Not all business debt is bad. It can be the deciding factor that makes or breaks a company’s ability to survive. A business owner’s understanding of when and how much to borrow can be a critical ingredient in the recipe for success.
Data from the Small Business Administration (SBA) shows that around 50% of businesses fail in the first 5 years after their establishment. One of the largest contributing factors, they say, is taking too on much business debt.
Types of Business Debt
Business debt comes in many varieties, most of which are loans designed specifically for small & large corporations.
- SBA Loans. The SBA provides loans to businesses for general use, disasters, real estate and equipment. These loans have some of the lowest interest rates of any type of business debt. The most popular SBA loans are SBA 7(a) loans, SBA 504/CDC Loans, and SBA Microloans.
- Term Loans. Business loan from a bank. Since leading banks deny nearly 75% of loan applications from small businesses, these loans are usually not the best option for companies that aren’t already an established, successful, and looking for room to grow. These type of loans have lower interest rates on average but also take much longer to secure, making it an unideal solution for businesses in need of quick capital.
- Invoice Factoring (Invoice Financing). Cash advance loans to pay for unpaid invoices. These types of loans are easy to secure as they often only require an unpaid invoice. The lender advances a portion of the total invoice & pays out the rest, short any lending fees, once the customer has paid. Invoice factoring can be a great way to cover building costs, employee pay, and other functioning expenses when a business has issues with the timing of their cash flow.
- Equipment Loans. Advancement loan to buy vehicles or equipment for a business. The real advantage with this type of debt is that the loan is backed by the equipment itself which is used as collateral. Equipment loans have decent interest rates that typically range between 5-30%.
- Merchant Cash Advances (MCA). With this type of business debt, lenders advance a portion of a company’s daily credit card sales in exchange for a portion of their future sales. The loan is paid back in 1 of 2 ways: weekly, fixed payments over time where the amount is based on the lender’s risk, or a % of the future credit card profits are used to repay the debt. The real downside is that merchant cash advances can have annual interest rates that exceed 100%.
- Business Line of Credit (Business Credit Cards). A line of credit for a business is a flexible, typically unsecured loan that can be difficult to secure because of the revenue and credit score requirements. The most common form of this debt is a business credit card. These cards may carry supplemental fees & maintenance costs but can also have worthwhile rewards that range from cash back to 0% introductory interest rates.
Business Debt Benefits
As a business owner, your relationship with debt does not have to be a bad one. There are many advantages that business debt offers such as:
- Opportunity to improve business credit. With nearly every type of loan or debt, comes the chance to improve credit score. When payments are made on time, debt can help a business establish a steady credit history & improve their chances of being approved to borrow more in the future.
- Fuels expansion. Business debt can be great for a company looking to grow, but the rewards must always be assessed with the risks in mind.
- Helps manage seasonal fluctuations. For companies that have an inconsistent flow of revenue throughout the year, a business loan can help bridge the difference in operational costs & seasonal revenue.
Safe Level of Business Debt
When considering a business loan, it can be difficult to determine what a “safe” level of debt may be to take on, but there are a few parameters to follow when calculating the risks involved. The following ratios offer a rough guideline for what many experts consider to be too much business debt for the average corporation.
- 25x Coverage Ratio. A business should maintain a minimum of 25% more cash flow than their fixed charges including leases, interest from loans, and other fixed forms of debt.
- Less than 2x Debt to Equity Ratio. Businesses that have debt that is less than 2x their total equity are considered to be much less risky for lenders.
- Less than 1x Working Capital Ratio. A business should have a larger volume of working capital than it does interim debts. The ratio of working capital to short-term debt should be less than 1:1.
Options for Business Debt Relief
Business Debt Consolidation is a loan that combines multiple debts into a single, monthly payment that has usually has a much lower interest rate. This form of debt relief is more difficult to qualify for than other loans and can put a businesses’ assets at risk as they are often required as collateral.
Business Debt Settlement is the process of negotiation with creditors to reduce the total level of debt, interest rates, or minimum monthly payments. Settlement can be done by business owners themselves or by a debt settlement company on their behalf. This is a common form of business debt relief that relies on factors such as: the type of business seeking the loan, total equity of business assets, size of debt owed, and sometimes even the value of personal assets.
Bankruptcy can be a viable option for business debt relief, but it comes with many strings attached. The two main forms of bankruptcy available to small business owners are Chapter 11 and Chapter 7 bankruptcy. Both allow businesses to arrange more favorable terms for their credit card debt and other unsecured loans.
Business Restructuring involves a complete rehaul of a company’s finances to create a quick flow of cash without the need for a loan. This form of debt relief involves substantial modification of the overall debt, framework, or operational costs of a company. Restructuring a business can mean downsizing the number of employees, selling off assets, or creating an opportunity to pay off debts from bondholders.
Conquer Your Business Debt Today
There are close to 20 different types of debt that a business can take on & which one is right for your company depends on your credit score, amount of revenue generated, time since the business was established, and what the capital is going to be used for. When taking all of these factors into consideration, there are often a handful of business loans that would work for your corporation’s financial situation & quite a few options for relieving that debt., should it become overwhelming.
If you do find yourself in need of a company to help with business debt relief, check out our company reviews to get an idea of where to start looking for help.Get Help Now