Being in debt as a small business isn’t uncommon; it’s often the nature of the beast. And not all debt is bad.
You may have needed to take on debt to finance initial start-up costs, expansion projects or to manage cash flow during periods of slow business activity.
However, if you’re facing financial distress and are unable to manage your existing debt, you may have thought about taking on more debt as a way of getting out of your business debt. But is it a good idea?
Let’s take a look at the types of debt you might be considering, weigh up the pros, cons and look at some financially smart alternatives.
More Debt You Can Access
So, what types of debt can you access as a business in this financial situation? Here are some of the main avenues of finances you can look to draw on:
Emergency Business Loans
Emergency business loans are financial products designed to provide quick access to funds if your business is facing urgent cash flow needs or unforeseen financial difficulty.
Examples of the types of emergency business loans on offer include:
- Business overdraft - Allows you to withdraw funds beyond your bank balance
- Short-term loans - Quick approval and shorter repayment periods
- Line of credit - Provides a pre-approved credit limit you can draw on
- Online business loans - Fast approval processes and quick funding
- Invoice financing - Receive funds against outstanding invoices
- Equipment financing - Provides funds to acquire or lease machinery
- Credit cards - Serve as a short-term option with a predetermined limit.
Refinancing
Refinancing involves replacing an existing business loan with a new one with more favourable terms. Refinancing aims to improve the loan's terms, such as getting a lower interest rate, extending the loan term, or adjusting your repayment schedule.
Debt Consolidation Loan
Business debt consolidation involves combining multiple existing debts into a single, larger loan. It aims to simplify your debt management by having only one creditor and one monthly payment instead of managing multiple debts with different terms and interest rates.
You could also look to friends and family for loans. But in our experience, this isn’t a good idea and can ruin relationships.
The Downsides to More Debt
While accessing more debt in one of these forms may seem reasonable—after all, it’s a form of legitimate financial support when you need it—it’s often little more than a bandaid fix covering up underlying issues. It can also lead you to further problems.
Here are some of the main downsides:
High interest; impossible revenue
When you’re in this vulnerable situation, your options for further debt are often very high-interest, short-term loans, which can lead to a debt spiral that worsens your cashflow and profitability issues.
In addition, often, when people look at their debt, they compare it to their revenue when thinking about how to pay it.
The problem is that debt gets paid from profit, not revenue. That means you deduct your expenses from your revenue to determine how much is available to pay your debts.
So, if you have an average 10% net profit, it will take $500k of revenue, after paying the associated expenses, to generate $50k of profit to pay down your debt. This is ignoring car and equipment finance payments, and income tax, as well.
You’re taking on your company's debts
Another downside is that these types of debt are personally guaranteed. This means if you’re using it to pay down ATO debt, or other debts which aren’t guaranteed by the directors, you’re effectively transferring company debts to yourself, making them personal debts.
This undoes some of the benefits of using a company in the first place, which is to offer a level of financial protection to directors when they’re starting, taking on or growing a business.
Your debt won’t disappear
If you have an ATO debt, landlord arrears or suppliers you can’t pay – they can feel like your problem. Make them go away, and your problems disappear, right?
But the reality is, if you pay old debts with new debts, the debt doesn’t disappear it just gives you a bit more time to pay.
Business is risky. An estimated 20 per cent of new small businesses in Australia will fail in their first year, and up to 60 per cent of start-up businesses will not survive beyond five years.
When looking at last-chance finance, you’re likely closer to becoming a statistic.
Fix the Leaks First
Essentially, what we’re saying is that adding fresh loans and finance to a business performing poorly is like pouring water into a leaky bucket.
So, if you’re weighing up new finance or other options, be comfortable that your cash flow and profitability factors are optimised—fixing these might solve your problem, meaning you don’t have to take on more debt.
Often it’s as simple as:
- Asking your customers to pay on time
- Increasing your prices
- Managing costs more closely
- Paying suppliers only when due
- Looking at whether you need all your stock/ assets you have on hand.
If you don’t know where to start, a good accountant or bookkeeper is your best friend.
If you think you still need the finance, at least you’ll know that the money will be applied to the areas that will deliver the most benefit and not delaying the improvements your business needs.
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Alternatives to More Debt
Up until fairly recently, a couple of formal insolvency options were open to you if you were facing financial distress and unable to pay your debts. These were voluntary administration and informal restructuring.
However, these have their own issues for small businesses, such as the cost, risks, loss of control of your company and the publicity. All are not great but necessary for the outcome.
Small business restructuring process
A more viable solution you now have is the Small Business Restructuring Process.
The SBRP provides a more streamlined and affordable approach to restructuring unsecured debts. It involves drawing up a restructuring plan alongside an SBR practitioner containing a creditors’ remuneration plan.
Benefits of the small business restructuring process include:
- Lower cost/fixed fee
- Reduced debt
- Improved cash flow
- Avoid insolvency
- Continued trading
- Improved credit rating
To demonstrate how effective they can be, the stats show that SBRP has a 90% plus success rate and achieves an average of 85% in debt reduction.
Tax debt management
If you’re struggling with overwhelming tax debt, it’s always best to be upfront and honest with the Australian Tax Office (ATO).
Tax debt management involves talking to the ATO about your situation and negotiating with them to come up with a viable payment plan—one that you can afford. They will require pulling together any financial documents or cashflow projections they ask for.
If you’re not a keen negotiator, there are experts (like us!) who can manage the entire process for you.
Liquidation
If your company is insolvent and beyond the point of no return, liquidation may be a good option. While you might see appointing a liquidator as a last resort and a negative, liquidation offers many benefits, including:
- No more debt
- An end to any legal action
- Relatively low one-off cost
- Employees get their entitlements
- You meet your responsibilities
- Closure and no more stress
Related: The Simple Guide to Liquidation
Say ‘No’ to More Debt and ‘Yes’ to Restructuring
Ultimately, getting out of business debt with more debt should be considered cautiously by small business owners as it often only exacerbates the situation.
Instead of thinking about loans and lines of credit as a first port of call, always take the time to weigh up all the options.
The small business restructuring process is a great way to go. Rather than taking on more debt when you owe money, it reduces it and resets you to a healthier business and mental state.
Debt reduction doesn’t need to be scary. Get in touch with our team of debt solution specialists today on 1800 861 247 for professional, non-judgmental support and advice on the best way forward. You can also contact the Small Business Debt Helpline.
If your business is struggling, see how we can help with our Instant Online Assessment.
