Borrowing is a normal part of running a company. But when an unexpected setback cuts into cash flow, debt that seemed perfectly affordable can soon become unmanageable, threatening the company’s very survival. When this happens, business owners are often desperate for any loan that they can get. But taking on new debt when the cash flow is already squeezed is often a band-aid and rarely a solution.
In some ways, “business debt relief” is like a “catch-all” term. It can refer to lots of options that can help a business get out of debt. The best known is settlement. A business debt settlement is an agreement between a company and its creditors in which creditors accept a one-time payment that’s less than the full balance owed. Other forms include business debt consolidation loans, as well as refinancing the existing loan. Small business bankruptcy is another option. Then there is restructuring. It basically means that a company can work with its lender to adjust the terms of the existing loan or loans. One example of restructuring is when a company renegotiates the interest rate.
So where does a loan fit in? A consolidation loan replaces several old debts with one new loan, ideally at a lower interest rate, and it can lower the monthly payment. However, it doesn’t get rid of your debt. All it does is take your current debt and create a new single, consolidation loan to replace it. It is also generally only an option for owners with good credit. Borrowing a loan (of whatever kind) can be a way to get some breathing room in the short run. In an emergency, it can even save the company. But like the aforementioned band-aid, it’s not a long-term fix for poor cash flow. In other words, if the debt is already too big and the cash flow is too low, a new loan might not be the best use of time, or money, or sleep.
Business Debt Settlement
Debt relief works from the opposite direction. Instead of borrowing new money to pay old creditors in full, you negotiate to pay less than you owe. With settlement, you repay a portion of what you owe, and creditors cancel the remaining balance. It knocks the debt you owe back to something you can actually pay, and no new loan is involved. Companies can’t guarantee a specific percentage up front because savings vary.
Not every debt can be settled, though. Business debts break down into two categories, secured and unsecured. A secured debt is one for which you have put up collateral, such as a building or equipment: something of value that the lender can take if you can’t pay the loan, and sell to get their money. If it doesn’t sell for enough to cover the debt, you may be able to negotiate the remaining balance. Unsecured debt, like a business credit card, doesn’t involve any collateral, so creditors generally have little recourse. Unsecured debts are generally the best candidates for business debt settlement. That group includes credit cards, merchant cash advances, business lines of credit and trade or vendor debt.
How the process works is another big difference. When you take out a loan, you apply, get approved and start making payments. Settlement takes longer. In a typical program, you make monthly deposits into a dedicated account that you own and control, and the deposits accumulate until they are sufficient to negotiate with each creditor. Most people stop paying their creditors during this period. It’s a hit on your credit rating, but it also puts more negotiating power in your hands. Many creditors won’t even discuss a settlement while you’re current. Meanwhile, creditors might call and call, or they might put the debt in collections or even take legal action against you. A full program can take at least two to four years, because it may take that long to gather funds to start negotiating. The first settlement, though, can come within a few months.
Even while you’re putting money aside in a settlement account, a creditor can still sue your business. Pausing your payments does not stop a lawsuit. The more your debts have aged or the larger the debts are, the higher the likelihood of a lawsuit. However, you can often still settle even if a lawsuit has already been filed. If you signed a personal guarantee on the debt, your personal assets might be at risk as well. Consult with a licensed attorney if you have been sued.
Credit is where the comparison with a loan cuts the other way. Settling debts will probably lower your personal credit score. Your business credit score could take a hit as well, making it difficult and costly to obtain new loans and lines of credit until you rebuild the score. Your credit scores may recover as you continue to build a strong credit history. Your results will vary. Long term, the business may be more stable without the excess debt.
Some debts are harder still. SBA loans are rarely settled. A normal lender gives you the loan, and the SBA guarantees it. If you default, the SBA pays the lender and then comes after you. The federal government can garnish wages, tax refunds, federal benefits and bank accounts without a court order. You may be able to make an Offer in Compromise with the SBA or IRS. You offer what you can pay, and support your offer with financial documents. Approval is not a given. And there are no government grants for business debt relief, though an SBA loan at an affordable rate could be used to refinance costlier debt.
For many owners, the real alternative to settlement isn’t a loan at all but bankruptcy. A settlement is often a better way to go than filing bankruptcy. Settlement is private, while bankruptcy is a public record. A settlement doesn’t require you to close the business. Chapter 11 bankruptcy lets you keep running the business but you must pay creditors back under a court-approved plan and may have to sell some assets. In Chapter 7, you can walk away from eligible debts but income limits apply and you may have to close and sell assets.
When Does Settlement Make Sense
So when does settlement make sense? Settlement usually works best if you have $7,500 or more in debt. If you have much less than that, you may want to consider other debt relief strategies. Whether you operate as a sole proprietorship, LLC or corporation affects whether your personal finances are at risk. Personal guarantees or collateral can make it harder to settle. If you have a tight cash flow, it can take a long time to save up money to make an offer. And older debts that are already in collections are generally easier to settle.
Picking a Debt Settlement Company
When picking a debt settlement company, choose one that offers a free first consultation, and has people who can answer your questions clearly about what services they will provide and how much you’ll have to pay for those services. Check reviews from past customers online and look for companies that employ certified debt experts. If the company is pressuring you to sign the dotted line, walk away. Never pay upfront fees before getting any service. Companies should only charge you fees once they settle a debt, and only if you’ve agreed to it. If something doesn’t feel right, follow your gut instincts — it could be a scam.
There’s no single right answer in terms of debt relief. There are advantages and disadvantages for both loans and debt settlement. And the right choice will depend on several things, including the borrower’s existing debt load, cash flow, and credit quality.
