Striking Out on Their Own: The Self-Employed in Bankruptcy

Abstract

A chapter on the self-employed may seem out of place in a book about consumer debt. We tend to think of the self-employed as business people, borrowing money to finance their entrepreneurial aspirations. But the reality is far messier. The personal and business finances of the self-employed are often completely intermingled. Far from the path to prosperity, some self-employed people declare consumer bankruptcy cases mired in business debt for which they are personally responsible. The consumer bankruptcy files tell a starkly different, and largely untold, story about self-employment. In reality, large numbers of self-employed people file consumer bankruptcy cases each year. Approximately 200,000 consumer bankruptcy cases each year are filed by someone who indicated self-employment. This works out to about one out of every seven so-called “consumer” bankruptcy cases.

If people in bankruptcy are at the bottom of the financial heap, the self-employed are the bottom of the bottom. Far from having won the American economic game, the self-employed in bankruptcy are the worst-off of the losers. The self-employed arrive in bankruptcy in truly terrible financial shape, even when compared with other people who declared themselves broke. At the time of bankruptcy, the typical self-employed person has debts that are close to five times his or her annual income. To finance their business, the self-employed have turned principally to credit cards and, to a lesser but significant extent, their home equity. Close to half of people who identify their business as a reason for their bankruptcy have no equity in their homes at all.

The findings on the self-employed in bankruptcy challenge the conventional story of the heroic, risk-taking entrepreneur who finds both independence and financial success from owning a business. Certainly, many people enjoy enormous success from business ownership but adding the bankruptcy debtors to the narrative about self-employment complicates the story. For a sizeable subgroup of self-employed people, business ownership was a path to the very bottom of the financial heap. They started businesses for the same reasons as most business owners and took the risks often necessary to build a successful business. The bankruptcy data are a reminder that even societally-favored, “good” risks can prove very costly. Government policies often encourage small-business formation, but they rarely consider the problem of small-business failure. It is time to think about what happens to the owners when businesses do not succeed. After changes in 2005, the U.S. bankruptcy laws can be especially punitive to the self-employed who find themselves on the wrong side of the American dream, but relatively modest changes could make the system much more responsive to the inevitable failures that accompany the many successes of self-employment.

Keywords: bankrupty, self-employment

JEL Classification: K35, D14