Comparing small businesses that have previously filed forbankruptcy to those that have not gone down that road, some firmsare no more burdened than others by poor cash flow, high healthinsurance costs or excessive taxes.

The Small BusinessAdministration's Office of Advocacy offered that conclusion ina new report, “Beyond Bankruptcy: Does the Bankruptcy Code Providea Fresh Start to Entrepreneurs?” Firms are surviving years afterthe filing, according to the report. The data also showed thatthere is little to distinguish these firms in terms of firm size,as measured by employment.

“Small businesses filing for bankruptcy have an opportunity fora new start. This new start is hampered by the challenges ofobtaining new loans. This can impede innovation and job creation,”said Winslow Sargeant, chief counsel for the SBA's Office ofAdvocacy.

Small businesses that filed for bankruptcy have a 24% higherlikelihood of being denied a loan and are charged interest rates atleast one point higher than other firms. The report also found thatfirms owned by African and Latino Americans are even more likely tobe denied loans and charged higher interest rates.

Owners of previously bankrupt firms are less likely to owncredit cards and are more likely to look for outside financing fromventure capitalists. The SBA said credit access remains an area ofconcern too. Firms with a bankruptcy record are rationed out of themarket with loan denial rates nearly three times higher than otherfirms, according to the report.

By the time failing businesses file for bankruptcy, they haveusually been delinquent on their payments for extended periods orhave been in outright default, the data showed. Therefore, theircredit score is likely to already reflect these missed payments andcreditors would take this into account before making loans.

Credit unions and other lenders are understandably concernedwith how these businesses will impact their financials. AparnaMathur, the author of the report, said credit rationing may ariseif the price affects the nature of the transaction. For example, ifthe interest rate is set high, then adverse selection would lead toonly the most risky borrowers obtaining loans at a certain rate,she wrote. Raising the interest rate decreases the return onprojects that succeed. One of the consequences could be that higherinterest rates induce firms to undertake projects with lowerprobabilities of success but higher payoffs when successful.

“Since the bank cannot directly control the actions of theborrower, the objective function facing the bank is to design theloan contract in such a manner that it attracts low-risk borrowersand successful investments,” Mathur said.

The report looked at data from the National Survey of SmallBusiness Finances. The surveys of firms with fewer than 500employees were conducted by the Federal Reserve Board for datayears 1993, 1998 and 2003, looking at 4,000 firms for each yeartracked. Mathur said one disadvantage of the data is the exact yearof the bankruptcy filing is not known for the firms looked at. Itis likely that the consequences of a bankruptcy are worse in theperiod immediately following the filing and are likely to getmitigated over time, she offered. Profitability, employment andfinancing are likely to show up as problems in the long term sincea filing stays on a firm's credit record for at least a seven-yearperiod.

During the 1993 survey, the data showed in the credit market,the average interest rate on loans was 8.77% and the loan denialrate was 15.5% for firms that had filed for bankruptcy. The averageinterest rate on loans was 0.67 percentage points higher than 1993and loan denial rates were 1.7 percentage points higher that year.Mathur said it appears that there was a tightening in creditmarkets during this time.

In 2003, the credit market started to ease, with the averageinterest rate on loans dropping by nearly three percentage pointsand the loan denial rates decreasing by 10 percentage pointsrelative to 1998.

“This is interesting since it reflects the generally easy creditmarket conditions of that period which have been blamed for thesubsequent financial crisis,” Mathur said. “This suggests thatsmall businesses also benefited from these policies by paying lowerinterest rates and getting a higher fraction of loansapproved.”

Another finding revealed that smaller firms with less than 20 orless than 50 employees obtained interest rates that wereapproximately 0.7 and 0.4 percentage points higher than the averagerate for the period of the respective surveys. Unincorporatedbusinesses, such as partnerships and sole proprietorships, werecharged higher interest rates than the average business.

Mathur acknowledged that the report's data prior to 2005 couldhave produced different conclusions since Congress passed theBankruptcy Abuse Prevention and Consumer Protection Act in 2005with the intention of making it harder for individuals to file aChapter 7 bankruptcy. Still, she said, the legislation's passagewould have had a marginal impact on the report's ending.

“While it influences the choice of chapter for a failingbusiness by pushing relatively more individuals toward Chapter 13,it might have little influence on the outcome,” Mathur said.“Businesses that are forced to reorganize and repay a portion oftheir debt are as likely to face problems of credit access and firmsurvival as businesses that file under Chapter 7.”