How Business Debt Settlement Works

Business debt settlement, also known as business debt negotiation or settlement, is the process of negotiating with creditors to reduce business debt balances. It can be an effective way for struggling businesses to resolve unmanageable debt and avoid bankruptcy.

How It Works

The business debt settlement process involves several key steps:

1. Stop Making Payments

The first step is for the business to stop making payments on the debts that will be negotiated. This is important in order to show creditors that the business cannot afford the current payments and needs relief. However, it’s crucial to understand that stopping payments can negatively impact credit scores and may result in late fees or penalty interest rates.

2. Open Negotiations

Once payments have stopped, the next step is to open negotiations with each creditor. This can be done by the business directly or through the help of a professional debt settlement company. The goal is to negotiate a lump sum settlement that is less than the total balance owed. Creditors are often willing to accept less than full repayment if they believe it is the most they can reasonably expect to recover.

3. Make Lump Sum Payment

If negotiations are successful and a settlement offer is made by the creditors, the business will then need to come up with the lump sum payment amount. This is often done by tapping savings, getting loans from friends/family, or securing a debt settlement loan. It’s important to have the full settlement amount available before finalizing the deal.

4. Debt is Settled

Once the negotiated lump sum is paid, the creditor considers the debt settled and closes the account. The business is no longer responsible for repaying the remaining balance. Getting settlements in writing from creditors is critical before making final payments.

5. Impacts on Credit

Settling debt for less than the full amount can negatively impact business credit scores. Accounts included in a settlement are typically noted as “settled for less than full balance” on credit reports. However, a settled debt is still better than an unpaid, charged-off debt in terms of credit scoring.

What Debts Can Be Settled?

The most common business debts that can be settled include:

• Business credit cards
• Business lines of credit or loans
• Past-due supplier/vendor invoices
• Commercial real estate loans
• Equipment financing loans
• Business taxes (in some cases)

Personal debts tied to the business, such as an owner’s personal credit cards used for business expenses, can also potentially be included in settlements.

Benefits of Business Debt Settlement

There are several potential benefits for businesses that settle their debts successfully:

• Avoids bankruptcy: Settlement allows businesses to resolve debt without resorting to bankruptcy, which carries severe long-term consequences.
• Saves money: Settling debt for pennies on the dollar compared to the amounts owed allows businesses to resolve debt at significant discounts. This frees up cash flow once debts are settled.
• Stops collections: Creditors will stop collection efforts and calls once debts are settled. This enables the business to focus on recovery without harassment.
• Enables payment: By spreading out payments through settlement, businesses can fund settlements over time compared to coming up with full lump sums to pay debts immediately.

Risks and Considerations

While settlement can be an effective debt relief strategy, there are also important risks and considerations:

• Creditors may balk at settlement offers and pursue full repayment through legal action if negotiations fail. Litigation can severely impact struggling businesses.
• Settling debt may trigger tax consequences. Settled debt of $600 or more can be considered taxable income by the IRS.
• Future access to credit may be limited after settling obligations for less than full repayment. However, after a few years, this impact lessens.
• Settling debt still requires coming up with lump sums that can place additional financial stress on businesses during the settlement period. Defaulting on settlement payments can negate deals.
• Reputational damage with creditors settled for less than full payment can impact important long-term business relationships.

Finding the Right Company

Choosing the right settlement company is critical to success. Warning signs of settlement scams include promises to eliminate debt entirely, requests for large upfront fees, or guarantees that creditors will accept proposals. Legitimate settlement companies charge performance-based fees only after settlements are negotiated.

When researching settlement companies, business owners should:

• Vet credentials, complaints records, client reviews and BBB ratings
• Understand fee structures – fees should be based on savings achieved
• Get fee/service agreements in writing before committing

Reputable settlement professionals can make the process smoother and increase success rates in negotiations. However, businesses should still vet proposals carefully.

The Settlement Process

The business debt settlement process normally takes between 6-36 months from start to finish. It begins with stopping payments and opening negotiations. Creditors will continue collection efforts during negotiations, which may include lawsuits if progress stalls.

Once initial proposals are presented, additional documentation and financial disclosures will likely be required by creditors before countering. Negotiations tend to take some time to secure acceptable offers but can then move quicker as deals progress.

Most creditors will not agree to final settlements or sign release of liability agreements until they have received negotiated funds. This means businesses need to come up with lump sum amounts before finalizing.

Alternatives to Settlement

Other options beyond debt settlement for businesses struggling with unmanageable debts include:

• Debt consolidation loans – Taking out a new loan to pay off multiple debts under one payment. This can reduce interest rates but will increase overall debt.
• Credit counseling – Nonprofit credit counseling agencies can help businesses set up debt management plans. These plans enable reduced interest rates and payments through creditor concessions.
• Bankruptcy – Filing for business bankruptcy protection like Chapter 11 enables businesses to eliminate qualifying debt entirely. However, bankruptcy can be complex and damaging long-term.

