This article was reviewed and updated on August 31, 2020
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 payment? That’s business debt consolidation in a nutshell. But in reality it is rarely that straightforward, and there are important considerations we’ll break down in detail here.
How Business Debt Consolidation Works
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 you’ll need to think through what’s most important to your business and focus on your top priorities. Identify which of these goals is your top priority:
- Lower payments. If your payments are cutting too much into your cash flow, you may want to see if you qualify for longer term consolidation programs.
- 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 preferable, but keep in mind that monthly payments may be larger and require more careful budgeting.
- Lower interest rates. Keep in mind that small business financing comes at a cost, but it 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 to a loan with a lower interest rate.
You may not always get the trifecta of the perfect consolidation loan. For example, you may lower your payments but stretch out your debt and that may cost you more over the long run. However, it helps to keep your main goals in mind as you explore your options.
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.
Small Business Debt Consolidation Pros and Cons
As with any type of financing, there are pros and cons. Here are a few you’ll want to keep in mind:
Pros of small business debt consolidation loans:
- Reduce your loan payment amount into one, low more affordable payment.
- Simplify budgeting and bookkeeping
- Save money if the new financing is cheaper
Cons of small business debt consolidation loans:
- New financing sometimes can be more expensive (especially for those deeper in debt)
- You may roll the “interest” expense or “fee” portion of the old loan or advance into the new one, which means you’ll effectively pay interest on interest
- It may result in a new UCC filing which appears on business credit reports
Business debt consolidation loan: what are my 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 require 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.
Some of the best business loans for consolidation require using your business assets as collateral. A few examples are accounts receivables, real estate, Inventory, or machinery and equipment financing.
Lower interest lines of credit and term loans that do not require collateral, typically require a minimum of two years time in business, 650+ (FICO) minimum personal credit score and good cash flow.
Credit card debt may be consolidated using a loan. Or you may use a business credit card balance transfer to help consolidate business debt.
SBA loans may be used in certain situations to refinance existing debt. 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 who makes these loans and meet their qualifications, on top of the minimum qualifications set by the SBA. Generally these loans require good credit and you must be able to demonstrate your business has the cash flow to repay the loan. Learn about SBA loans in detail here.
Home equity 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.)
Microloans 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 has a microloan program among others.)
Does a business consolidation loan make sense for me?
To understand whether consolidation makes sense you’ll need to take into account:
- Your outstanding loan balances
- Your current payments
- Repayment periods of current loans
- Your revenues
- Your cash flow
You’ll then need to compare those to the loan terms of the consolidated loan you’re considering.
An important question to ask yourself is whether consolidation will really help your business financially. Or are there other issues you need to deal with first, such as a decline in customers, increase in costs, etc.?
Can I qualify for business debt consolidation?
Most small business lenders will lend up to 50— 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:
- Credit scores: 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 scores for free at Nav.
- Revenues: Lenders are likely to look at how much money your business brings in as well as the various sources of revenue. 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 is overdrafted— a red flag to some 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.
- Collateral: Some lenders like collateral; it reduces risk by giving them something to go after 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.
- Debt: 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.
Generally the more debt your business has, the harder can be to get a debt consolidation loan. That doesn’t mean it’s not worth investigating but be very clear and up front with your broker or lender so they can help you as best as possible.
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
Keep in mind that restructuring debt or bankruptcy can 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.