Starting a business is difficult, but establishing a new business from scratch after filing for bankruptcy can be an even bigger challenge. Nothing is as stressful as bankruptcy. Your income and every asset you own are put in the spotlight for analysis. After the legal analysis is done, you’ll get your discharge or dismissal. But remember, this is not the end of the financial challenges you will face.
Filing bankruptcy will offer a fresh start and keep your debts behind you. So, you might think starting a business will be easy. But that is not actually true. You may face several financial challenges when you try to set up a business after bankruptcy. For instance, you may find it difficult to get business credit.
For a fresh start, you have to rebuild your finances and credit from scratch. Without these two things, you can’t establish a new business after bankruptcy.
How soon can you start your own business after filing for bankruptcy?
You can establish a business the day after filing for bankruptcy or after it has been discharged.
The bankruptcy court requires you to earn a livelihood throughout your bankruptcy. For that reason, you may need to start a business or engage in other forms of self-employment.
If you need financing to launch your new business, you may need approval from the court to take on further debt.
If you want to establish your new business after filing bankruptcy, focus on these two main strategies:
a) Find steps to rebuild your finances and credit after bankruptcy
b) Identify things to consider before starting a new business after bankruptcy
How to rebuild your finances and credit after bankruptcy
Your credit will take a big hit after filing for bankruptcy. Most of your assets will be liquified during the bankruptcy process for paying off your debts. So to start a new business, it is essential to rebuild your credit and finances.
Here are the four most effective steps to help rebuild your finances and credit:
1. Reconfigure your budget
In most cases, people face bankruptcy due to poor budget planning, even if other financial factors affect their situation.
Learn from your experience and understand the reasons why the old budget plan didn’t work. If you can’t figure out the reasons, it will be tough to fix the problem. Reasons may include overspending, unplanned investments, and wrong financial decisions. So, before making any significant financial plans, you must evaluate and reconfigure your budget.
Categorize Fixed, Variable & Irregular costs
Set up a budget and categorize your expenses into three areas: fixed, variable, and irregular.
In the fixed category, list your fixed monthly expenses, such as housing bills and car payments.
Under the variable category, list all the variable expenses every month. Expenses such as food, clothes, travel, entertainment may be added to this category.
The third category is for irregular expenses, such as medical costs, insurance costs, expenses for gifts to others, etc.
Reduce expenses as much as possible
Decide how much you need to save every month to rebuild your finances. It is best to focus on at least 10% every month. After bankruptcy, focusing on savings will be easier because you’ve been discharged from most of the horrible debts weighing you down.
Start by analyzing fixed expenses and decide what can be lowered and what you can completely eliminate. But it is tough to reduce these expenses since they are usually connected to an asset.
You can reduce variable expenses much easier than your fixed expenses since they depend on the choices you make. So, reduce these expenses as much as possible.
As with variable expenses, it is up to you to trim your irregular expenses, as well. To manage this category, you should open a separate account and save a little every month to ensure payment.
2. Plan for savings
You can’t reach your financial goals if you ignore the benefits of saving money. In most cases, people don’t fill the gap between what they decided to save and what they keep every month.
Set up automated savings
The more visible and accessible your money is, the more likely you are to spend it.
So, you have to get this money out of sight before you can touch it. Open a savings account at a different bank or credit union. That way, you won’t see all the money lying there waiting to be spent when you log into your primary account online.
Set up a periodic, automated ACH transfer from your checking account to your savings account. This way, you won’t have to do any work to save money. Discipline will fail eventually, so don’t put your faith in it.
Start building an emergency fund
How much should you put aside for an emergency fund? This is a personal choice.
During your post-bankruptcy financial recovery, keep more cash on hand than you think you’ll need. Begin with a primary target of $1,000 in your savings account. If you save 10% of your net income, it won’t take you long to reach your goal—perhaps only a few months.
Prioritize building an emergency fund over investments in the first year following your bankruptcy discharge. You should have at least one month’s worth of expenses stashed away in your emergency fund.
3. Try an “all-cash” budget strategy
Using a credit card makes spending far too easy. So, credit cards probably had a significant role in your bankruptcy.
However, when you’re just reviving from the ashes of bankruptcy, even using debit cards can make it tough to keep track of your expenses. So, you may switch to cash for the first three to six months as you regain control of your finances.
Remove all debit cards from your wallet and store them away in a safe place.
Major recurring expenses like mortgage, car payment, and utilities are the only exceptions that should be paid through account transfers. All other expenses must be paid in cash.
By resetting all of your old spending habits and developing new ones, you will take control of your finances.
4. Start rebuilding your credit
Bankruptcies filed under Chapter 13 stay on your credit report for seven years, while those filed under Chapter 7 last around ten years.
