The Right Option Depends on Whether the Business Is Cash-constrained or Truly Insolvent
The general rule for small businesses in the United States in 2026 is to refinance when the business can still service its debt on improved terms and qualify for a new loan. Choose settlement only when the debt total is beyond the company’s ability to repay. Refinancing maintains the total debt balance, pays a better rate or payment, and preserves the company’s credit relationships. Settlement reduces the debt balance but usually requires suspending payments, risks collection lawsuits, and can trigger a tax liability. The right option depends on whether the business is cash-constrained or truly insolvent, the type of debt being held, and whether the owner has personally guaranteed the debt.
Is the Business Insolvent? If the company requires debt consolidation, you first should check to see whether the company is short on cash flow or if it’s insolvent, what sort of debt the company has, and whether you have personally guaranteed the debt.
SBA 7(a) Loan
The most common way to refinance a qualified business is with an SBA 7(a) loan. SBA’s lending rulebook, Standard Operating Procedure 50 10 8, tightened the refinancing terms on June 1, 2025. SOP 50 10 8 requires that any debt that has been refinanced has been paid within the last 12 months (meaning that none of the payments were over 29 days late). The refinanced loan installment payment also must be at least 10 percent lower and the SBA lender must document that the loan’s current terms are unreasonable. A 7(a) loan can be up to $5 million. On variable rate interest, it is capped at 3 percentage points above the base rate, on loans over $350,000. Smaller loans can have interest up to 6.5 percentage points above the base rate.
Refinance the Proceeds of a Merchant Cash Advance
The biggest knock against the loans for cash-strapped businesses who do qualify for the programs is that SOP 50 10 8 disallows the use of 7a loan proceeds to refinance the proceeds of a merchant cash advance or factoring contract. The restriction applies to all 7a loans and 7a Small loans ($350,000 and less), the SBA Express, Export Express and International Trade Loans. You can’t use 7a working capital loans to refinance existing merchant cash advances. Businesses that have stacked advances cannot refinance them into a loan backed by the federal government. They can only refinance the advances privately, which for many businesses means getting a new high-cost advance to pay the old ones off. Or, they can negotiate with the funders. The 12-month payment rule also disqualifies businesses that have missed some of the payments on bank debt.
SBA refinancing can be expensive in ways that comparing just monthly payments can obscure. SBA charges an upfront guaranty fee on the guaranteed portion of most 7(a) loans with terms longer than 12 months. During fiscal year 2026, which ended on Sept. 30, 2026, the fee was tiered — ranging from 2% on the first $150,000 guaranteed to 3.75% on amounts above $1 million. SBA 7(a) loans that have a 15-year maturity or longer are also subject to a prepayment penalty if the borrower voluntarily pays off 25% or more of the principal within three years of the first disbursement. It’s 5% in year one, 3% in year two and 1% in year three, so an owner should factor it in when considering an early payoff.
Settlement trades a smaller balance for several risks, and taxes are the one owners most often miss. Under federal tax law, debt a creditor forgives is generally treated as ordinary income in the year it is canceled. Banks and other lending entities that cancel $600 or more must file Form 1099-C, but the forgiven amount must be reported even if no form arrives. The two main exclusions are for debt discharged in bankruptcy and for debt canceled while the taxpayer is insolvent. Claiming either exclusion means filing Form 982 and giving up tax benefits, such as net operating losses and asset basis, in exchange. Insolvency is measured by comparing total liabilities with the fair market value of all assets immediately before the cancellation.
Here is an example from the IRS regarding its specific calculation of the insolvency exclusion for a taxpayer who is partially insolvent: For instance, if $5,000 of debt is forgiven and the debtor has liabilities of $10,000 and assets of $7,000, the debtor is insolvent to the extent of $3,000. Consequently, $3,000 is excluded from income, and $2,000 would be taxable income. If the debtor had liabilities of $15,000, the debtor would be insolvent to the extent of $8,000 and the entire $5,000 would be excluded from income.
And an important clarification: the IRS clearly states that the ownership of an insolvent or bankrupt disregarded entity, such as a single member LLC, will NOT trigger the insolvency or bankruptcy exception for the owner. The exception will only apply if the owner is himself/herself insolvent or bankrupt. This is significant for owners of single-member LLCs.
Owners who use settlement companies should be aware that the most important federal rule governing the debt relief industry was written to apply to consumer debt relief. The FTC amended the Telemarketing Sales Rule in 2024, effective May 16, 2024. The amendment extended only the bans on material misrepresentations and false or misleading statements to business-to-business calls, not the rule’s other protections. This means the terms of the fees of a business debt settlement contract should be as important as the debt that is being settled.
Merchant Advances as Disguised Loans
Business owners attempting to settle merchant cash advances can push back against them more effectively, as some regulators have seen merchant advances as disguised loans. The New York Attorney General announced a $1.065 billion judgment against Yellowstone Capital and its affiliates in January 2025. The company had provided financing to over 18,000 small businesses at rates that were reported to be as high as 820%. The judgment included over $534 million of debt forgiveness and $16.1 million in restitution. The court also vacated more than 1,100 court judgments and banned the companies and their executives from the industry. The companies did not admit any wrongdoing. All pending lawsuits and liens against guarantors and merchants were also dismissed, demonstrating that the funders make claims against the owners personally.
Federal regulators have also pursued similar cases. In FTC v. RCG Advances, the FTC accused the funder — formerly Richmond Capital Group — of misrepresenting the terms of its advances and threatening violence to collect. RCG Advances and its principal Robert Giardina settled in June 2022 with a permanent ban from the merchant cash advance industry, a $1.5 million upfront payment, and over $1.2 million in future payments. Another operator named in the case, Jonathan Braun, was ordered to pay $20.3 million after the FTC’s first jury trial. These cases do not render any specific advance unenforceable, but set the stage for settlement talks with aggressive funders.
A confession of judgment is a document the borrower signs up front allowing the creditor to obtain a judgment without a traditional suit being filed. On August 30, 2019, New York revised CPLR 3218. Thereafter, a confession can only be filed in the New York county where the debtor was domiciled at the time it signed the confession. This effectively prohibits filing New York confessions against out-of-state businesses. New York businesses remain vulnerable, and there are still many states that will allow a confession. A funder with a valid confession can seek swift collection, even when settlement negotiations are pending.
Subchapter V
If refinancing or settlement are not viable, Subchapter V of Chapter 11 is the streamlined bankruptcy for small businesses, and the threshold for using Subchapter V is set to be adjusted. For cases filed currently, the threshold for total debt must be no more than $3,424,000. This new inflation-adjusted figure went into effect on April 1, 2025. The $7.5 million cap under the pandemic relief provision expired on June 21, 2024. In September 2026, Congress passed H.R. 7730, the Bankruptcy Threshold Adjustment Act, which would make the $7.5 million limit permanent. As of October 1, 2026, the bill remains unsigned. The new threshold would only apply to cases filed on or after the effective date of the law.
