If you’re juggling business debt you probably wish there were a simpler way. What if you could consolidate your small business debt into one affordable payment? That’s business debt consolidation in a nutshell.
Finding the right debt consolidation strategy and loan option can be confusing though, so we’ll break it down in detail here.
What is Business Debt Consolidation?
With business debt consolidation, you get new financing to pay off existing loans. The ideal debt consolidation loan will give you one lower monthly payment at a lower interest rate. It isn’t always possible to achieve the ideal scenario, though, so identify which of these goals is your top priority:
Debt consolidation is also sometimes used to describe debt workouts for businesses in severe financial distress. We’ll cover that later, but for the moment we’ll focus on lending strategies.
Debt Consolidation Basics
Because debt consolidation involves trading one debt for another, it’s important to really understand whether it makes sense for your business. Start by taking an inventory of your current debts:
- Outstanding loan balances
- Payment amounts
- Repayment periods of current loans
- Annual percentage rates or factor rates
You’ll want this information handy both for the application process, and to compare your current loans to the terms of any loans you’re considering consolidating.
With certain types of business financing, especially merchant cash advances, the cost of financing is built into the amount of the advance. If you then refinance the balance with other financing, you’re in effect paying interest on interest, which can make it more expensive. That doesn’t mean it’s a bad move, but you do need to understand the financial implications.
Develop a Debt Consolidation Strategy
It’s not always possible to get a loan that offers a lower payment at a better interest rate, so think about which of these goals is your top priority:
- Lower payments.
If high payments are cutting into your cash flow, you may want to see if you qualify for longer term consolidation programs to lower the amount of your periodic payment.
- Less frequent payments.
If you have loans or advances with daily or weekly payments, that frequency may also put a strain on your cash flow. A consolidation loan with monthly payments may be easier to manage.
- Lower interest rates.
While better rates should always be a goal, keep in mind that the cost of small business financing isn’t always expressed as an interest rate. It may be expressed as a “factor rate,” “fee” or in some other form that makes it difficult to compare to other financing. If your financing is high cost, you may want to try to reduce it with a lower interest loan.
Sometimes you do get the trifecta of the perfect consolidation loan that offers all three benefits—lower rates, more affordable payments, and monthly payments—but not always. For example, you may lower your payments but stretch out your debt, and that may cost you more over the long run. Or you may wind up with a higher interest rate but more affordable payments. However, it helps to keep your main goals in mind as you explore your options.
Small Business Debt Consolidation Pros & Cons
As with any type of financing, there are pros and cons. Here are a few you’ll want to keep in mind:
- Reduce multiple loan payments into a single payment
- Simplify budgeting and bookkeeping
- Save money with lower interest rates
- New financing may cost more
- May pay interest on interest
- New UCC filing may appear on business credit reports
Business Debt Consolidation Loan: What are my Loan Options?
Small business financing options may include lines of credit, term loans, cash advances, accounts receivable financing and more. (Cash advances are a type of short-term financing that usually requires weekly or daily payments.)
All of these types of financing have their pros and cons. But what’s important to understand here is that the lender will look carefully at the affordability of any new financing. It will take into account the outstanding debt you already have. And some lenders may want you to take “cash out,” meaning they want to add new financing to your business debt consolidation loan. That means you must be able to afford the new larger loan or cash advance.
Here are some options for refinancing or consolidating small business debt:
1. Multi-year term loan (1-5 years)
A term loan may be one of the best ways to consolidate your short-term debt and get some cash out for growing your business. You may qualify for low monthly payments, and no prepayment penalty. Interest rates currently range from 8-18%, depending on qualifications.
Business owners interested in this product should be able to demonstrate 2-3 years of profitability on the business tax returns, 2+ year time in business, personal FICO above 650 and good business cash flow. Those who qualify may be able to get up to 250% (2.5 times) average gross monthly deposits.
Traditional bank loans (or credit union loans) typically require a minimum credit score of at least 680 or higher, while online lenders may allow for slightly lower credit scores.
2. Commercial mortgage refinance
If you have equity in the building out of which your business operates (or any other commercial property you own), you may be eligible for a “cash out refinance.” The cash portion can provide funds to pay off more expensive debt. You may be able to get a 30-year repayment term, low interest rates and more affordable monthly payments. SBA 504 loans may also be used for this purpose in certain cases.
3. Accounts receivables financing
Are your customers or clients other businesses (“B2B”)? If you have a sizable amount of accounts receivable due from other businesses, you may qualify for a line of credit using your receivables as collateral. You may be able to get an advance for 80-90% of your accounts receivable upfront and use that to pay off more expensive financing such as daily or weekly cash advances, or short term high-interest loans.
4. Equipment refinancing
Businesses with large amounts of equipment owned free and clear (or with significant equity) can also qualify for refinancing. Interest rates will often be in the mid-to-upper teens with multi-year terms. Generally, your business should be looking for larger amounts of funding (around $300,000 or more) for this option.
