A closely held business is an entity that has only a limited number of shareholders. These majority shareholders tend to hold on to the company’s stock and are generally unavailable to outsiders.
A business generally has two options when filing for bankruptcy, Chapter 7 (Liquidation) or Chapter 11 (Reorganization). Similar to an individual filing, once the petition is filed, the business’s assets are under control of a court-appointed private trustee.
A Chapter 7 is not generally recommended for a small closely-held business without a concurrent individual bankruptcy by the owners. This is usually because:
• the owners may be guarantors of the business’s debt and can be personally liable for failure to pay off the creditors; and
• debts of the business are not discharged as they are in an individual Chapter 7.
There are only a few instances where filing Chapter 7 for a business may be advantageous:
• when a creditor is going to levy or lien assets in the very near future for debts the owner(s) may be liable for;
• when the owner(s) would prefer to have a court-appointed trustee wind down the business operations while they deal with their own bankruptcies and/or find new employment; and
• if a creditor is threatening to file a lawsuit that would name the owner(s).
Chapter 11 Bankruptcy Reorganization is the most complex bankruptcy proceeding under the Bankruptcy Code. A Chapter 11 allows the debtor to restructure its debts in a court-approved Plan of Reorganization.
In the bankruptcy of a closely-held business, two particular factors that affect the value are, discounts for minority interest and lack of marketability. Investors in closely-held companies, unlike those investing in publicly-traded companies, are burdened by significant illiquidity. They cannot control the timing for profit-taking or disposing of their investment.
Share holders of a closely held business can include a provision in the incorporating agreement that allows the company and/or its owners the option of purchasing the interest of an insolvent owner before the owner is declared bankrupt by the court.