As economic indicators continue to strengthen and access to credit eases, more small business owners are assessing their financing options. But borrowing always presents an element of risk, and it’s wise to educate yourself in advance about how to manage your debts if your small business experiences slower than projected growth, a change in cash flow patterns, or market changes that create debt repayment challenges.
You may already be familiar with the benefits of refinancing to obtain more advantageous credit terms. But debt restructuring is a more complex matter: rather than a means of improving terms, it is a strategy for pulling a company out of crisis. Charles Fraas, principal owner of Fraas Advisory Services, explains that there are four ways to exit from a debt crisis: you can improve your company’s performance, sell some of its assets to generate cash, secure an outside investment, or negotiate a loan restructure.
Identifying problems, averting crisis
“Knowing that those are the only options, the first step in figuring out how you’re going to resolve a debt problem or prepare yourself to resolve a debt problem is to understand what your business can produce and why it is not producing,” he says. The next step is to weigh your options for resolving the problem. “You either are going to have to cut expenses, somehow squeeze out profitability from some other part of your business, or grow your business. If you don’t do one of those things, you’re going to have a debt crisis on your hands.”
A further complication for many small business owners (particularly sole proprietors) occurs when the business loan is backed by a personal guarantee. Fraas cautions that this can make debt restructuring “a much more limited option” because the lender may prefer simply to seize the assets of the person who backed the loan. But it may still be possible to present other solutions for the lender’s consideration.
Contingency planning and collaboration
If you anticipate—or are already experiencing—a problem in meeting your debt repayment obligations, Fraas advises that you develop contingency plans before you address the matter with your financial institution. “Banks for the most part do not want to call a loan, do not want to have to grab the collateral. That is an expensive, messy process,” he says. “It is up to you, though, to bring in a very good plan and explain to them what the expectations are for repayment. You don’t want to ring an alarm bell until you really know what you’re going to need from the bank.”
It’s equally important to understand what the bank needs from you, such as a demonstration that the plan you’re presenting will generate sufficient free cash flow to allow you to meet your debt obligations. “That is the gauge of whether or not you will be able to satisfy your debts,” Fraas says.
The goal is to preserve your relationship with the lender and gain an ally in bringing your company to full recovery. By presenting a practical plan and delivering on your restructured commitments, you can avert a debt crisis, and in partnership with your lenders, put your company on a path to restored stability and prospects for long-term success.
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