5. SBA loans
The Small Business Administration does allow some SBA loans it guarantees to be used to refinance existing debt, particularly when it improves the cash flow of the business. If you qualify, this can be an excellent way to reduce costs as SBA loans typically offer favorable repayment terms. Keep in mind the SBA doesn’t generally make loans (except Disaster Loans). Instead you will need to find a lender (often a bank) that makes these loans and meet their qualifications, on top of the minimum qualifications set by the SBA. Like most bank loans, SBA loans generally require good credit and you must be able to demonstrate your business has the cash flow to repay the loan. Learn about SBA loans (including the popular SBA 7(a) loan) in detail here.
7. Short-term to mid-term financing
If your business cannot qualify for any of the other options listed here, it may be possible to consolidate two (or sometimes three) advances with 6-18 month financing in the form of a loan or another advance. Typically this financing requires you to qualify for twice the amount of the total balances on existing advances or loans, and to take that additional financing upon approval. In other words, you will consolidate your debt but you will take on additional debt, so be careful.
Approval for this type of financing is often based on revenues, so the business will need strong consistent monthly deposits and healthy daily balances. Clients experiencing cash flow stress from their daily or weekly payment financing with excessive negative balance days in their business bank account will not likely qualify.
8. Home equity
A hot housing market in many parts of the country means that you may be sitting on significant home equity. This is often tapped by entrepreneurs to help pay business debts. It’s risky. If you can’t pay your home equity loan you can lose your home. If you are considering using home equity to consolidate small business debt make sure you explore all your options and get help from a business mentor first. You may have alternative options available without putting your home at risk. Similarly, personal loans always carry a personal guarantee which puts your personal finances at risk. (Some business loans require personal guarantees, but not all do.)
9. Business credit cards
Although a credit card may not seem like a logical option for business debt consolidation it may be an option in certain situations. Most business credit cards are approved based primarily on the applicant’s personal credit scores and income from all sources, so business debt may not be a disqualifier. If you get a large enough credit line, the card offers a balance transfer, you may be able to use it to pay off some higher interest debt.
Credit card rates can be high, but not as high as some other types of financing such as business cash advances. And a low-rate balance transfer or 0% intro APR may be helpful for several months.
If you don’t need a significant amount of money to consolidate debt you may consider a microloan. These are smaller loans— less than $50,000 in many cases—that are usually available through Community Development Financial Institutions (CDFIs). Interest rates and repayment terms are often attractive, and these loans often come with “technical assistance” which is designed to help the business be as successful as possible. It can be hard to find these loans, but inquiring with your local SBA office can be a good place to start. (The SBA offers a microloan program where funds may be used to refinance debt at the lender’s discretion.)
How to Get a Business Debt Consolidation Loan
Before you look for a consolidation loan, your first step is to take an inventory of your current debt.
- How much do you owe?
- What type of financing do you have?
- Is the debt secured by collateral?
- What are the repayment schedules?
- What interest rates are you paying?
Next you’ll need to inventory your qualifications. (See more about this below.)
- What are your personal and business credit scores?
- Average monthly revenues for each of the past 6 months?
- What is the age of your business?
- How much in B2B invoices are outstanding?
Lenders are going to look at this type of information when making a decision about whether to extend financing. You want to be prepared.
Can I Qualify for Business Debt Consolidation?
Most small business lenders will lend up to 50 to 100% of monthly average gross deposits. Higher business loan amounts are going to go to the least risky customers. If your business revenues fluctuate, or you already have several cash advances subtracting payments from your account on a daily or weekly basis, your business will be considered more risky and probably won’t qualify for as much.
Lender requirements can vary significantly by product, but you should be prepared for any of the following to be part of the decision when applying for a business loan:
Strong credit will provide you with more financing options. Lenders may check business and/or personal credit scores. Lenders will often (but not always) start with a soft credit check on the applicant’s personal credit. This soft credit check doesn’t affect your credit scores.
Some may check business credit and/or other data in order to determine whether there are UCC filings, tax liens or judgments against the borrower. It’s a good idea to check your business and personal credit before you apply. You can check your personal and business credit with Nav.
Lenders are likely to look at how much money your business brings in as well as your various sources of revenue. They may require business bank statements, or analyze your bank account electronically. Businesses that are making only a few bank deposits a month in some cases are considered a higher risk than companies that make multiple deposits in a month (e.g. 10 or more).
A higher frequency of deposits can make a difference in your loan approval and interest rate with some lenders. (Businesses that deposit only a couple times a month may only have one or two customers and that is why they are viewed as higher risk.) Lenders will also look at how many times your account has a negative balance (overdrafts or NSFs)—a red flag to many lenders—as well as days with low balances. Finally, lenders will look at whether your business revenues are fairly steady or very up and down—or worse yet on a steady decline.
