Time to Fold? Here's a Primer Learn how to use bankruptcy as a tool if it's time for your inventions-based business to close shop.

By Tamara Monosoff

Opinions expressed by Entrepreneur contributors are their own.

If you've taken your invention through the entire process of design production and to market, you've overcome many high hurdles. It probably never occurred to you that once your product hits stores, there could be insurmountable challenges, particularly if you face bankruptcy.

It's important for you to have the facts, because the odds of failing are even higher than the typical economic environment's odds of most businesses failing within five years.

There's a stigma surrounding bankruptcy that you need to overcome. Given that we spend most of our personal and professional lives trying to look good, and glorifying those who succeed against all odds, deciding to abandon the fight and openly acknowledge failure is something many of us find hard to do.

One positive outcome of today's economic situation is that it's now obvious that failure is a business risk. Everyone from the savviest investment banker to once-hot companies to major public corporations is failing. If you've failed (or are about to), you're in very good company. Let go of any shame and get the facts you need to make good decisions going forward.

There are two main categories of bankruptcy: business and personal. For many small business owners, these lines are somewhat blurred because it's difficult to separate personal finances from business finances. From a bankruptcy perspective, this can be a positive. First, however, I need to address one caveat: I'm not an attorney, I don't give legal advice, and this is a very general description. Second, bankruptcy laws and the income level--"means"--that can impact eligibility for certain forms vary by geography. Therefore, I recommend seeking the advice of an attorney when considering bankruptcy.

Nonetheless, it's useful to gain an understanding of bankruptcy basics. Following are some brief descriptions and helpful tools:

The Three Bankruptcy Laws
Chapter 11 is the bankruptcy description that's applied to a corporation that has sought bankruptcy protection. Chapter 11 provides a way for a business to place creditors on hold. This gives the filer an opportunity to reorganize; usually pay creditors some fraction of what they're owed, and also catch up. Technically, this form is also open to individuals with very high debts. However, in relation to the other forms of personal bankruptcy, the administration and oversight are a significant burden and cost. Statistically, the failure rate of Chapter 11 cases (meaning they don't survive even after going through Chapter 11) is extremely high. Companies lose out after having spent a hefty amount on attorney's fees.

Chapter 7 is an option for individuals, including small business owners. This form of bankruptcy means that you'll give your non-exempt assets (clothes and household goods are exempt), including your business, to the bankruptcy trustee. The trustee will then sell any marketable assets and disperse the cash to creditors in order of priority provided in the bankruptcy code. The benefit of Chapter 7 is that most of your non-secured debts--such as your credit cards--will be eliminated, essentially wiped clean. This generally doesn't eliminate obligations for debts such as recent income taxes, student loans, child support and similar obligations. Another interesting possibility is for the trustee to sell all of your non-exempt assets. If he can't sell something, such as your business, it reverts back to you.

Chapter 13 is the third option for small-business owners and individuals, with some key differences. First, Chapter 13 filers don't surrender their businesses to a trustee. If you just need time and some accommodation to catch up on your personal debts or to prevent a foreclosure on your home, you can force your non-secured creditors to give you that time by filing Chapter 13 while keeping your business. The Chapter 13 plan may provide for repayment of only a fraction of the debt, depending on income level and the value of your non-exempt assets. The discharge at the completion of the Chapter 13 plan eliminates any unpaid, unsecured debt. This only applies to individual debt, not corporate debt, although some company debts, such as credit cards, may be in the owner's name. To qualify, the filer can't have more than $1,010,650 in secured debt (homes, cars) and more than $336,900 in unsecured debt (credit cards, student loans, etc.)

There are other lingering consequences to consider. For instance, bankruptcy will remain on a filer's credit report for up to 10 years, depending on the form of bankruptcy filed. Also, reestablishing credit after filing can be difficult.

It's important for inventors to understand that patents, trademarks and copyrights are assets. You need to know who owns such assets--you or your company. Depending on which form of bankruptcy you file, the assets could end up as part of the liquidation.

If you're an inventor considering bankruptcy, I'd recommend you complete the following seven steps:

  • Organize and total your personal debts by unsecured debts (e.g. credit cards) and secured debts (e.g. home mortgage).
  • Organize and total your business debts by vendor debts, unsecured debts, leases, etc.
  • Figure out your exact monthly personal expenses, including every expense from mortgage, rent, food, utilities, gas, entertainment, etc.
  • Communicate with creditors and ask them to be patient. If they're aware that the alternative is bankruptcy--wherein they may get nothing--they'll likely want to help you get through the rough period.
  • Leverage any assistance available through local, nonprofit or government agencies such as the Hope program through the Department of Housing and Urban Development (contact: 800-569-4287), and Consumer Credit Counseling Services .
  • Be wary of scams.
  • Consult with an attorney who specializes in bankruptcy.

I've repeatedly been amazed and inspired by the strength and stamina of inventors who overcome daunting challenges. They do so by leveraging information and tools at their disposal. The decision about whether to file bankruptcy shouldn't be viewed as a moral question, but as one tool among others to help a business survive or close. "A business failure is not evidence of moral failing," says bankruptcy attorney Cathleen Cooper Moran of the Moran Law Group .

Your Million Dollar Dream: Regain Control & Be Your Own Boss Tamara Monosoff is the author of Your Million Dollar Dream: Regain Control & Be Your Own Boss and The Mom Inventors Handbook, Secrets of Millionaire Moms, and co-author of The One Page Business Plan for Women in Business. She is also the and CEO of www.MomInvented.com. Connect on Twitter: @mominventors and on Facebook: facebook.com/MomInvented.

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