How to Settle Business Debt, Step by Step

Settling business debt, also called debt negotiation, is the process of resolving business debts for a fraction of what you owe. The process usually begins with an analysis of debts and cash flow to identify opportunities to offer creditors a lower payment. Negotiation with creditors is always part of this effort. In exchange for the creditor accepting your terms, you should also negotiate a form of “release” from future liability on the debts in question. It is very important to negotiate the terms of your resolution in writing prior to making any payments. Paying debts that have been negotiated down is usually achieved over a period of 6 to 24 months.

Accepting less than is due on business debts is, understandably, not something most creditors want to do. Knowing a business is struggling financially raises concerns that the creditor will have to write the debt off and declare it a loss. Therefore, to increase the potential for repayment of business debts, creditors will frequently agree to take less than the original balance.

Business debt that can be settled encompasses most unsecured or lightly secured debts. Merchant cash advances, business credit cards, lines of credit, and online loans from commercial lenders are all examples of what you may be able to settle. Vendor balances and sometimes equipment leases can also be settled. It’s important to note that settling debts is different from restructuring debts or consolidating them. When you settle debts, you agree to pay less than the original balance. When debts are restructured or consolidated, it means taking on new loans or agreements for the full original balance of what is owed.

Negotiating a Settlement

Start by laying out every debt your business owes: the creditor, the balance, the terms of the contract, and whether you’ve personally guaranteed that debt, plus any UCC liens. Are you being sued? Has a judgment already been granted? These details all need to be gathered for every creditor you plan to negotiate with. Also get a sense of your cash flow, what your business can pay and how fast, before any offer.

The second step in the process is to fund the offers you’ll be making to your creditors, which must still enable you to cover payroll, rent, inventory and taxes. For this, you need a lump sum, or at least cash available to make payments over several months. Often, it comes from the cash you’re no longer using to meet daily or weekly debt payments.

The third step is contacting your creditors. As you do so, make it clear that they should communicate with an assigned representative. Begin the process with the creditor who represents the greatest risk: for example, a funder who has threatened to sue or who could pull payments from your bank account.

When negotiating a settlement with creditors, don’t forget to include terms that define not just the settlement balance, but also the exact payment schedule; any release of a personal guarantee when the payment is complete; dismissal of a pending lawsuit; terms for the deadline to file UCC-3 that terminates its lien; and how the account will be reported to business credit bureaus.

Never pay on a verbal promise. Pay exactly as agreed, keeping proof of each payment. After the final payment, get a ”paid-in-full” or release letter; confirm a UCC-3 termination of lien was filed.

If you use a settlement firm, be wary of promises to cut debt by a certain percentage. Costs vary widely, and a settlement firm’s fee may be calculated on the debt enrolled or on the amount saved, so make sure to get fees in writing and understand when they will be charged. One possible consideration: for consumer debt only (not business debt), it is not legal for a company to charge a fee before settling a debt.

The Tax Bite That Forgiven Debt Imposes

Beware the surprise cost of taxes owed on the forgiven debt. In the eyes of the IRS, that forgiven amount is income and may be taxable. Even if you never receive a Form 1099-C, you must report the forgiven debt on your next tax return as income. Sole proprietors would typically use Schedule C, E or F to report a debt forgiveness.

There is an exception, the so-called insolvency exception. If you were insolvent just before the cancellation, the forgiven debt would not be income to you to the extent your liabilities exceeded the fair market value of your assets just before cancellation. You can claim this exception on IRS Form 982. Talk to a tax professional before you settle.

Tax debts are different. If the IRS is after you for unpaid payroll withholding, the ”trust fund recovery penalty” can make the person responsible, if they willfully failed to pay, personally liable for 100% of the unpaid trust fund tax plus interest. The IRS has an ”offer in compromise” process with a $205 application fee that is not refunded if the offer is rejected. To pay in a lump sum, you must include 20% of your offer with your application. The IRS will generally reject any offer if you can pay the amount owed in full through an installment agreement or asset equity.

COVID-related loans made under the Economic Injury Disaster Loan program are not forgivable like the PPP loans were. The Small Business Administration (SBA) considers an “offer in compromise,” essentially reducing the debt, only after all collateral has been liquidated. There is a six-month ”hardship option” that halves your payments. But you can use it only once every five years. You can’t be more than 90 days past due. And you must still be operating. Once an SBA loan has been referred to Treasury Cross-Servicing, deal with the Treasury, not the SBA.

Risks

A settlement carries risks: A creditor can sue during negotiations, especially if you’ve stopped paying. And it can come after you personally if you’ve guaranteed the debt. So it’s crucial to get the guarantee released. At some point during the negotiation, your business credit can be affected, and your personal credit, if any debt was guaranteed. Some creditors refuse settlement, demanding almost the full amount. None of these risks is a reason to avoid settling. Instead, go in with a plan, not on your own after the first missed payment. Most businesses that settle keep operating.

Settling your business debt is usually worth considering when your business is viable, but its debt payments are more than you can sustain. Merchant cash advance loans that take a daily or weekly payment can be crippling. Settlement is a likely option if you’re behind, or soon will be, and you have no refinancing available. Settlement makes less sense if you can refinance, or a short-term crunch can be fixed by deferral, or your business is not viable.

If you choose a third-party to negotiate settlements for you, watch for these red flags: Guaranteed results are not something a reputable company promises in this field, because every creditor is different. You should be skeptical of anyone who pressures you to sign a contract today. A refusal to explain how to build the fund for paying settlements, or a refusal to explain how and when their fees will be paid, should be a warning sign.