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United States Small Business Administration
Office of Advocacy
RS 144
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Purpose

The bankruptcy of a business is viewed by some as a relatively minor event in the ordinary operation of a market economy - an experiment in entrepreneurship that has failed. Legal bankruptcy proceedings help a free enterprise system reallocate resources among competing uses. Others believe, however, that when a business fails, real economic losses are imposed on the economy and, therefore, it is good public policy to intervene in order to prevent or reduce such losses.

This study examines the personal experiences of small business owners whose businesses failed. It also looks at the best methods for obtaining information necessary to address some of the problems created by bankruptcy.

No empirical work exists that traces the costs of small business bankruptcies. This research is organized as a pilot and not a nationally representative statistical sample.

Scope and Methodology

This pilot project focuses on a sample of Chapter 7 filings from the U.S. Bankruptcy Court for the District of Maryland, Rockville Division, during the 1987þ1993 period. The quantitative results cannot be generalized and applied to a national level.

Two sources of data were used in this project: (1) information from the Bankruptcy Court records on filed Chapter 7 cases, and (2) survey data from 101 former business owners compiled through telephone interviews. Information was collected on characteristics of the bankrupt business, including data on liabilities to creditors and assets of the owner, the pre- and the post-bankruptcy work experience of the business owner, and demographic information on the owner.

The universe of 503 Chapter 7 filings between 1987 and 1993 available in the court were reviewed in 1993. Current phone numbers were obtained for 353 of these; 213 individuals could not be contacted. Thirty-nine former owners declined to participate in the survey; 101 individuals cooperated with the research. The successful phone connections with completed interviews represent a response rate of 72 percent.

The telephone survey instrument solicited information not available in the court records. Data on business characteristics, such as number of employees, sales and experience with government programs, were solicited. Pre-bankruptcy work activities included items regarding previous business ownership, industry and managerial experience. The questions on post-bankruptcy work experience attempted to profile the recovery path of owners and included items on income, assets and labor market activities. Because the sample drawn for the study included cases from one to six years old, a pseudo-longitudinal panel was created that allowed an examination of the recovery path.

The former business owners participating in the survey were typically male (81 percent of the respondents), middle-aged (46 years old), well-educated (some college), and married (75 percent of the sample).

Highlights

Statistical analysis of the survey results strongly suggests a number of conclusions regarding the failure process.

• Failure does not appear to be associated with individuals who have little prior work experience. In fact, the opposite is true: the average level of previous work experience was 14.5 years, comprising a diverse set of sectors and occupations. More than 50 percent of the respondents had never owned a business before starting the bankrupt business; a significant minority of the respondents (37 percent) had been entrepreneurs before.
• Failure is not generally associated with the end of one's career. Only 12 percent of the respondents left the labor force. Of those who remained, more than half (53 percent) became owners of another business; the rest pursued wage-and-salary employment. Generally, people tended to come from and gravitate back to the industries of their bankrupt business.
• Typically, the post-bankruptcy experience shows former owners moving quickly back into the business/employment mainstream. The size of the average post-bankrupt business seems considerably smaller than the business that went bankrupt.
• The financial implications of the failure process are not devastating. The post-ownership profile strongly suggests a significant recovery from any financial hardship that the business failure may have imposed on the former owner. From both a current income and a net worth perspective there was significant improvement during the study period. Those who become wage-and-salary workers, however, report greater and faster financial recovery than those who remained business owners.
• Two distinct groups emerged from the 101 owners of bankrupt businesses studied. The first distinct group owned several businesses before the bankrupt one; they also started another business shortly after their current bankruptcy. For these "committed entrepreneurs," bankruptcy appears to be a part of a cycle of starts, failures and rebirths. By contrast, a second group of "one-time entrepreneurs" were wage-and-salary workers both before and after their bankruptcy experience.
• The median level of liability left by the failed business was $172,800. The largest portion ($120,000) was held by creditors holding security. It was not possible in this study to assess the ultimate costs to these creditors. All creditors having unsecured claims without priority were left with a median loss of $72,000; the largest single group among these creditors were the suppliers of non-bank loans at $40,700.
• The estimated losses from all the Chapter 7 bankruptcies in the Rockville Division Bankruptcy Court were $86 million; this was 0.1 percent of the personal income of the jurisdiction.
• The responses to two speculative questions capture important non-economic aspects of the bankruptcy experience. When asked "If you were to do it all over again, would you have started your bankrupt business?" 61.4 percent of the respondents answered "Yes." When asked "Would you ever start your own business again?" 73.2 percent answered "Yes."
• This study demonstrates that a nationally representative statistical study can be undertaken to provide insights into the policy issues raised in this research.
  

Ordering Information

The complete report is available from:

National Technical Information Service
U.S. Department of Commerce
5285 Port Royal Road
Springfield, VA 22161
(703) 487-4650
(703) 487-4639 (TDD)

Order Number: PB94-175718

Cost: A04; A01 Microf.

*Last Modified 6-11-01