Managing a thriving small business in Massachusetts can be harder than starting it. If a loan was negotiated to get the business going, repayments may be hard to make at times. It’s not unusual for small businesses to experience volatility in their finances, but if it leads to a risk of a default on the loan, business owners must find a way of avoiding the potential serious consequences of not being able to maintain repayments.
What is meant by the term “default”?
When a business goes into default, it means that repayments to the loan provider have been missed too many times. When a loan is negotiated, the loan agreement between the creditor and the business will determine how much should be paid back in repayments, when the repayments should be made and the overall length of the loan period. It’s rare for a small business to experience such financial stress that it goes into default immediately after launching the business. More commonly, a repayment is missed by a period longer than the ‘grace period’ allowed in the loan agreement. This grace period is a time period which depends on the lender but is typically between a month and three months after the date of the repayment. Missing a single repayment after the grace period is known as delinquency. Missing more than a single repayment may put the business into default.
Reasons for avoiding defaulting on a small business loan
Small businesses that default on a loan will discover that any further loans may be harder to obtain. This is because every business has a credit score, similar to that of an individual borrower. Going into default affects the business’s individual credit score, which is one of the most important criteria used by lenders to assess whether a loan should be offered.
Defaulting on a loan doesn’t end there as the loan still has to be repaid. The lender may seek to have the loan repaid by seizing any collateral that was used to negotiate the loan in the first place. Collateral may include personal property and personal assets as well as business property and business assets.
If the loan was unsecured (i.e. no collateral put up by the small business), then the lender may seek repayment through the civil court in the form of a lawsuit.
Options for small businesses at risk of default
Avoiding defaulting on a loan is always a better option than tackling the problems that will come from a default judgment. If repayments are proving difficult to maintain in the early stages, small business owners should try and contact the lender as soon as possible to work out a plan for continued repayments. Possible options which may help to relieve financial pressure and stave off a default judgment may include:
- making interest only payments for a period of time to allow relief on the business’s cash flow;
- extending the overall time period for the loan which would reduce further monthly repayment amounts;
- negotiating a longer grace period before a loan repayment needs to be repaid;
- reviewing the business plan and assessing whether a restructure can help the business to resume making repayments on time.
When at risk of default, it is prudent to ask for legal advice from a business attorney and / or business advice from somebody like a certified public accountant. These professionals can advise the business owners about their options and suggest possible actions to relieve financial and legal pressure on the business. If the lender seeks to take matters further after default has been declared, then an attorney may be needed to represent the business owner in court or to provide advice when collateral is demanded as part of repayment of the loan.
Avoiding default on a SBA loan
It can be difficult for many would be start ups finding a lender who is prepared to offer a loan to get the small business operating. Lenders are typically loathe to offer business loans to first time businesses, and may require the business to have been in operation successfully for a minimum period of time before a loan will be considered. The federal Small Business Administration (SBA) can help start ups with what is called a SBA loan, although the SBA itself is not the actual lender. The SBA basically acts as an intermediary between the small business and a suitable lender.
Even though it may be easier to take out a SBA loan, similar provisions are in place to ensure that repayments of the loan are made on time. If the business is in danger of defaulting on a SBA loan, then the lender legally has the right to seek to take possession of business and personal assets that were put up for collateral just as a non SBA mediated lender would do. Where collateral is not available or is less than the debt, then the lender may decide to sue the business owners and file a lawsuit to recover the loan.
This is where a SBA loan is somewhat different from a non SBA loan. If the amount of collateral is insufficient or there is no collateral at all, then the lender may apply to the SBA under a SBA loan guarantee. The SBA may then agree to pay the outstanding balance but will subsequently seek to obtain repayment from the business owners by issuing a 60 day demand letter. Any non repayment will mean that the business’s account may be transferred to the U.S. Treasury Department. The business owners do have the option of submitting an “Offer in Compromise” (OIC). This is an offer to make some sort of repayment or a repayment plan, even if the payments promised are insufficient. The SBA and the lender may accept the OIC request if the owners can provide evidence that full repayment of the outstanding loan cannot be made and the business is liquidated and funds from the liquidation are used to help pay off the debt.
It is advisable to seek legal help from an experienced business attorney to avoid going into default and ending up with an unsatisfactory credit score and having to lose personal and business assets to pay off the loan.