Bankruptcy and Small Business Loans

You're unlikely to get an SBA government-guaranteed loan if you already have too much debt, but there are ways to improve your chances

My son was in an accident and I borrowed money to pay his medical bills. Before the accident, I hoped to get an SBA loan to expand a construction business I operate part-time (I also have a full-time job). Now, I'm contemplating bankruptcy due to my debt. Will a bankruptcy filing ruin my chances for getting a small business loan in the future?

—S.H., Minneapolis

A U.S. Small Business Administration loan is actually a private loan guaranteed by the government and made to small companies and startup entrepreneurs with viable business plans who couldn't get commercial loans. The borrower must undergo a criminal background check and demonstrate creditworthiness. If you have a history of insolvency or are perceived to be a credit risk, you're unlikely to qualify for a loan of any kind.

If you have good credit aside from the loan you've taken out to help your son, you'd be better off applying for the SBA loan first and then filing for personal bankruptcy later if necessary, says Steve Berman, a business bankruptcy attorney based in Tampa. "You'll need to give the bank a financial statement and a business plan. Be careful not to make any fraudulent misrepresentations to them. They may look at your situation and ask if you intend to file for bankruptcy, and if you do, you'd have to disclose that and it would probably kill the loan," says Berman. If the loan officer does not ask you about the possibility of a future bankruptcy, don't volunteer that information, he adds.

May Be Possible to Avoid Bankruptcy

You might try to work through your financial difficulty first and then apply for the loan, using the extra time to build up your construction business while you continue with your full-time employment. It's possible you may be able to avoid bankruptcy. "Many times, medical providers will write down bills in exchange for lump-sum payments," Berman says. "If your son owes $10,000 and you can make a lump-sum payment of $5,000 or $6,000, they may be willing to write down the remainder of the debt, especially since you are paying for your son's bills and you're in difficult straits." Sometimes medical providers will provide interest-free payment terms as well, he notes.

If you do get the SBA loan and then find you eventually have to declare personal bankruptcy after all, you will not automatically be declared in default on the business loan. "As long as you're still making payments and you haven't breached the other provisions of the loan agreement, they can't cancel the loan on you just because you file for bankruptcy," Berman says.

The bottom line: The more financially precarious your situation, the more difficult it will be for you to meet your current obligations, let alone make a payment on a new loan. If you're heavily in debt or highly leveraged in your assets, you're not likely to get a small business loan—bankruptcy or no.

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