How Does Business Debt Consolidation Work?

Companies can get into financial trouble if they have too much debt. All too often, they also have too much of the wrong kind of debt.

This creates a situation that is financially unsustainable. Debt payments take a substantial portion of revenues. Therefore, the business cannot keep up with payroll, supplier payments, and other important expenses. Ultimately, the situation gets out of control and the small business goes into a financial tailspin.

This situation can often be prevented by consolidating your debts. Debt consolidation helps companies that have a good business model but are saddled with “too much of the wrong kind of debt“.

What is debt consolidation?

Debt consolidation combines existing loans and cash advances that have unfavorable terms and refinances them with a single loan with better terms. The new loan is designed to improve the company’s cash flow.

The objective of the loan is to leave the company in a better financial position and able to service debt payments. The new loan also frees cash flow, enabling your business to take on new opportunities.

Is debt consolidation right for your business?

Determining if debt consolidation may help your business requires a careful assessment. However, you can get a good idea if it can help by asking yourself these three questions:

1. Are debt payments taking most (or all) of your available cash flow?

Spending most of your available funds on debt payments is not healthy for the business. It indicates that there is either a problem with the loans – or with the business itself. If the loans are the problem, debt consolidation may help. Your loans may be the problem if you have:

  • Loans with high interest rates
  • Multiple cash advances
  • Short-term loans (in some cases)
  • Loans with a balloon payment

2. Are your interest rates exorbitantly high?

Some forms of financing, like cash advances, have very high interest rates. These can hurt your business due to their cost. Even if you can afford high rates, they ultimately come out of your profits. If your interest rates are well above market rates, examine if a consolidation solution can lower your costs.

3. You juggle supplier payment or delay payroll due to lack of funds?

Juggling expenses due to lack of funds may be an indicator that you should consider loan consolidation. However, it could also indicate other problems completely unrelated to debt load.

If your funds are low because you are spending too much on debt payments – debt consolidation may work. If funds are low for any other reason, such as slow-paying clients, consider factoring your receivables.

4. Are your monthly debt payments preventing you from buying equipment?

This is can be an issue among companies that have a high cost of debt. The cost of existing loan payments prevents your company from buying new equipment (or other assets). Consequently, operations are affected negatively. A consolidation loan can also be used to buy new equipment, if the equipment is bought while consolidating your other loans. Actually, many lenders prefer this scenario because it strengthens the collateral base.

Transaction goals

Debt consolidation transactions usually aim to achieve at least two of the three following goals:

  1. Reduce monthly payments
  2. Reduce interest rates
  3. Extend payment term

Reducing monthly payments is the most important goal for most companies. This is accomplished by providing a new loan with longer terms, a lower interest rate – or both.

Lowering your monthly payments relieves financial pressure. It improves the company’s financial position providing stability and a platform for growth.

Typical profile of a small business client

Small businesses that need debt consolidation have some common characteristics. The most obvious one is cash flow problems. They have cash flow problems because their debt payments are too high.

However, these businesses also share similarities in their debt profiles.  They usually have some of these types of financing:

1. Inadequate term loans

Companies that need consolidation often have term loans that are not well suited for them. Either their term is too short, the rate is not sustainable – or both.

In some cases, loans are for a short term and have a balloon payment at the end. These loans can be hard to manage since they require you to come up large payment at the end of the term. If the company is not able to pay the balloon, it must refinance the loan.

2. Cash advances (MCAs)

Cash advances, also known as merchant cash advances, are term loan products that have gained popularity in recent years. They are very easy to get but often come with high rates and short terms. This combination of features makes them very dangerous if used incorrectly.

Unfortunately, companies that get into trouble due to their first cash advance, often get a new cash advance to pay the old one. This is called “stacking”. Stacking cash advances always is a bad idea. It seldom works as intended. Instead, it leads to getting more cash advances, more debt, and further stacking.

Companies with stacked cash advances usually enter a financial tail spin. If the situation is not corrected promptly, the company will soon become insolvent. Unable to pay their vendors, they are forced to close their doors.

3. Equipment loans

These loans are used specifically to buy equipment for the company. There is nothing wrong with these products. However, some companies have multiple equipment loans with disparate terms and rates. If the market rates are better, it may help your company if you consolidate them. However, this advantage varies depending on the collateral backing the loan among other things.

4. Shareholder loans

Lastly, some companies also have shareholder loans as part of their financing mix.Some have very good terms, while others are very expensive. Loans that have a long enough track record can be taken out by the consolidation loan.

Advantages of debt consolidation

Consolidating business debt can have a number of advantages. When executed correctly, a debt consolidation package will improve your company’s financial situation. It provides your company with a sustainable debt payment. This is the most important advantage of debt consolidation.

Managing your debt payment will be simpler since you have a single lender. You will also be able to focus your efforts at growing your business, rather than managing lender payments. Lastly, your new loan may have a better rate or terms (or both) than your previous financing.

Disadvantages of corporate debt consolidation

However, debt consolidation loans are not meant to help everyone. These loans can fix bad financing decisions. However, debt consolidation cannot fix a bad business model.

The biggest risk of using debt consolidation is applying it to a business that cannot be saved. This may extend the apparent life of the company. However, in the end, you will have a worse problem in your hands.

Another disadvantage can surface is you are consolidating equipment loans. Often, consolidation loans have longer terms than regular equipment loans. You must be careful about refinancing equipment past its usable life.

How is a transaction structured?

Our preferred structure is to use two financing tiers: the consolidation tier and the growth tier.

Consolidation tier

The debt consolidation component is  straight forward. The finance company merges all your current loans facilities into a single loan with a lower payment. Additionally, any new assets/equipment that you purchase at the time of consolidation are covered by this loan.

The new loan should also improve cash flow, which strengthens operations. However, the new cash flow availability may not be enough to handle any substantial future growth. This is not uncommon. To help with this, many packages also include a growth tier.

Growth tier

Were applicable, the lender can also issue a cash flow financing solution as well. The goal of this financing tier is to provide a cash flow vehicle to support future growth. Most transactions use one of the following solutions:

1. Accounts receivable financing

Also known as factoring, receivables financing helps you to improve your cash flow. It works by financing slow-paying receivables (net 30 to net 60) from credit worthy clients. This enhances your cash flow and ensures you can keep up with growing sales. To learn more, please read “What is factoring” and “How does factoring work?

2. Asset-based financing

Asset-based financing can help improve the cash flow in companies that have a more complex asset base. It can be used to finance receivables (like accounts receivable factoring) and inventory. This solution is better suited for companies that have a finance/accounting department.

Qualification criteria

We can work with companies that have:

  1. At least $500,000 in debt
  2. Been a minimum of 3 years in business
  3. Equipment and/or real estate
  4. Up to date taxes (or a payment plan in place)

Looking for business debt consolidation?

For information about our business debt consolidation program please fill out this form – a specialized agent will contact you.