It doesn’t mean you won’t be able to repair your credit. However, it will take several years to rebuild what you’ve lost. You’ll have to work hard, so buckle up for the ride.
Check your credit report first
After a bankruptcy discharge, the first step in rebuilding your credit is pulling your credit report. Wait for three months so creditors can update the reports after your discharge.
You can pull your credit report for free without affecting your credit score once a year. After you check your credit report, focus on identifying and correcting errors on it.
You must make sure that your credit report is accurate. If you notice anything unusual on your credit report, contact the credit bureaus and file a dispute for errors.
After correcting any errors on your credit report, consider the benefits and drawbacks of getting a new credit card. Using credit cards can lure you towards overspending. But they can also help you rebuild your credit.
But make sure you use new credit cards responsibly. If you misuse them, you may find yourself right back where you started.
Start with secured credit cards
A secured credit card keeps you from overspending since it has limited funds.
A bank, credit union, or other card provider will require a cash deposit as collateral when applying for a secured credit card. Before opening a secured credit card account, make sure that the card company reports to all three credit bureaus. Without it, you can’t rebuild your credit.
Make sure to repay your credit card bills on time. For the first few months, keep your credit card usage low. You can gradually increase your usage, but make sure you don’t exceed spending limits in a month.
How to start a new business after bankruptcy
After filing for bankruptcy, the law doesn’t prevent you from starting a new business. However, obtaining credit for the business will be difficult if you initiate the process too soon. You may also face issues if you have closed a similar business shortly before filing for bankruptcy.
Here are five things you can do before starting a new business after bankruptcy.
1. Check the risk factors
Like many business owners, you might have specialized skills in a particular industry or product. After bankruptcy, you may want to pursue your expertise and start a business as you’ve done in the past. Unfortunately, this isn’t always a good idea.
If you start a new business similar to your old one, you might face allegations of fraud. It doesn’t matter which business form you choose; the consequences will be the same.
Your previous business’s creditor may be able to collect debts owed by that business from your new one. You should talk to an attorney about your situation and discuss the risks. They will inform you of your options when dealing with creditors.
2. Keep the entities separate
It’s not uncommon for a business owner to file for individual bankruptcy when the business firm collapses. Business owners frequently declare personal bankruptcy in order to discharge their personal liability towards business debt.
In most cases, the owner is a sole proprietor or partner in a failed partnership or signed on behalf of a limited liability company or corporate entity.
So, you should create a separate entity for your new business, such as a corporation or a limited liability company. The advantage of this strategy is that these types of companies are solely accountable for the business debt.
If you sign a personal guarantee for the business debt, you will lose this benefit and will be responsible for the obligation as a sole proprietor.
3. Be ready to tackle funding issues
When you seek business funding from banks and other lenders, they will ask about your personal credit history. After filing bankruptcy, it will be difficult to convince them to offer funding with your poor credit and devastated financial condition.
But there are things you can do to increase your chances of approval. Prepare a comprehensive business plan, get a business partner with good credit, apply for financing from a small community bank, contact investors to fund your business, or find financing and grants offered to businesses by local communities.
You can also consider the Small Business Administration for funding your business. But beware! The Small Business Administration may require a personal guarantee, as well as personal assets as collateral, to cover the business debt.
4. Get new Tax or Employer Identification Numbers
You need new tax or employer identification numbers for starting a business, if:
- Your old business was a sole proprietorship and was included in your personal bankruptcy
- If you previously filed for Chapter 7 bankruptcy and liquidated a corporation or limited liability firm
Keep in mind that under Chapter 7 bankruptcy, a corporation or a limited liability business cannot be discharged. The debt is still owed by the company.
As a result, if you re-establish the business or start a new one under a different name, creditors can still pursue you for a debt that wasn’t completely discharged.
5. Pay your business taxes
Tax debt is usually non-dischargeable, which means you’ll still owe it even if you declare bankruptcy.
When launching a business after bankruptcy, the most important thing to remember is to make provisions for paying your business taxes. Set up a business budget that will pay off your business tax obligation on time.
To prevent being caught with a huge penalty, make sure the business pays its tax obligations along with any “trust fund” taxes to the property taxation authority.
The taxes that the business collects from others, such as payroll withholding and sales taxes, are known as trust fund taxes (but usually not excise taxes).
It’s not the end; it’s the start of something fresh
After you’ve declared bankruptcy, take time to put everything you’ve learned into a solid business strategy. Then implement these tactics and recommendations to create a self-sustaining and profitable business.
Bankruptcy does not mean you are doomed for the rest of your life. All it takes is confronting your problems head-on with thorough, cost-cutting solutions that will help you reclaim your credit and trust.