Should your Company Refinance its Business Loans?

This article is written for business owners that are trying to figure out if debt refinancing is the right solution for them. The article covers:

  1. A simple way to determine if you need refinancing
  2. Pros and cons of refinancing
  3. Types of debt that can be refinanced
  4. How to get the loan
  5. Qualification criteria

Do you need refinancing?

A thorough review of your financial statements is the best way to determine if your company has a debt problem. However, you can also start by asking yourself five simple questions. If you answer ‘yes’ to any question, there is a chance that you could benefit from refinancing you debt. If this is the case, consider doing a more in depth review.

1. Are loan payments taking up your available revenues?

The most common symptom that a company has a debt problem is spending most of their available cash on loan payments. This is an unhealthy situation for the company. It’s often not sustainable and can lead to serious financial problems.

If you handle your company’s cash inflows and outflows, you already have a good idea of where the money is going. Consequently, you should know if you are spending most of your cash paying for debt. To be certain, though,  it’s best to review your financial statements. They will tell you for certain if this is the case.

2. Are you juggling debt or supplier payments?

Another sign of financial problems is juggling supplier and debt payments. If you have to juggle any of these payments, your company definitely has a cash flow problem.

Not all cash flow problems come from debt payments though. They can come from slow client payments, or from other sources as well. However, if you are juggling payments, you should consider a more careful review of your situation.  For more information, read “Cash flow problems and solutions“.

3. Do you have a (very) high interest rate?

You may want to consider refinancing your debt if the interest rate is too high, compared to the market. However, just having a “high” interest rate isn’t always a reason to refinance. This is because the concept of a “high interest” can be a matter of perception.

Instead, examine the potential savings of having a new loan. Consider that you will also have to pay closing costs and other fees. Once you have all the numbers, decide if refinancing is a good idea.

4. Do you have “too many” cash advances?

Cash advances, often called Merchant Cash Advances, provide fast – but expensive – financing. They are easy to get and often require minimal documentation. However, they often come with a very high interest rate and a short payment term.

The problem with cash advances is that business owners don’t use them correctly. The apply them to situations that can’t be solved with a cash advance. This creates further problems.

Things get worse if the business owner gets a new cash advance to pay the first one. This situation can worsen as owners keep getting a new advance in order to pay previous ones.

Having multiple cash advances is called ‘stacking‘ and is very dangerous. Stacking cash advances creates serious problems and often leads to business failure.

Refinancing this expensive debt by consolidating in with a single cheaper loan may solve this problem. If the situation is serious, examine it with a CPA or financial professional.

5. Are you unable to buy new equipment?

There are times when the company can’t buy new equipment because existing debt doesn’t allow it. If the new equipment is indispensable, consider refinancing your old debt.

This provides you with a new loan for the value of the new equipment plus the value of the old debt. The old debt is retired, and your company keeps the new loan.

Pros and cons of refinancing

Like every business alternative, refinancing has advantages and disadvantages. In this section we examine both. Let’s start by reviewing the advantages.

a) Smaller monthly payments

Loans are usually refinanced so that the monthly payment is lower. This relieves financial stress and frees up cash flow. It is done by extending the term and/or lowering the interest rate.

b) Better cash flow

The impact of the lower debt payment can be substantial. It improves your monthly cash flow and enables you to operate your business more effectively.

c) Allows you to focus on growth

Companies that struggle with debt payments focus only on survival. Once the debt situation is handled, you can focus your resources on growing the business.

d) Can be structured for growth

Most companies refinance their debt to improve their cash flow. They expect that the incremental cash they get by reducing debt payments will be enough to sustain growth. Sometimes, this is not enough though and you need more funds.

If the incremental gains are not sufficient, consider adding a cash flow line of financing. This can be accomplished for business-to-business companies only if the lines are combined as part of the initial structure. Providing this requires a certain level of expertise by your lender.

e) Easy payment management

Payment simplicity is an advantage that often is overlooked by owners. Managing a single debt payment is easier than managing multiple payments. This benefit applies only to companies that are consolidating and refinancing multiple loans into a single one.

f) Available to small businesses

This solution is available to small business. Many lenders can work with companies that have as little as $500,000 in debt and three years of business operations experience.

