At some point, we’re going to need to talk about bankruptcy.

Since the pandemic began, programs large and small have been rolled out by governments to support businesses. On the surface, these programs have worked — despite a complete collapse of revenue in large sectors like hospitality, tourism and recreational services, there have been far fewer bankruptcies across the country than expected. In fact, according to Statistics Canada, there were about 20,000 fewer business closures between June and November 2020 than there were in 2019.

But this promising result masks an impending crisis: many of these programs require businesses to take on more debt and most others will expire soon. Bills and leases are being deferred, and for industries that rely on large or indoor gatherings, demand will continue to be lower for the foreseeable future. What will happen when those bills come due?

Many of these businesses will eventually close. Others that are barely viable with reduced demand, higher debts and overdue payments will continue to scrape by because their owners are trapped by personal guarantees they’ve made on leases and loans. In either case, many of the small business owners who have long been a significant source of employment in our economy will be sidelined. This sub-optimal result is driven by fear of the long-term implications of bankruptcy. A better option would be enabling fair COVID-induced bankruptcies and business closures, and releasing these entrepreneurs to be part of the recovery.

While the public perception of bankruptcy is often as a way to get out from under debt in order to start again, Donald Trump-style, the reality is quite different. For most, bankruptcy makes it very hard to start over, as qualifying for leases or new debt can become, at least temporarily, impossible.

A crushing burden

It’s worth taking a moment to paint the picture of what small business owners are facing in the most affected industries. They have been mostly closed for much of the past year. Due to late and inconsistent evictions moratoria, many have negotiated rent deferrals with their landlords, meaning their rent will be higher when they return, while demand is expected to stay low. The Canada Emergency Wage Subsidy (CEWS) might have allowed them to keep some staff, but they will soon need to bear their full labour cost. They have been granted deferrals for bills that can’t be avoided, like utilities and insurance, but those deferrals will run out. If they were lucky, they qualified for either of the two rent subsidies available (CECRA and CERS), but in no case did this cover all their rent. For the rest of their fixed costs, they accepted loans backed by the government, maxed out their credit cards and lines of credit and dipped into their savings. These are real, new liabilities that will weigh on these businesses, and their owners, for years.

A reasonable question is, if it’s so bad, why didn’t these owners choose bankruptcy earlier, before they ran up all this debt? Say, when the second wave of COVID hit?

Bankruptcy is quite complicated, and the rules and implications are confusing. While the public perception of bankruptcy is often as a way to get out from under debt in order to start again, Donald Trump-style, the reality is quite different. For most, bankruptcy makes it very hard to start over, as qualifying for leases or new debt can become, at least temporarily, impossible. Not everyone can just borrow money from the Russians. And most small businesses require owners to provide personal guarantees for things like debt, leases and credit cards, meaning liabilities survive business bankruptcy and may drive personal bankruptcy, affecting owners’ families long into the future. It’s not surprising that business support organizations have been regularly fielding calls from business owners contemplating suicide since the pandemic began.

Fear of bankruptcy drives sub-optimal economic results. In conversations, text exchanges and survey responses, the business owners I met through our Save Small Business campaign expressed a continuing fear of business and personal bankruptcy. More than half of the respondents to our surveys said they had personally guaranteed their commercial leases (which often run for five or 10 years) or bank loans. Here’s an example from the owner of a chain of fitness studios who recently spoke to The Globe and Mail:

“I went through the stages of grief closing down the studios,” Ms. Stuart said. “We had a great business, and then it was gone.” Although the company likely won’t file for insolvency — she said it has no assets left — Ms. Stuart now worries that she may face personal bankruptcy because of personal guarantees on the loans [the company] took to open its studios.”

A second chance to contribute

In 1999, I was part-owner of a moderately profitable retail business that none of us wanted to run any more. We couldn’t find a buyer and we would have been happy to shut it down. But we were four years into a 10-year lease that we had personally guaranteed and the feeling of being trapped was intense. We were lucky — we ended up giving the business away just to get out from under our personal guarantee. While it was a terrible result for us financially, each of us was able to rebuild in new entrepreneurial ventures. I would argue that we’ve contributed more to the economy than we would have if we’d been forced to stick it out just to pay the rent.

In our case, we deserved our fate. It was a bad business, poorly executed. For most businesses destroyed by the pandemic, that isn’t true. Like Ms. Stuart above, they were often thriving and likely still would be, if not for a risk they could never have predicted or prepared for. (In fact, many did prepare by buying business interruption insurance, only to find out later that losses due to a pandemic are not covered.)

For an economy, business owners are not easily replaceable; there isn’t a repository of risk-takers on the sidelines, just waiting to sign long-term leases and personal guarantees. That will be doubly true in the uncertain post-COVID environment. If preparations aren’t made now, before business-support programs run out and deferred bills come due, the same people we will need to create innovative small businesses appropriate for the post-COVID economy will either be trapped in businesses that are no longer viable or facing the long road back from bankruptcy. Releasing them to help revive our main streets should be a policy objective.

We know that trouble is coming for our debt- and deferral-ridden small business owners. There is still time to develop a robust pathway for fair COVID-induced bankruptcy before business support programs run out.

The federal government should work with provincial governments to create a time-limited, structured program for COVID-induced bankruptcies or business closures. In addition, small and medium enterprises, banks, insurance companies, credit-rating agencies and the country’s largest commercial landlords should be engaged.

The program should create a new, clear and facilitated pathway for business owners to wind down their COVID-affected businesses without causing them substantial long-term financial harm. An approach could include some of the following:

  • Clear guidelines on winding down highly affected businesses
  • Agreements with banks not to enforce personal guarantees
  • Compensation for landlords in exchange for releasing tenants from long-term leases
  • In cases where personal bankruptcy is required, eliminating or reducing the impact of the bankruptcy on credit ratings
  • Special provincial courts to expedite COVID-induced bankruptcies
  • Establishing an office to support business owners through the process of winding down their businesses

Canada’s major banks can play a significant role here. They will hold a lot of small business debt and a lot of mortgages for commercial landlords. If a new program helps release affected small business owners from personal guarantees on long-term leases, the banks could support those landlords with their mortgages. They also play a central role in providing loans for new businesses, and could ignore COVID-induced bankruptcies when reviewing credit ratings. Canadian banks have received great press lately for their support for small business during the pandemic, despite never doing anything comparable to Australian banks, which, acting collectively, deferred commercial mortgages in exchange for landlords committing not to evict their tenants. Maybe now, with their balance sheets in much better shape than expected, they could work together to ensure that the most COVID-affected small business owners can help lead Canada’s recovery.

This is a complex idea, crossing jurisdictions and involving many stakeholders. As with many of the other business support programs, it will be a challenge to decide which businesses should qualify. But the implications of just leaving people to their fate are significant. The CFIB predicts 181,000 more business closures, and that doesn’t include the zombie businesses trapped by personal guarantees. It is clear that we’ll see a significant reduction of entrepreneurial talent in our most affected industries, making a robust recovery that much more difficult.

Much of the criticism of Canada’s response to the pandemic has been about being one step behind, reacting to issues as they arise. The delays in rolling out wage and rent relief, imposing strict travel quarantines and building vaccine manufacturing capacity all fit that category. We know that trouble is coming for our debt- and deferral-ridden small business owners. There is still time to develop a robust pathway for fair COVID-induced bankruptcy before business support programs run out. In doing so, we’ll give our economy a much better chance at recovery.

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Jon Shell is Managing Director of Social Capital Partners, co-founder of Save Small Business, and a former “main street” small business owner.