This article is written for business owners who are trying to figure out if debt refinancing is the right solution for them. The article covers:
- A simple way to determine if you need refinancing
- Pros and cons of refinancing
- Consolidation vs. refinancing
- Types of debt that can be refinanced
- How to get the loan
- Qualification criteria
- Is refinancing the right choice for your company?
1. 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, you might benefit from refinancing your debt. If this is the case, consider doing a more in-depth review.
a) Are loan payments taking up your available revenues?
The most common symptom that a company has a debt problem is that it spends most of its 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.
Resource: “How much debt can your company handle safely?”
b) 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.
However, not all cash flow problems come from debt payments. They can come from slow client payments or from other sources. Regardless of the source, if you are juggling payments, you should consider a more careful review of your situation. For more information, read “Cash flow problems and solutions“.
c) 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 rate 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.
d) 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. They apply them to situations that can’t be solved with a cash advance. This mistake 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 new advances 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 it with a single, cheaper loan may solve this problem. If the situation is serious, examine it with a CPA or financial professional.
e) 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 strategy 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.
2. 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) Lower monthly payments
Loans are usually refinanced so that the monthly payment is lower. This lower payment relieves financial stress and frees up cash flow. Lower payments are achieved 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. However, sometimes this gain is not enough and you need more funds.
If the incremental gains are not sufficient, consider adding a cash flow line of financing. This financing can be accomplished for business-to-business companies only if the lines are combined as part of the initial structure. Providing this financing requires a certain level of expertise by your lender.
e) Easy payment management
Payment simplicity is an advantage that is often 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 businesses. 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:
g) Longer debt terms
Your monthly payments will be lower, but you will be making payments for a longer time. Over the term of the loan, you will usually have to pay more than you would have paid with your previous loans. This important trade-off should be taken into consideration.
h) 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.
i) 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.
3. Consolidation vs. refinancing
Most business owners use the terms “debt consolidation” and “debt refinancing” interchangeably. They are similar – but they are not the same. This difference is important when you speak to potential lenders.
Debt refinancing replaces one loan with another one. Debt consolidation replaces a group of loans with a single loan.
4. 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:
a) 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, you may have loans with 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.
b) Merchant cash advances
As mentioned before, cash advances often have short terms at high rates. This combination can be dangerous 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 approach provides for a lower payment and more affordable terms.
c) Equipment loans
Some businesses have many equipment loans. Each loan has its own rate and terms. In some cases, you can consolidate them into a single loan with easier payment terms.
d) 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.
5. How do you get a refinancing loan?
Refinancing a loan is relatively simple, but it requires some work. Here is a summary of the steps to get the loan:
a) Initial loan consultation
The first step is to have an initial consultation with the lender. This step helps determine if the lender and their offer is a good match for your situation.
b) 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 often need to provide:
- Personal tax returns
- Personal financial statements
- 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.
6. 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.
7. Is refinancing the right choice for your company?
In some situations, 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 in which 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 would be 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.
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