Frequently I meet with small business owners who own companies that have become so burdened with debt that I describe the corporation as being “toxic.” Even if business improves and cash flow increases, the corporate entity is so weighted down by bank liens, court judgments, and tax debt, it can never recover. The business may have a bright future, but the corporate debt is simply too much.
So, what should a business owner do in this event? In a word, reincorporate.
Incorporating a new business has many advantages. First, the new company is not subject to the bank and IRS liens that exist on the former company. A frequent problem of the small business debtor is that you cannot build wealth if everything you accumulate–cash, equipment, accounts receivable–is subject to a pre-existing lien. Even worse, if you attempt to sell or transfer the assets of the old company, the bank may cry foul and accuse the business owner of tampering with their lien and object to the business owner’s bankruptcy discharge. After all, what good is a lien if it does not prevent the owner from transferring the asset? Violating a bank’s lien in business assets is considered fraud, and it is a common basis for denying a bankruptcy discharge to a small business debtor.
What the business owner cannot do is to simply transfer all the assets of the old company to the new company without consideration. That is, if assets from the old company are transferred to the new company, the old company must receive compensation for equal value. As a general rule, it is best if no assets of the old company are transferred to the new company. Start the new company with new assets. There should be a clear “line in the sand” between the old and new companies. If assets of the old company are mixed with assets of the new company, creditors will claim that the new company is nothing but a continuation of the old company under a new name, and the courts will impose the old company’s liens and debts on the new company.
Discarding the old “toxic” company and incorporating a new entity to carry on a similar business is complex. The small business owner should work carefully with legal counsel to ensure that the old company’s liens and debt problems do not contaminate the new company.