Now that we have covered the advantages, let’s turn our focus to the disadvantages. The most important disadvantages are:

a) Longer debt terms

Your monthly payments will be lower, but you will be making them for a longer time. Over the term of the loan, you will usually have to pay more that with your previous loans. This is an important trade off that you have to take into consideration.

b) Requires discipline

Companies usually get refinancing to solve financial problems. That is one of the main benefits of this solution. However, you must maintain discipline to ensure these problems don’t happen again. Getting a second refinancing loan may not be an option.

c) May not solve your problem

Refinancing can solve previous bad financial decisions. However, it will not fix a broken business model. Before getting new financing, examine your business to determine the root cause of the problems.

Consolidation vs refinancing

Most business owners use the terms ‘debt consolidation’ and ‘debt refinancing’ interchangeable. They are similar – but not the same. This difference will be important when you speak to potential lenders.

Debt refinancing is when you replace one loan with another one. Debt consolidation is when you replace a group of loans with a single loan.

What type of debt can be refinanced?

In principle, you can refinance any type of conventional business debt. Here are the most common types of loans that can be refinanced:

1. Term loans

Term loans are usually refinanced because they are no longer helping the business. For example, the term length or interest rate may no longer match your needs. Also, many loans that have a “balloon payment” provision. These loans can be challenging because few companies have the resources to make the balloon payment at the end of the term. If this is the case, the loan must be refinanced.

2. Merchant cash advances

As mentioned before, cash advances often have short terms at high rates. This can be a dangerous combination if not managed properly. Furthermore, the situation can become serious if the business has more than one cash advance. Cash advances are commonly refinanced through debt consolidation. This provides for a lower payment and more affordable terms.

3. Equipment loans

Some businesses have many equipment loans. Each loan has their own rate and terms. In some cases you can consolidate them into a single loan that has easier payment terms.

4. Shareholder loans (some)

Shareholder loans can be very helpful under the right circumstances. However, they can also outlive their usefulness. Properly executed and maintained shareholder loans can be refinanced with a better suited option.

How do you get a refinancing loan?

Refinancing a loan is relatively simple, but requires some work. Here is a summary of the steps to get the loan:

1. Initial loan consultation

The first step is to have an initial consultation with the lender. This helps determine if the lender and their offer is a good match to your situation.

2. Gather documents

The next step is to gather the needed information. Every lender requires that you provide information so they can examine your business. You will often need to provide:

  • Personal tax returns
  • Personal financial statement
  • Business tax returns
  • Business financial statements
  • Business debt schedule
  • Projection of future sales (sometimes)
  • Payment history for loans being refinanced

Learn more about how to get a refinancing loan.

What are the qualification requirements?

To apply for a refinance loan, your company must have:

  • A minimum of $500,000 in debt
  • Three years of operational history
  • Equipment and/or real estate
  • Up-to-date taxes (or a payment plan)

Additionally, the owners:

  • Must have reasonable credit
  • Must be up to date on taxes (or have a payment plan)
  • Can’t have defaulted on a federal loan

And the company:

  • Must be up to date on taxes (or have a payment plan)
  • Must be profitable (or have solid comeback plan)
  • Can’t have defaulted on a federal loan

Learn more about the requirements for a refinancing loan.

Is refinancing the right choice for your company?

There are some situations were the benefits of refinancing your debt are clear cut. An obvious example is a company with a heavy debt burden imposed by multiple cash advances. In this case, consolidating the debt is usually the right choice.

But how do you handle situations were the benefits are not so clear cut? Frankly, the only way to manage this scenario is to do a careful financial analysis.

Examine your financial statements and determine the impact of existing debt in your business. Run a forecast to establish the effect of the new debt load in your business. Lastly, decide if the company is better off.  Ask the question – will the new debt support future growth?

If you are ever in doubt, a good alternative is to consult a CPA with experience in business financing. They should be able to give you the best advice on how to proceed.

Need to refinance business debt?

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