Miss one payment on a business loan and it is usually a fixable problem. Miss several, and that’s when the loan starts to get interesting. A business loan isn’t necessarily going to go into default if you miss a payment or two, but missed payments can lead to a loan defaulting. While a missed payment can usually be remedied quickly, several missed payments can start the process of a loan going into default. How quickly that happens depends on the lender, the loan and the agreement you signed. Some smaller and alternative lenders can freeze assets after only a few missed payments. With a larger bank, you might have several months to work with. Even so, six months of missed payments is a common benchmark for triggering a default.
The first missed payment puts the loan into delinquency. However, a delinquency is not the same as a default. Being delinquent can be considered a less severe offense than defaulting. You are in delinquency, and you still have time to catch up on your payments to avoid default. Default occurs after the lender has not received a payment for a specified period. Being in default means you have broken the terms and conditions of a loan or other agreement with a lender. Defaults will have a greater impact on a borrower’s credit rating than a delinquency.
If you miss a second or third payment, you might receive a letter or phone call from your lender. If you’re like me, the thought of hearing from your lender is scary. You know there’s trouble, and you don’t want to hear about it. Take the call anyway. I promise, it will be better than avoiding it. This is a crucial bargaining period, and you and the lender may be able to agree on a reasonable plan to pay back the loan. In the best-case scenario, the bank sends you a friendly phone call and asks you to describe the problem that led to the missed payment. Hopefully they’ll extend you some concessions, and help you get back on track. But you never really know in advance how your situation will be handled by the bank.
If no plan is reached and the loan goes into default, many lenders trigger the acceleration clause in the agreement. Acceleration happens when a lender demands immediate repayment of the entire outstanding balance on a loan or line of credit. Instead of owing the missed payments and interest, the business owner now owes the entire remaining balance, plus any accrued interest and fees. The lender will also add the charges spelled out in your agreement, such as collection and attorney fees. The amount can be much larger than expected.
If the late payments continue, things will start to go sideways fast. If you and the lender can’t reach a resolution, the lender may take legal action or start the collection process by turning the loan over to a collection agency. The personal guarantee is a serious risk. If you have a personal guarantee, it will become a lot easier for the lender to come after you for the loan. From there, things usually go one of two ways. The lender might decide to seize a business’s assets and use those to pay the debt. That can mean personal assets too, along with liens on business property or wage garnishment. Or the lender may decide to cut its losses and settle with you for a defined amount. Settlements are another option, and what that means is negotiable.
Then there is the credit damage. Loan defaults are reported to the credit bureaus. A default decreases your business credit score, and your personal score takes a hit too. It will likely impact your ability to qualify for future loans and raise your interest rate on future loans. It’s important to remember that you and your credit score are on the line.
The SBA Guarantee
SBA loans follow a slightly different path. They are government-backed, but the SBA itself is not a lender; it simply guarantees a portion of the loan to make the lender’s risk lower. That portion can be up to 85 percent. In other words, you make your payments to the bank that made the loan. So even if the loan is government-backed, you’re still on the hook. SBA loans almost always require collateral, and because the terms are favorable, the owner is expected to pledge all of it, often including personal assets, like a house. If you default, the lender might force a liquidation of that collateral. Often, the lender will try to work with you first. Some lenders charge a late fee, while others allow a restructuring or interest-only payments for a while. The lender calls in the SBA guarantee only if its own collection efforts fail, and if the government takes a loss, it may garnish wages or freeze bank accounts.
Be Proactive and Reach Out Before the Problem Escalates
The good news is that much of this can be headed off. You should definitely contact your lender when you start falling behind. Reach out to the lender before they reach out to you. Your lender doesn’t know you are having problems unless you tell them. Make early and honest contact with the lender. Don’t keep it a secret. You won’t be in any better shape a month or two later. Many lenders can come up with workable solutions, like creating a new payment schedule. Give the lender a chance to help you out. Above all, going silent is always a bad idea.
A lot depends on who you borrowed from. A large bank understands that some accounts will always underperform. The write off of those bad loans has been built into the bank’s business model. A relationship-based lender may also be more willing to avoid foreclosing. Arm’s-length lenders, such as merchant cash advance companies, are a different story. The money may come from one person or a small group of private investors. When one of these lenders advances money to a small business, they are betting that the business will be able to pay the advance back, and their main concern may simply be getting that money back.
Settlement is another route. An “offer in compromise“ is essentially a negotiation with the lender in which you offer to repay less than the total amount owed on the loan. Some lenders, including SBA lenders, will consider one if you can show financial hardship. A lender may agree to accept less than the amount owed to provide the small business with an exit option if the business has no realistic prospect of repaying the debt. When a debtor offers a settlement (i.e. an offer), the lender can accept or reject it. A business attorney or a professional who specializes in debt settlement can help you navigate the process.
If you would rather keep the loan alive, ask about a loan modification or refinancing. First, it’s important to have an accurate picture of your business’ financial health. You need to figure out where you want to go and what you need from the bank to get there. Then work out whether you can realistically pay back the loan under the new terms. You’ll need to come up with a solid restructuring plan, including the amount of each new payment. Be reasonable and realistic. Restructuring can mean extending the loan term to decrease your payments. The typical restructuring discussion between the lender and the businessperson is about the ability to pay the loan back, the interest rates, and cash flow. Explain the problem, how it has impacted your cash flow, and how long it has been going on. Be prepared to negotiate, and get any agreement in writing.
You don’t have to sort this out alone, either. It’s important to have a professional review your finances and evaluate your situation. A business attorney can explain your loan agreement and help negotiate better terms, and a CPA can help you evaluate your finances. The National Foundation for Credit Counseling also offers small business owners free counseling and resources. The take away is to be proactive and reach out before the problem escalates.
Longer term, good cash flow and careful bookkeeping start with keeping business and personal money apart. When the two get mixed together, the problems can multiply. It becomes easier to miss the warning signs, or to “borrow” from the business for personal needs and then slip up on a payment. The accounts should be kept strictly separate.
Sometimes default can’t be avoided. Even then, a delinquency or default is not a death sentence for your business. Lenders are people, and if they can see you’re doing your best, they’re more willing to help.