Many struggling small business owners consider debt settlement before resorting to bankruptcy or closing down entirely. By negotiating directly with creditors or working with a settlement firm, businesses can resolve unmanageable debts for fractions of amounts owed – often the only viable path forward.

FAQs

How much can I settle debt for?

In general, business debt can typically be settled for between 40 to 60% of balances owed. However, results vary by creditor, balances, and negotiating strategy. With the help of a settlement firm, some debts may be settled for as low as 10-25% of balances owed in some instances.

Can I settle without hurting my business credit?

Unfortunately, settling debt for less than full repayment will likely have a negative impact on business credit scores as notated in credit reports. However, a settled account is still better than an unpaid, delinquent account in terms of credit.

Are all business debts eligible for settlement?

In most cases, unsecured business debts like credit cards, lines of credit, past-due invoices, and business loans can be settled. Exceptions include recent debts, secured debts like mortgages/auto loans, student loans, child support, alimony, and certain business taxes.

What debts should I start with when settling?

It is usually best to start settlement negotiations with smaller debt balances first. This enables lump sum payments to be made more easily to finalize settlements and build momentum. After initial successes, larger debts can then be tackled.

The Bottom Line

Business debt settlement can be a lifeline for struggling companies overwhelmed by unmanageable debts. Negotiating directly with creditors or enlisting the help of a settlement firm may provide the only path forward besides bankruptcy. While certainly not without risks or downsides, a carefully orchestrated settlement strategy can resolve crippling business debt and provide renewed viability.

Resources

What to Know About Business Debt Settlement

Everything You Need to Know About Business Debt Settlements

Business Debt Settlement: Is It Right For Your Company?

Business Debt Settlement: An Alternative to Bankruptcy?

Navigating Business Debt Settlement: A Helpful Guide for Small Business Owners

As a small business owner, I know how tough it can be to manage finances. When cash flow gets tight, it’s easy to rely on credit cards or loans to stay afloat. But that debt can quickly snowball, leaving you struggling to keep up with payments. If you find yourself in over your head, debt settlement may seem like an appealing option. But it’s important to understand both the risks and potential benefits before moving forward.

In this article, I’ll walk through the ins and outs of business debt settlement. My goal is to provide an honest, human perspective on the pros and cons so you can make an informed decision. I’ll also share tips on negotiating with creditors yourself or finding reputable settlement companies. My hope is that you’ll come away better equipped to tackle your business debt in a strategic way.

What is Business Debt Settlement?

Debt settlement involves negotiating with creditors to pay a lump sum that is less than the total amount owed. The creditor agrees to consider the remaining balance “settled” and stop collection efforts. This can be an alternative to bankruptcy or continuing with regular payments.

Settlement companies advertise that they can reduce debt by 40-60% on average. However, there are risks to be aware of. Your credit score will drop and creditors may sue you or continue harassing calls while you save up for settlements. Fees also range from 10-25% of enrolled debt, on top of any interest and late fees racking up.

That said, settlement can still provide relief if done strategically. The key is prioritizing which debts to target and having realistic expectations. Don’t believe promises of slashing debt in half with no consequences [1].

When Does Settlement Make Sense?

Settlement works best for unsecured debt like credit cards, medical bills, and personal loans. Debts with collateral like mortgages and auto loans are riskier. The lender can seize the asset if you default.

You need a lump sum saved up to make credible offers. This means settlement works best for debts with a small enough balance that you can save the funds within several months. That might be $3,000-15,000 on a credit card, not $100,000 on a business line of credit.

Settlement also makes the most sense when you have a reasonable plan to avoid racking up new debt. There’s no point settling current debts if you’ll just accumulate new ones.

Weigh the Pros and Cons

Settlement can provide meaningful relief, but also comes with costs. Consider these key pros and cons:

Pros

• Settle debt for less than you owe
• Stop accruing interest and fees on settled accounts
• End creditor harassment and collection calls
• Avoid bankruptcy which can liquidate business assets

Cons

• Fees to settlement companies often 10-25% of debt
• Credit score drops 100+ points on average
• Continued late fees and interest while saving up for settlements
• Creditors may sue you before settlements paid
• Taxable income on forgiven debt

As you can see, there are advantages but also substantial drawbacks. Make sure you’re clear on both before making any decisions.

