A 2019 Federal Reserve survey estimated that about 70% of small businesses have outstanding debt. Borrowing is a normal part of doing business. Then something unexpected comes along, a pandemic or a recession, and the payments get harder to make on time. Maybe you can’t close the month with a profit, or you’re unable to pay the bills, or maybe it’s not quite as bad as that, but your cash flow is getting squeezed. Matters get more complicated when you’re carrying debt. Loan payments, even if they’re small, have to be made. If you’re a business owner and you aren’t sure what to do at this point, let me say that it’s normal. Many people feel unprepared and overwhelmed by debt issues, and that’s understandable.
Three Things an Owner Can Do
The good news is that defaulting is not your only path. According to Nav, a small business financing company, there are three things an owner can do. The first is to refinance, which means to get new financing that will replace your existing debt. The second option is debt consolidation. That involves combining all of your credit card debts, lines of credit and possibly bank loans and vendor financing into one single loan, so there is only one payment to keep track of. The third option is to restructure your existing loans.
So, those are the three options. The rest of this article is about the third one. Restructuring means going back to the creditors you already have and working out better terms. When you restructure existing debt, that can mean stretching out the payments, making them more manageable. Pay it over time. The loans won’t get paid off sooner but could this help keep the payments smaller? Can they extend the loan period to make repayment easier? Pay it less. Or maybe renegotiating the interest rates is possible. You might ask a lender to lower your rate for a while. If a supplier normally wants to be paid within 30 days, you could ask them to extend your terms to 60 days so you have more time to earn the money. That has to be agreed to, of course.
Not every restructuring starts with a crisis. The Small Business Chronicle notes that some companies restructure their debt to prepare for an employee buyout, a merger, a sale or a transfer to family members. They don’t really need a lifeline. They just want to get to a healthier place. In those cases, business restructuring is often a deliberate, pre-planned action.
That is why restructuring is usually split into two categories. The first is general debt restructuring, where the creditor does not lose anything. For example, when a firm is having a cash flow issue, the creditor might extend the loan term, which reduces the size of the regular payment. So, the overall amount of the debt stays the same, but the payments go down. A lender might also lower the interest rate, giving the business room to steady itself and pay later. Creditors can live with this. They’re just trying to get paid; when a borrower keeps on paying up in some fashion or another, they’re going to let the borrower take advantage of a few options as long as the creditor doesn’t end up taking a loss.
The second is troubled debt restructuring. Here the business is truly in financial distress. The debtor can’t possibly cover all of the loan costs. Something has to give, and the creditor ends up losing some of the value of the original loan. In this case, the lender agrees to take a hit. Understandably, creditors try to avoid this whenever they can.
How you go about restructuring depends on which situation you are in. If it is a general restructuring and not an emergency, then the situation is more like you’re negotiating with a friend. Creditors are more willing to change payment terms and interest rates. If it is TDR, or troubled debt restructuring, then the situation is a lot different. Then you’re dealing with a creditor who has seen big red lights waving over your shop for a while now, so the conversation and the negotiations will be that much tougher. In that case it may help to hire a professional to negotiate with your creditors on your behalf. You could also look at refinancing or consolidation instead. Either way, the basic steps look much the same.
Start by figuring out where the problem is. Not all of your debts need to be restructured. Is it just the line of credit or the credit cards that are causing problems? Or do you have the vendors to worry about as well? Get a better picture of exactly where your problem lies. Just looking at it this way will likely reveal that some of your obligations are more critical than others. Aim for the changes that will have the biggest impact. You have to evaluate why you’re having trouble paying your debts and how you will be able to tackle the problem in a way that your creditors can accept. You will need to explain to each creditor why the business can’t meet the terms it agreed to.
Next, work out how much your company can put toward these debts each month. One expert’s rule of thumb: if the percentage you can pay is 8% or more, restructuring on your own is doable, but if it is under 8%, it is time to call a professional. In determining how much you can afford, consider both what your business needs (to stay open, to pay employees, etc.) and what you will need to come out of this debt situation: possible new equipment, advertising, inventory, etc.
Then prepare a hardship letter. This is an official written request to the creditor asking them to be more lenient with payments or other terms. This can help prompt negotiations, but to be effective, it has to be convincing. Include data and financial statements to back up your case. Explain to them how you got into this situation. What you want in the letter is clarity and specifics. Make it detailed. Set forth each circumstance which contributed to your current financial hardships. This letter is your chance to prove that you are a willing debtor and demonstrate your good faith. Be open and honest when you make the request.
Finally, negotiate. A creditor has good reason to work out a better payment plan with you, because otherwise it might never see a return on that original loan. Banks and lenders usually prefer to work things out. They like it when debts are paid off. So, if a borrower is having a hard time making payments, and they can stretch things out or accept a lower interest rate, the creditor will be much happier than if the borrower goes into default. For your part, explain why it is in their best interest to work with you. Business debt restructuring is not a conflict between your interests and the creditor’s interests. It is a negotiation. Avoid rushing into a solution without explaining why you need to restructure, and why you can’t make payments as is. Otherwise the creditors will not take you seriously. Be clear and consistent in your communications and make sure you document every agreement you come to. If you are unsure how to handle the negotiation yourself, it is often a good idea to hire a professional debt restructuring firm to help.
Debt restructuring happens to businesses of all sizes, but it is not your only choice. You can refinance, consolidate or apply for an SBA loan, and if the business is financially sound and only going through a rough patch, a business line of credit may be your answer. It’s a good idea to learn as much as possible about what to expect before you act. But if it’s a reasonable strategy, and restructuring is the best option, take your problem and talk to your creditors about your vision. You may surprise yourself and them with how far negotiation will take you.
