Does the Bankruptcy Code Provide a Fresh Start to Entrepreneurs?

June 24, 2011

Fundamental to the philosophy of the U.S. bankruptcy code is the notion of a debt discharge.  The debt discharge legally absolves the business of its pre-bankruptcy debts, thus allowing the owner to start afresh, says Aparna Mathur, a resident scholar with the American Enterprise Institute.

Using data from the 1993, 1998 and 2003 National Survey of Small Business Finances to explore how firms fare after a bankruptcy filing, Mathur finds:

  • Previously bankrupt firms are not any more burdened than the average small firm by problems relating to profitability, cash flow, health insurance costs or taxes -- all considered to be major problems facing all small businesses.
  • However, the one area of concern that persists after a filing is financing or credit access.
  • A bankruptcy on a firm's credit record negatively affects the firm's ability to obtain loans, especially at reasonable interest rates.
  • In general, these firms have a nearly 24 percentage point higher likelihood of being denied a loan and are charged interest rates that are more than 1 percentage point higher than those charged to other businesses.

A bankruptcy affects all types of financing, even trade credit, which is a significant form of lending between businesses.  In fact, it appears that firms with a bankruptcy record are rationed out of the market, with all types of loans being denied at significantly higher rates than other firms.  Of course, whether the bankruptcy causes the poor credit access is debatable.  By the time failing businesses file for bankruptcy, they have usually been delinquent on their payments for extended periods, or have been in outright default, says Mathur.

Source: Aparna Mathur, "Does the Bankruptcy Code Provide a Fresh Start to Entrepreneurs?" American Enterprise Institute, May 25, 2011.

For text:

http://www.aei.org/docLib/Mathur-Bankruptcy-SmallBusiness.pdf

 

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