Understanding the Process

If you decide to pursue settlement, here is a typical timeline:

1. Stop payments – You’ll stop making regular payments so you can save up for settlement offers. This will likely trigger late fees.
2. Open dedicated account – Settlement companies require you to save lump sums in a dedicated account they can access.
3. Wait for account to build – It takes several months to save enough to make credible offers.
4. Settlement company negotiates – Once there are sufficient funds saved, the company negotiates with creditors.
5. Creditor accepts or rejects offer – There’s no guarantee creditors will accept the initial offer amount.
6. Settled debts paid off – If accepted, you pay the settlement amount and the account is closed.

Expect this to take at least 6-12 months. During that time, your credit score will drop, creditors may sue, and interest/fees accrue. Make sure you’re prepared for the consequences before moving forward.

Should You Hire a Settlement Company?

Settlement companies advertise that they can secure better deals with creditors compared to what you could negotiate directly. However, you need to vet companies carefully, as many overpromise and employ predatory tactics.

Watch out for any company that [2]:

• Charges upfront fees before settling debts
• Guarantees specific settlement amounts or terms
• Advises you to stop communicating with creditors
• Touts “new government programs” to erase personal debt

Reputable companies will offer a free consultation, charge fees only on settled debts, and provide realistic assessments of what settlements you can expect. Get promises in writing and read the fine print!

Alternatives to Debt Settlement Companies

Negotiate Yourself

You can negotiate debt settlements yourself directly with creditors. This allows you to avoid settlement fees. Success depends on your negotiation skills and the creditor’s policies.

Inform creditors you’re experiencing financial hardship due to COVID-19 or other circumstances. Ask what options are available, like reduced payments or interest rates. Don’t admit you don’t intend on paying the full balance, as this gives them less incentive to settle.

Non-Profit Credit Counseling

Non-profit credit counseling services charge small monthly fees to act as an intermediary with creditors to reduce interest rates or create debt management plans you can afford. They can be a good alternative to settlement companies.

Be wary of “credit counseling” services that behave more like for-profit settlement companies.

Bankruptcy

Filing for bankruptcy stops collections and can discharge some business debts. However, you’d lose control of the process. An experienced bankruptcy lawyer is best able to advise if this is a good option.

What Debts Should You Target?

All settlement offers depend on the specific creditor. But certain types of debts have higher success rates:

Credit Cards

Credit card companies would rather take a partial payment upfront than nothing at all if you’re headed towards default. They’re often willing to settle for 40-60% of the balance.

Medical Debt

Medical providers also commonly accept discounted lump sums, often 20-50% lower than what’s owed. Some may also have financial assistance programs.

Old Debt

Debt that is older than the statute of limitations in your state (often 3-6 years) can sometimes be settled for 10-30% of the balance. Collectors may prefer a small settlement over nothing.

Be prepared for each creditor to accept different offers based on their internal policies. Don’t assume across the board discounts.

What If Creditors Sue Me First?

It’s possible creditors may file a lawsuit against your business to recoup debts, even as you attempt settlement. This is a last-ditch recourse for them to get paid. If you’re sued, be sure to respond within the required timeframe, either personally or through an attorney. You can still negotiate settlement or payment plans, often for a reduced amount. Ignoring a lawsuit will allow them to obtain a default judgment against you.

The Impact on Your Credit

Debt settlement will negatively impact your credit score. Accounts will likely be closed or charged off. Late payments will show up on your credit report. Your score could drop 100 points or more.

However, creditors will also stop reporting the settled debts. So over time, as long as you avoid new debt, your score can recover. But it may take several years.

The Tax Implications

One hidden consequence of settlement is that forgiven debt is treated as taxable income by the IRS. If a creditor forgives $10,000 of debt, you may owe taxes on that $10,000.

Certain exceptions apply, like if you are insolvent or bankrupt. But make sure to understand the potential tax liability, which could reduce the savings from settlement.

How Much Should You Offer Creditors?

There are no hard rules on exact settlement amounts, since it depends on each creditor. But based on typical accepted offers, aim for:

• Credit cards: 40-60% of balance
• Medical debt: 20-50% of balance
• Old debt: 10-30% of balance

Lowball offers are often rejected while offers too close to the full amount remove creditors’ incentive to settle. Start on the lower end and negotiate up as needed.

Final Tips on Navigating Settlement

If you move forward with settlement, keep these tips in mind:

• Get everything in writing – Verbal promises won’t cut it.
• Send dispute letters – This can freeze collections until settled.
• Keep meticulous records – Track all debts, fees, and settlements.
• Set aside funds for the tax man – He’ll want his cut on forgiven debt.
• Consult a tax pro – They can advise you on reducing tax liability.

Debt settlement is a major decision with consequences. But armed with the right information, you can make the best choice for your business. Wishing you the very best as you chart a path to financial stability.