Chapter 7 is a liquidation bankruptcy: the company ceases normal operations, assets are sold, and proceeds pay creditors before anything reaches equity holders.

How it works

After filing, a trustee (or sometimes management in simpler cases) inventories assets—cash, equipment, IP, customer contracts where assignable—and sells them. Secured creditors get paid from collateral first. Unsecured creditors, including vendors and some lenders, share what remains by priority rules. Employee wage claims and certain taxes may jump the line within limits. Equity holders sit last and usually receive nothing. For startups, the most valuable asset is often IP, talent, or customer relationships sold in an asset sale rather than a going-concern transfer. Many venture-backed failures skip formal Chapter 7 and simply dissolve after an acqui-hire or assignment-for-benefit-of-creditors, but Chapter 7 is the clean legal liquidation path when debts remain.

Why it matters

• Founders: Personal liability depends on guarantees, payroll taxes, and fraud—not the bankruptcy chapter itself. A Chapter 7 wind-down ends your ability to operate the entity and can complicate future ventures if obligations linger.
• Investors: Liquidation preferences only matter if there is distributable cash after creditors. Most Chapter 7 outcomes for early-stage companies are total losses for preferred and common alike. Write-downs hit fund marks and DPI math.
• Creditors: They recover fractions of claims, if anything. Secured lenders fare best; trade creditors often get minimal recovery.

Common mistake

Believing liquidation preference guarantees a payout in Chapter 7. Preference rights govern distribution order among equity classes, not a bypass of creditor seniority or the absence of assets.

Related ideas

Chapter 11 reorganization, assignment for benefit of creditors (ABC), asset sale, dissolution, and wind-down planning are the adjacent paths when a company cannot continue as a going concern.