09 Sep 23

Consolidate Small Business Debt

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Last Updated on: 2nd October 2023, 02:59 pm

Running a small business can be extremely rewarding, but it also comes with financial challenges. One of the most common issues facing small business owners is dealing with debt. As a business grows and takes on more expenses, it’s easy to accumulate debt through business loans, lines of credit, and credit cards. While some debt is normal and even necessary for growth, too much debt can become unmanageable and put the business at risk. If your small business is struggling under the weight of high-interest debt payments across multiple accounts, consolidating and restructuring this debt may help relieve some of the burden.

How Debt Consolidation Works for Small Businesses

Debt consolidation combines multiple debts into one new loan or line of credit, ideally with a lower interest rate. This simplifies the repayment process into a single monthly payment instead of keeping track of many separate accounts. Common ways small businesses can consolidate debt include:

  • Taking out a new small business loan to pay off credit cards and other high-interest debt
  • Using a business cash advance or merchant cash advance to pay off outstanding invoices and loans
  • Getting a small business line of credit and using it to pay off other accounts
  • Refinancing equipment loans or commercial mortgages into a new loan with better terms
  • Using retirement funds to pay off business debt through a 401(k) business loan or ROBS plan

Consolidating through a reputable lender like a bank or credit union can help secure reliable terms and rates for repayment. However, make sure to shop around and compare options, as online lenders and alternative financiers may also offer competitive consolidation loans tailored to small businesses.

Benefits of Debt Consolidation

Restructuring business debt through consolidation can provide several advantages:

  • Lower monthly payments – Consolidating high-interest debts into a new loan with a lower rate can reduce monthly payments and improve cash flow.
  • Simplified repayment – Rather than tracking multiple accounts, you make one payment to one lender, which can simplify bookkeeping.
  • Fixed interest rate – Consolidation loans often have fixed rates, locking in low interest and providing predictability.
  • Improve credit utilization – Paying off credit cards and lines of credit can lower your business’s overall credit utilization ratio and improve its credit score over time.
  • Access cash fast – Options like merchant cash advances provide a lump sum of cash quickly to pay off other debts immediately.
  • Tax benefits – Interest paid on formal business loans is tax deductible, which lowers costs. Interest on credit cards is not deductible.
  • Lower default risk – Consolidating and structuring debts with set repayment terms can help avoid missed payments and default.

Risks and Downsides to Understand

While debt consolidation can provide meaningful benefits, business owners should also weigh the potential downsides before moving forward:

  • Closing accounts – Paying off credit cards or lines of credit closes those accounts, which can temporarily lower your business credit scores.
  • Fees and prepayment penalties – Some lenders charge fees for consolidating debts or penalties for paying accounts off early.
  • Higher total interest costs – If consolidating into a longer-term loan, the total interest paid over the life of the loan may increase.
  • Tax headaches – Consolidating business and personal debts together can create tax issues and loss of deductibility.
  • Collateral requirements – Loans often require fixed business assets like equipment or real estate as collateral, which puts those assets at risk.
  • Balloon payments – Some business loans require large balloon payments after a few years, which can renew problems.
  • Deeper debt – If mismanaged, consolidation loans can dig a deeper debt hole and worsen financial health. Disciplined budgeting is critical.

Consolidating debts is not a magic bullet or cure-all. It also requires adjusting business operations and finances to ensure the root causes of accumulating unsustainable debts are addressed.

Alternative Debt Relief Options

In addition to formal consolidation loans, small businesses can explore other forms of debt relief:

  • Negotiate with creditors – Directly ask lenders to reduce interest rates or minimum payments. Many will negotiate to avoid default.
  • Change payment due dates – Align loan due dates with your cash flow cycle, so payments are manageable each month.
  • Sell assets – Selling unused equipment, vehicles, or other assets can provide a cash infusion to pay down debts.
  • Business bankruptcy – Chapter 7 or Chapter 11 bankruptcy proceedings can eliminate some business debts under court supervision.
  • Debt settlement companies – Hiring a settlement firm to negotiate reducing what you owe is an option. But fees take a chunk of savings.
  • Debt management plan – Nonprofit credit counseling agencies can set up DMPs that consolidate debts into one payment.

The best approach depends on your specific situation. Talk to a business credit counselor or advisor to review all consolidation and relief options.

Steps to Consolidate Small Business Debt the Right Way

If you determine consolidating your business’s debts could be beneficial, follow these steps to improve the chances it succeeds:

1. Review debts and cash flow

  • List all business debts and key terms – interest rates, monthly payments, balances owed.
  • Analyze revenue and expenses to understand your cash flow cycle.
  • Identify debts that are unaffordable or have highest interest rates to target first.

2. Check credit score and report

  • Obtain your business credit reports from Experian, Equifax, etc to check for errors.
  • Know your business credit scores when approaching lenders to qualify for the best rates.

3. Research lenders and loan options

  • Compare offerings from multiple banks, credit unions, online lenders, and alternative financiers.
  • Consider the types of consolidation loans that best fit your situation.
  • Vet lender reputations carefully and read all terms closely.

4. Apply and obtain new consolidation loan

  • Once approved, close on the new consolidation loan and pay off old debts immediately.
  • Try to avoid accruing new debts on old accounts in the process.

5. Adjust business finances

  • With consolidated repayment in place, realign budget, improve cash flow, and build savings.
  • Avoid practices that led to growing unsustainable debt levels in the first place.

6. Monitor credit and maintain good standing

  • Check credit reports regularly and continue making on-time consolidated loan payments.
  • Over time, reducing debts and showing responsible behavior will improve credit health.