Small business owners take out loans and lines of credit for all sorts of reasons. They do it to pay for inventory before a busy season, to fund payroll, to smooth out short-term cash flow gaps, to put a bigger budget behind a marketing campaign, and to buy equipment. But even if business owners plan carefully, the day-to-day can get tough. A seasonal slowdown, late-paying customers, or a cost of doing business that keeps creeping up can make it hard to keep up with repayments. Falling behind is rarely a sign of a bad business. It’s usually a cash flow misstep, a timing issue, or a forecast error. And when that happens, business owners start looking for a way to quickly reduce the debt on their books. That’s when debt settlement companies appear. A debt settlement company (or debt relief company) offers to negotiate a reduced payoff with your funders on your behalf, for a fee.
Red Flags to Look for in a Debt Relief Business
Professional debt settlement isn’t bad. Not all debt settlement companies are shady, but many are, and the FTC has repeatedly warned business owners and consumers to be very careful about working with them. The tactics debt settlement companies use to solicit business are often misleading. Knowing what red flags to look for in a debt relief business can save you from falling victim to scams or ineffective services. Here are the ones worth knowing before you sign anything.
The first, and the most dangerous, is advice to stop paying. Some tell you that you should stop making payments as your first step toward settlement. Some go further and call an intentional default a “negotiation strategy.” This tactic is dangerous, misleading and just plain wrong. Owners hearing this pitch should be asking themselves: Why on earth would we want to start torturing our own bank account and credit rating in advance of actually finding out if we’ll even be negotiating for a settlement? This seems like the opposite of a solid negotiating strategy. As the example below shows, you’d likely end up worse off than if you kept paying.
Be wary, too, of a firm that ’guarantees’ that it can cut your debt or says it can easily get you a new, better deal with your funder. No honest firm can promise that, because they have no way of knowing whether it’s possible without fully understanding your business. Another red flag is if the firm promises to ’make the lender go away.’ Lenders are in business to earn money, and they aren’t going to just go away. Don’t look for the quick fix.
Listen closely to how the company talks about your funder. If it keeps harping on the funder’s supposedly outrageous fees and shady practices, you need to be extra-wary. This is a sign that the settlement company may be trying to paint your funder as the bad guy, to get you on their side. Some of these firms call themselves “financial rescue services.” Keep in mind, however, that these companies can leave business owners in a much worse situation than where they started.
Then there is the question of fees. Be cautious when someone wants to charge a fee up front before they do any work. A big upfront fee can be a sign of a scam. A reputable company will be transparent about their fees, and you should know before you sign exactly when and how you will be charged.
To see why all of this matters, consider an example. A small business, say a rural spa, takes a working capital advance (also called revenue-based financing) from an alternative funder, where it gets a lump sum of cash up front in exchange for paying back a small percentage of its monthly sales, plus a tiny fee. Months later, that spa is contacted by a settlement company, which promises to lobby the funder to lower the remaining balance and asks the owner to stop paying meanwhile. If the business stops paying, default fees kick in, which can be a percentage of the remaining balance (think: thousands of dollars in fees alone). It may be responsible for reimbursing the funder for attorney fees and court costs, plus any collection agency charges. Many contracts include ACH access, which can give the funder the ability to restrict or freeze the business’s accounts, leaving it without day-to-day working capital. If you don’t have access to your business checking account, you can’t manage the account and can’t spend your company’s money. This can have a significant effect on business cash flow. There are even more late fees and penalties for missed or partial payments.
The spa owner is still on the hook for the settlement firm’s fee, which may be billed upfront, as a percentage of the negotiated savings, or both. Its business credit can take a hit too, making it more difficult and expensive to get any sort of financing in the future. Worst of all, you could end up paying both the funder and the settlement firm, and it might cost you much more than the original advance.
Protect Yourself
How do you protect yourself? Default fees and penalties are common contract terms. Know the terms of your agreement: how often you’re supposed to make payments, how long that’ll last, how much each payment is, and what happens if you stop paying. Don’t be afraid to call your funder to ask questions, even if you’ve already signed the contract. Reviewing your contract yourself helps you identify misleading advice given by outsiders. Make sure that you’ve truly understood all the obligations. Can you meet them? If not, you have a problem and should reach out to your lender for help.
If you think you might miss the next payment or two, the best thing to do is contact your funder immediately. Many alternative funders are open to working with business owners directly before an issue gets too big, and sometimes they’re able to adjust the structure of the loan, change the schedule, or find some other way to keep the business running. Reaching out early can keep a small problem from turning into a big one.
However, if you are going to engage a debt settlement company, proceed with caution. Don’t work with any debt relief company that recommends you stop paying your creditors, guarantees results, promises to get your lender to back off, or asks for large fees before they do any work. A reliable debt settlement company will be up front with you and communicate clearly instead of making false promises and unreasonable demands.
