Avoiding bankruptcy: Capitalization, planning essential to business survival

Being financially secure from the beginning is one of the best ways to prevent bankruptcy.

"The biggest reason that companies fail in the first three or four years is just purely undercapitalization," said Craig McMichael, counselor with SCORE and Associates, a business consultancy.

McMichael said sitting down with an accountant and working up cash-flow projections for about a year is one way to keep a business from going down the wrong path.

"(Business owners) think with $10,000 or $20,000 and maybe a bank loan, that they can open a business. Business just doesn't come to you that quickly, especially in these times we are in right now," said Jack Preston, CPA with Preston and Nacy CPAs.

He added that a business needs at least six months of operating funds to begin with.

"That means if they have payroll and overhead of $10,000 a month, they should have at least $60,000 to $120,000 to back them up," he said.

If things are starting to look unhealthy for the business, reanalyzing the business plan is crucial. McMichael said sticking to a business plan and preparing for the unexpected will help the business stay open during difficult times.

"You need to put together a business plan for the next 12 months to see if you are going to come out of this (hard time), and if not you better close the business as soon as possible to save your funds for a future business," McMichael said.

Handling debt

Understanding the amount of debt the business has and to what level the owner is responsible can help when the business starts to falter.

Companies issuing credit to new clients often require personal guarantees from the owner. With a personal guarantee, creditors can still come after the owners individually unless they file personal bankruptcy.

"I find that people don't really understand or know what they may have committed to personally. You have a lot of people that go out and sign a personal guarantee and wind up never really getting a handle because they don't know exactly all the debt they may be responsible for," said attorney Jon Gold, partner with Reynolds, Gold and Grosser.

Don Wengler, strategic insolvency and bankruptcy consultant for BKD LLP in Kansas City, said it is to a business owner's benefit to understand the business' risk-reward earning profile when it comes to incurring debt.

"If you have more debt, you can actually have a higher return on your investment in good years, but then in bad years you are going to have higher interest expense and greater losses than you otherwise would have. So, (debt is) really a risk-reward decision," Wengler said.

Wengler said companies can avoid trouble by avoiding excessive debt and over expansion, and staying alert to and responding to changes in competition, the economy and technology.

Wengler said owners should not bet the company on a single strategy but should be aware of new and changing ideas in the industry.