Some lenders want collateral; it reduces risk by giving them something they can liquidate if the business defaults. It also adds an element of urgency for the business to repay its debts or risk losing that collateral. Collateral can come in the form of hard assets like equipment or inventory, but can also be in the form of accounts receivable or even personal assets like home equity.
Be candid with your lender about all forms of outstanding financing your business has. Don’t try to hide debts; they are likely to come to light in the loan underwriting process and can result in a rejection.
How Does Consolidating Business Debt Affect Your Credit?
Debt consolidation is often confused with debt negotiation or debt settlement. Those programs don’t technically consolidate your debt. Instead, they negotiate settlements with creditors, after you stop paying. Because you don’t pay your debts in order to force the creditor into negotiation, it can significantly and negatively impact your credit scores.
True debt consolidation—where one loan is used to pay off another—typically has a neutral or positive impact on credit scores, depending on how the lender reports to business or personal credit.
Small Business Debt Consolidation vs. Refinancing
Small business debt consolidation is a form of refinancing. The key difference is that with refinancing, you’re usually refinancing one loan with a new loan. With consolidation, you’re typically trying to take multiple loans and refinance them all into a single loan.
Consolidation can often be more complicated than simple refinancing because the financing you already have probably carries a variety of repayment terms. That means it can be hard to compare the cost and terms of your new loan with the multiple loans (or advances) you had before. In other words, the math isn’t always as simple and straightforward as it is when you refinance your home or auto loan, for example.
Either way, your new financing will be used to pay off previous financing. Sometimes you’ll be able to consolidate all your outstanding balances, and sometimes you’ll only be able to consolidate part of it.
Importance Of Debt Management
Managing your business cash flow is one of the most important financial tasks for creating a financially healthy business. Businesses can successfully leverage debt to expand and to manage the ups and downs of cash flow, but debt can also become overwhelming.
If you use small business loans, you want to make sure you understand:
How payments will impact cash flow. How long will it take you to pay off the financing, and how much will your periodic payments be? This may sound obvious but some types of business financing feature payments that are based on a percentage of revenue, and payments can fluctuate.
How much the financing will cost. Interest and fees are expenses. While they may be tax deductible, there is a cost. You need to understand how that affects your profit margins.
How you’ll make money. If you use financing to open a new location or add a new product line, you may come out ahead. But if you’re using financing just to plug holes in your business, you may dig a deeper hole of debt.
Role of Debt Consolidation
Debt consolidation is just one part of an overall strategy you may use to help improve the financial health of your small business.
In addition to debt consolidation, you will want to delve into your business financials. (Your accounting software can come in handy here.) You want to evaluate:
Income. What are the main sources of your revenue? Are there more profitable products or services you should lean into? Less profitable ones you should cut? New sources of income you should pursue?
Expenses. Are there expenses you can trim or even eliminate? Can you get better deals from your suppliers and vendors?
Alternatives to Business Debt Consolidation
If you can’t qualify for business debt consolidation, you may need to explore other options for business debt relief. Those options vary but they could include:
- Selling part of the business, or selling assets of the business
- Restructuring debt through debt settlement or workouts with creditors
- Business bankruptcy
The first thing you’ll want to do is to reach out to your lenders. They may be willing to restructure debt or provide a temporary pause on payments. Keep in mind this may impact your ability to get other financing, so you may want to explore other options first.
Bankruptcy is also an option, but keep in mind that it will hurt your personal and/or business credit scores and may significantly impact your ability to get business financing in the future.
Sometimes the problem is bigger than the loan. If you’re struggling with debt payments and can’t qualify for another business loan or cash advance, it may be smart to work with a business advisor who can help you review your business plan and operations. You may need to focus on increasing sales, decreasing expenses or both.
Free help for growing your business is available through SBA resource partners such as SCORE or SBDCs, and there are accountants, attorneys and business debt experts who work with small business owners who need help dealing with their debt.
Best Practices For Managing Debt After A Consolidation
Once you’ve consolidated your debt, you want to try to avoid too much debt. That isn’t always easy, especially when the economy and business environment is changing rapidly. A few strategies that can help:
Stay on top of your bookkeeping. Keeping up with your bookkeeping also helps you stay on top of your business finances. If you outsource this task, make it a habit to review your business financials at least monthly; sometimes weekly or even daily is most helpful.
Monitor your business credit. Your business credit can give you insights into how your business is handling its debt. It can also alert you to problems like fraud. Check it regularly.
Proactively seek financing. If you wait until your business is in a cash crunch you may wind up overpaying.
How Can Nav Help
Nav can help you understand what financing your business qualifies for before you apply. View your top financial options from 160+ trusted loans and credit cards based on your business data.
This article was originally written on February 21, 2020 and updated on May 3, 2023.