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The Ugly Truth About Business Debt and How to Fix It

Business Finance

The Ugly Truth About Business Debt and How to Fix It

Updated: March 27th, 2020

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Taking on debt is part of running a business. Unless you have considerable savings or support from investors, you’ll likely need financing to help with at least one area of your business, whether it’s getting started, expanding, or covering short-term operational costs. 

However, like most tools, debt can both solve problems and create them; it all depends on how you use it. 

Let’s go over some of the advantages and disadvantages of taking on debt, along with solutions for getting out of business debt if you’re feeling buried. 

What are the benefits of business debt? 

Paying off your debt on time helps improve your business credit score. With more substantial business credit, you’re more likely to get approved for future financing and receive lower interest rates.

Plus, though it may seem counterintuitive, taking on business debt can give you more financial freedom. Here are three advantages of debt. 

1. More working capital

Financing gives you easier access to working capital for a variety of needs, including buying fast-moving inventory or covering payroll, said Christina Sjahli, a CPA and the owner of Christina Sjahli Consulting. Not only that, but short-term debt also helps relieve cash flow pressure, she added. 

When you don’t have to balance incoming payments with outgoing payments, Sjahli said, you can be more selective with your clientele and avoid taking on challenging work. 

2. Better growth potential

Here’s another piece of business debt advice: Taking on debt gives you more opportunities and financing to grow your business. “When a business needs to scale, depending on the type of business, it may require you to purchase capital equipment, purchase a warehouse, expand to an international market, or acquire another business,” Sjahli said. 

Having the financing to make these large-scale purchases or embark on growth projects is vital. Plus, you can use these projects to increase your revenue or sales, said Logan Allec, a CPA and the owner of the personal finance blog, Money Done Right

“If you are using debt to generate positive cash flow greater than the payments toward the debt,” he said, “then you are making money from the debt.”

3. More help getting through difficult periods

“If you are having issues with the business in general, and need some extra funding to keep your business running,” Allec said, “then taking on debt can be beneficial.”

Unless you want to rely on your savings, it’s wise to have a cash cushion to get through slow periods, personnel losses, crises, and other economic hardships.

“You just want to ensure you have a plan to use the debt effectively,” Allec said, as well as pay it back on time. That means figuring out how you can spend the money to set yourself up for success. Beyond strategizing about growth opportunities, it’s also a good idea to reexamine your budget and look for any money leaks in the business. 

The drawbacks of debt

Just as debt can propel your business forward, it can also set it back. If you’re not smart about managing your debt and are unsure of how to get out of business debt when necessary, it has the potential to overwhelm you and put your business in a worrisome financial position. Here are three ways debt can be harmful. 

1. Getting out of business debt is hard when you take on more than you can handle 

Debt is only helpful if you make responsible repayments. “As a business owner, you need to know how to budget your cash flow correctly so you don’t need to take on more debt than you can handle,” Allec said. 

When you’re overwhelmed or under-prepared, you might miss loan payments or possibly pay only your minimum amount. As a result, you can rack up even more debt in interest fees. 

If you fail to plan and budget, Sjahli said, you could default on your loan, ruin your credit score, or even put the business at risk of closing. That’s why it’s critical to consider why you need business debt before you take it on, she added. “Too many business owners think of debt as a quick solution for cash flow issues, without understanding why cash flow issues happen in the first place,” Sjahli said. 

In addition to hiring a CPA to help you budget, Allec also recommended consulting an attorney for business debt advice, among other things. They can help review your loan documents and make sure you know what’s in store in terms of fees and payment timelines. 

2. You make hasty business decisions

“A quick cash infusion can lead to poor business decisions,” Allec said. “When times are tight, business owners tend to be a bit more conscious of where the money’s going. However, a business owner flush with cash from a lender may not be so fastidious when it comes to making sure every dollar is put to its highest and best use,” he said. 

If you don’t put your debt toward a promising growth initiative, you might find yourself with new payments but no business progress. So, instead of letting your loan money sit there, use it to generate more revenue by investing in a popular marketing method or buying new equipment, for example. 

3. You fall into a business debt spiral

Ideally, taking on debt should give you more freedom to grow and increase your profits. But, sometimes, it just triggers a bad pattern that makes getting out of business debt nearly impossible. Rather than using one source of debt to grow your business, you might simply find yourself with another problem where you resort to applying for another loan. 

“It really can become a vicious cycle where a business owner goes from expensive financial product (such as an MCA) to expensive financial product just to stay afloat,” Allec said, “but they can’t truly focus and increase profitability in their business to escape these debts because the debts themselves are such a huge weight.”

Types of business debt solutions: What’s the difference between consolidating debt and refinancing debt?

