on, the fact remains that each year hundreds of thousands of businesses — including many startups — file for bankruptcy protection. What’s more, many of their owners were blindsided by factors totally beyond their control.

For example, noted bankruptcy attorney Charles H. Huber writes in his firm’s blog about the tragic case of Boston-based digital TV startup Aereo. When it arrived on the scene, Aereo was hailed as “the next big thing” that would revolutionize the television and entertainment industry. Yet the Supreme Court had another view, and in a 2014 ruling essentially pulled the plug due to copyright violations. It wasn’t long before Aereo filed for bankruptcy, and was a sold in 2015 to TiVO for $1 million. No, that’s not pocket change. But it was massively lower than the company’s $800 million (yes, you read that correctly) valuation in early 2014.

The moral to this story is clear: no, you absolutely don’t want to file for bankruptcy — and either pause your startup dreams, or shut them down (for now at least). But you should nevertheless be somewhat prepared for what the bankruptcy landscape looks like, so that if it emerges — or better stated, erupts — into your world, you can take quick action to mitigate the damage, and potentially salvage your startup.

There are typically three types of bankruptcy filing options available to troubled startups and other businesses: chapter 7, chapter 11, and chapter 13.

• Chapter 7 is known as “liquidation bankruptcy.” The good news is that this will wipe out many, if not most of your debts, and your creditors will have to accept whatever the count-appointed bankruptcy trustee decides (creditors can object, but as long as the trustee is acting appropriately the courts will side with him or her). The bad news is that you’ll have to permanently shut down your start-up.

• Chapter 11 allows you to work with a court-appointed bankruptcy trustee and your creditors, in order to put together a structured debt repayment plan. This is a highly complex process, and it can be difficult to get creditors on the same page. However, your business will remain afloat, and ideally emerge in a 3-5 years debt free and ready to grow.

• Chapter 13 is also a structured bankruptcy, but one where you commit to paying back your creditors an agreed upon amount based on your future income. For most business owners, filing for chapter 13 bankruptcy is far preferred to chapter 11, since they maintain much more control of their business. However, getting approved for chapter 13 is difficult, and the courts must be convinced that the plan is going to work. What’s more, if at any time during the restructuring period a creditor thinks that you’re not acting in accordance with the plan, they can file an objection and pull the matter back into court.

If bankruptcy is a route that you may need to take to protect your finances — and possibly and hopefully preserve your startup — then speak with an experienced bankruptcy attorney right away. Get the facts you need to make a smart, safe and informed decision.