How Do I Place a Value on My Small Business in Bankruptcy?

Valuing Small Business in BankruptcyNo doubt it’s because I practice debtor’s bankruptcy in San Jose, which has traditionally had more than its share of entrepreneurs and small business owners, many of my bankruptcy clients are self employed. Because every debtor, whether in Chapter 7 or 13 must list all of his or her assets and provide a value for those assets in the bankruptcy petition, small business owners must likewise provide a value of his or her business. In Chapter 7, the bankruptcy trustee has the authority, the duty, in fact, to seize all assets that are not protected by an available exemption, liquidate such assets and distribute the proceeds to the Chapter 7 debtor’s creditors. And that means, of course, that the trustee can seize the very business that is the source of the debtor’s livelihood. And while there is no seizure of assets in Chapter 13 bankruptcy, an accurate valuation of a Chapter 13 debtor’s business is likewise critical because the value of assets in excess of available California bankruptcy exemptions is a determining factor in how much the debtor will have to pay in the Chapter 13 plan.

So how does one place a value on his or her small business for bankruptcy purposes? Arriving at a valuation of some small businesses may be relatively easy, while with others it will require a professional with expertise specific to the type of business. A silicon valley startup, for example, with intellectual property with unknown market potential will require a very different valuation review than will a hair salon. First, the bankruptcy attorney needs to help her client determine what it is that is being valued and listed in the debtor’s schedules. If the business is a sole proprietorship, then the debtor owns each and every business asset, from inventory to shop fixtures to accounts receivable to tools, while of course, deducting the debts of that business. 

But if the small business is a corporation, partnership or LLC (assuming the business entity was properly created and capitalized in the first place), then the debtor merely owns shares of stock, a membership interest (LLC) or a partnership interest in the company. Moreover, the debtor and his bankruptcy lawyer need to carefully review the rights of co-owners, for example, by reviewing an LLC operating agreement, a shareholder buy/sell agreement, if one exists, or a franchise agreement if the business is a franchise. These may contain specific rights triggered by a co-owner’s bankruptcy filing, for example. The bankruptcy attorney may in such situations assist the debtor in obtaining the advice of a corporate attorney specialist.

It is beyond the scope of this post to analyze every permutation of business valuation for bankruptcy purposes. John Hilla at the Michigan Bankruptcy Blog has written an excellent piece about this very topic as well. For our purposes, though, let’s just consider a common and relatively simple situation. Say we have a Santa Clara, California, Chapter 7 bankruptcy debtor with a personal service business, such as an electrician who operates as a sole proprietorship. The value of this business for Chapter 7 liquidation purposes may be minimal. Of course, the debtor must list any business vehicles and tools at their current liquidation value or what the debtor could sell them for at auction or on CraigsList. But what about intangibles like “good will,” which frequently make up the bulk of a sale price when a third party buys a business in order to operate it as a going concern? Generally, when it comes to a personal service business like that of our electrician, “good will” is entirely personal to the business owner. It’s the value of that electrician’s personal history of customer service with his customers. The Chapter 7 bankruptcy trustee is not going to step into the shoes of the electrician to operate his business. In fact, the only items of any value to the trustee in our sole proprietor’s bankruptcy will be his old tools and equipment, vehicle(s), accounts receivable and liquid money in the bank. Furthermore, the debts of that business will reduce the aggregate value of the business. The value of such a business may, in fact, be minimal or even zero, and entirely protected under California’s wildcard exemption.

This example illustrates the fact that valuing a small business in the context of bankruptcy may be as simple as creating a list with good faith estimates of the current values of the business’s assets, less its debts of course, that the small business owner can provide himself. Or, it may be an exercise well beyond the expertise of either the business owner or the bankruptcy attorney. Whenever a self-employed individual needs to file for bankruptcy, whether Chapter 7 or Chapter 13, it is all the more imperative that he or she seek the advice of an experienced bankruptcy attorney.

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