If you’re in over your head and are trying to figure out how to get out of business debt, there are several steps you can take to alleviate the pressure. Debt restructuring, debt refinancing, and debt consolidation are all options for reorganizing your debt, so it’s more manageable. Keep reading to learn how each business debt solution compares. 

Debt restructuring

“In most cases, debt restructuring is used to avoid bankruptcy,” Sjahli said. There are a couple of ways restructuring works, she said: 1) Creditors can scrap some or all of your debt in exchange for equity in your company or 2) You can convert your old debt into new debt. 

If you choose the second option as a business debt solution, Sjahli said, “Normally, the lender delays the interest payment or extends the debt repayment into the longer term.”

Debt refinancing

Refinancing your debt involves paying off and replacing one or more loans with a new loan that has more favorable terms. Most business owners choose to refinance their debt if they have an opportunity to get approved for a better interest rate. 

In addition to a different principal amount, Sjahli said, the new debt usually has a different interest rate, which could be lower or merely a change from a variable-rate to a fixed one. There’s also a chance the new loan could have a longer repayment timeline, she added. 

Debt consolidation

Debt consolidation, Sjahli said, is when “several debts — possibly with different lenders, different interest rates, and multiple monthly payments — are combined into one large debt with one interest rate and one monthly payment.”

Most business owners choose to consolidate their business debt as a solution because they want to streamline their monthly payments. Consolidating your debt may result in a better interest rate, but it’s not a guarantee. 

Why should you consider restructuring your business debt as a solution?

If your debt has become unmanageable, then taking strides to change it and considering ways of getting out of business debt can be helpful. Depending on the route you choose to make, you could receive better loan terms and enjoy the increased cash flow. Another bonus: more time — “time to remediate current business issues or get into a better financial position,” Sjahli said. 

The psychological benefits of reorganizing your debt and exploring business debt solutions are also significant, said Allec. “I’ve seen firsthand how the burden of high-interest debt weighs down on business owners. Crushing debt is a constant worry, causing unnecessary stress and distracting business owners from focusing on how to grow their business.” By streamlining your payments or changing your loan terms, you’ll have more time and mental clarity to focus on your business to-do list and goals. 

3 steps to take to get out of your business debt

There are many reasons to consider restructuring, refinancing, or consolidating your debt. The stress of multiple payments might be too overwhelming, for example, or you may want to try for a lower interest rate. At an extreme, you might find yourself unable to maintain regular operations because of the burden of debt. 

If you’re interested in consolidating or refinancing your debt, it’s critical to get prepared first. Here are three pieces of business debt advice to follow. 

1. Review your current debt

Before you decide to reorganize your debt, it’s crucial to look at how much debt you have and calculate how much time it’ll take you to pay off, Allec said. Crunching the numbers will give you a better idea of what’s possible and realistic for you when it comes to getting out of business debt.  

“[Business owners] also need to look at their monthly or even bi-weekly cash flow to see how much they could put toward their debt without feeling like they’re drowning,” Allec said. “In other words, they need a target to shoot for.”

It’s important to review your long-term business plan, assess current and future market conditions, and re-evaluate your current business processes to gauge where you’re at, Sjahli said. “If a business owner believes the business has no ability to pay for the debt on time while continuing to operate and generate positive cash flow,” she said, “then a business owner should approach the lender and ask for debt restructuring.” 

2. Evaluate the reasons for your debt issues

Once you have a better understanding of your current debt situation, the next step in how to get out of business debt is to address the root of the issue. What factors led to your desire to restructure in the first place? “Is it an operational issue, is it market conditions, or simply a cash flow management issue?” said Sjahli. 

Figuring out why you want or need to fix your debt is key to ensuring you make a smart, sustainable choice for your business. Maybe you need to streamline tasks to better manage your workload, for example. Or, perhaps you’ve recently boosted your business credit score and want to try for a lower interest rate on a new loan. 

Whatever the reason, it’s essential to do a long-term forecasting plan, Sjahli said. Consult your accountant and look over your profit and loss statement, cash flow statement, balance sheet, and sales forecasts for the next year. You need to ensure your business has enough income and predicted sales to support new debt and make timely payments. 

3. Do your research into debt solutions and their impact on your business

How you reorganize your debt depends on your business’s current finances, loans, and loan terms, as well as your stress levels. 

Sjahli said it’s crucial to understand the overall impact refinancing and consolidating will have on your business, both financially and otherwise. “Run the cost-benefit analysis for each scenario and determine the impact of each one on the business,” said Sjahli. 

Make sure you meet with your accountant to review your options, then choose the option that 1) yields the best results for your business, and 2) feels manageable for you. 

Reduce your burden and get out of business debt

Ready to reorganize your debt? Consider a consolidation or refinancing loan with Funding Circle. You can apply in just minutes and receive a response in as little as 24 hours. See our rates or learn how we compare to other lenders. 

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