Business loans can pay for an expansion or carry you through a slow stretch. But too much debt can be a major problem for a small business, especially if you’re struggling to make ends meet. Many businesses go through multiple cash crunches and are forced to take on more and more debt. Over time, this can lead to them getting overwhelmed by the payments and trying to stay on top of their bills. Imagine having to remember ten different payment dates every month. It’s a nightmare, right? But what if you only had to remember one? That’s the main selling point of debt consolidation. Whether it actually helps your business is a different question.
Taking Out a New Loan to Pay Off Other Debts
The most common form of debt consolidation involves taking out a new loan to pay off other debts. If you have several smaller debts, you can take out a single larger loan to roll them all into one payment. That way, you no longer have to worry about making multiple payments each month. By combining your debts, you might be able to secure a lower interest rate or extend the repayment period, resulting in smaller payments each month. For a business owner who’s already stretched thin, this can be a lifesaver.
Before you sign anything, do the math on getting out of your current loans. Check whether any of your current lenders charge a prepayment penalty if you pay off your loan early. If so, find out how much money you’ll be charged. Then look at the interest rates on consolidation loans and find out if any fees are involved. After that, compare the annual percentage rate on every loan you carry. The best-case scenario is that you would be able to secure a consolidation loan for a rate that’s significantly lower than what you’re currently paying. If some of your debts already carry a lower APR than the new loan would, leave them out of the deal.
Community and national banks are the usual place to start. The U.S. Small Business Administration offers the lowest rates, on loans as large as $350,000. Online lenders also offer loans, but they’ll typically be more expensive, and they tend to want higher credit scores. If you have a lower credit score and aren’t an ideal candidate for a business loan, you may be unable to consolidate your debts.
People use consolidation and refinancing interchangeably, but they aren’t quite the same. Consolidation refers to the process of combining multiple debts into a single loan. Refinancing means changing or modifying an existing loan’s terms and conditions. This is done by replacing the old loan with a new one, which has more favorable terms. In practice, consolidation is about simplicity, while with refinancing you want to obtain a better deal (interest rate, term, etc.).
Taking out a debt consolidation loan for business could be a good idea if it lowers interest costs and makes it easier to manage cash flow. Getting one isn’t effortless, though. You’ll need to provide financial documents, go through another lender’s underwriting process and answer questions about how the business is doing and what it owes. On top of that, you’ll have to put a lot of time into a new application. But the upside is real. Instead of paying off five loans, you just have to worry about a single one. If you can get a rate with a lower interest payment than you’re currently paying, then it’s a win for your business. You can also shop for repayment terms that cut your fixed expenses, and whatever you save can go back into running your business, paying employees, or investing in growth.
If you’ve been paying high interest on unsecured business loans, putting up business assets as collateral to secure a new loan may be worth considering. Say you manufacture something and own equipment that holds its resale value. A lender may let you use that equipment as collateral to get an easier and cheaper term loan, at a lower rate than you were paying on the unsecured debt.
Consolidation Loans Don’t Work Well
Now the downside. A fixed-rate consolidated loan can work very well if your revenues are increasing month after month and you have the cash flow to pay it down faster than scheduled. But if your revenues have flatlined or, worse yet, are declining, then you need to act very carefully before choosing to consolidate. Consolidation only pays off other loans, it doesn’t create additional income or margins, so the company still has to earn enough to service the debt on an ongoing basis. When cash flow is already going in the wrong direction, consolidation loans don’t work well.
A longer term will stretch out the debt service and decrease monthly payments, but it also will stretch out interest payments. Unless the new loan actually lowers the interest you pay, it could just mean you are paying for the same debt longer. When you consolidate, you’re just replacing several smaller debts with one bigger one. The math might look better on paper, but the reality is that you’re still carrying the same burden, just in a different form.
Sometimes consolidating or refinancing just doesn’t save enough. If sales keep falling month after month, then restructuring your loans is like rearranging deckchairs on the Titanic. You could sell the business. As an alternative, you could liquidate the assets and close down. Short of that, push customers to pay faster and ask suppliers whether they will be willing to give you more time to pay. Not all of them will. Offering customers a discount if they’ll pay you early is a good way to cash in faster.
You can also try settling your debts with your creditors. This can work for a sole proprietor or very small business, especially if you’re using your personal credit to finance your business. In a settlement, you negotiate with your creditors to pay less than the full amount of your outstanding balance. After the business or the owner makes the offer, the creditor has the option to accept or decline. If you want to know how that could work for your business, talk to a nonprofit debt counselor or a debt management firm.
Bankruptcy is the final option. The federal bankruptcy code offers several routes, and two of them, Chapter 11 and Chapter 13, are restructuring chapters that offer opportunities to adjust debts. Chapter 13 is usually only open to sole proprietorships and limits how much debt you can have to file. Chapter 11 is the more common business bankruptcy. Under either one, a bankruptcy judge reviews your case and approves a repayment plan that lets you pay less than full value on some or all of your debts. You may have to sell business assets to cover part of what you owe. Chapter 7 is the most extreme form of bankruptcy. It does not provide the debtor with the chance to reorganize, or work out a repayment plan for their debts. You liquidate the business and repay creditors part of what you owe. Even if your business emerges from Chapter 11 or 13, you still face the financial aftermath. Your business credit score has tanked, leaving you vulnerable to high interest rates on future loans, if you can get a loan or credit line at all.
Consolidation isn’t always a one-size-fits-all solution. The key is weighing the short-term relief against the long-term costs. For a business in trouble, consolidation can feel like a lifeline, but it’s not a magic fix. If you don’t have a solid plan for the business, the consolidation might only delay the inevitable.
