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Business Debt Consolidation

Do you want to expand your business or handle your expenses and finances better? Business loans are a great way to manage your business expenses, but sometimes they become too burdensome and may lead to financial turmoil in the company and our finances.

The best way to manage your debt may be to consolidate all business debt and restructure loans to lower interest payments so that all loans become a single payment.

This article will walk you through a simple breakdown of what business debt consolidation is all about and how it can help you manage your expenses and finance your business better.

What Business Debt Consolidation is all about

Business debt Consolidation is a business loan obtained by the management of an organization to settle all existing or part of all existing loan liabilities of the business. It involves merging all existing debts or some of the existing debts in the capital structure into a single form of business loan. Business debt consolidation is a useful business strategy that assists businesses in solving problems of keeping track of business debt obligations. Debt obligations include:

  • Repayment of the loan.
  • Cost of debt.
  • Any other forms of arrangements related to the debt capital.

Business debt consolidation will reduce the total number of debt investors a business is committed to. It does not necessarily imply reducing the total debt assumed by the business in value. If your business makes an excess profit even after deducting all finance costs, you consider settling some of your debt investors. It is important to note that settling creditors from the earnings after finance costs does not constitute a business consolidation.

It is crucial to note that business debt consolidation involves taking a larger loan to settle all existing or existing business loans. Business debt consolidation does not affect the business’s actual cash or other components of equity instruments. The interest rate, known as the cost of debt, for the consolidated business loan is expected to reduce depending on the business’s bargaining power. It will reduce the streams of payments made by your business to the new loan repayments agreement.

Business debt consolidation can be immensely beneficial to your business if you have a good credit rating. A good credit rating allows you to negotiate a favorable (lower) interest rate for the consolidated loan. You can also reach out to any credit rating agencies like Fitch Ratings Inc, Moody’s, and Standard & Poor for a credit rating.

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How Business Debt Consolidation Works

Business debt consolidation may involve you considering various processes and options. If this process is not considered diligently or is done without appropriate business planning, it may not benefit the business in the way it should. The steps on how to consolidate a business debt are simplified as follows:

1. Consider the business objectives for debt consolidation

The business objectives should come first. All business decisions must align with the business objectives. Ensure that any consolidated debt does not contradict the objectives of the business.

2. Understand the existing debt structure

You should concentrate your analysis on the debt investors (lenders), repayment structure, interest rate, and other agreements incidental to the debt. You must understand which debt investor (lender) provides the cheapest form of debt and if debt finance from that source is sustainable in the long run.

3. Decide on the business debt to be consolidated

Business debt consolidation does not necessarily imply that you should consolidate all business debts. The value of all companies depends on their weighted average cost of capital. Consolidation should cover the debt that will be inefficient if retained in the new weighted average cost of capital.

4. Apply for the new loan needed for consolidation

This process involves submitting necessary documents and entering into required agreements with the new loan provider to consolidate the existing loan. The lender will consider all necessary details and conduct its due diligence necessary to provide the debt finance.

5. Consolidation of the selected loans

The loan will be available to make payments to the lenders of the selected loans considered for settlements, which the business has decided to consolidate. This consolidation process will reduce the business lenders and streams of repayments, and it is expected to reduce the business cost of debt.

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Does Debt Consolidation mean Debt Refinancing?

A straight answer for this is no! Debt consolidation and Debt Refinancing are two different concepts, although linked to each other whenever we talk about debt strategies in finance. Debt Refinancing involves retaking a loan from a debt investor after the full settlement of the loan.

The process of debt refinancing is similar to debt consolidation in the following ways:

•New Loan

•Lower cost of debt.

New loan

If you think of refinancing your debt, you will have to request it again after full repayment. Debt consolidation also requires the business to opt for a new loan but does not necessarily need to wait till the end of all loan payments.

Lower cost of debt

Business debt consolidation and Debt refinancing could lead to a lower interest rate if planned properly. When a business wants to refinance its loan, it is expected that the management of the business will negotiate for a lower interest rate. On the other hand, a consolidated loan should provide a lower cost of borrowing.

The process of debt refinancing is not similar to debt consolidation in the following ways:

•Single debt

•Existing Lender

•Time of execution

Single debt

Debt refinancing does not require the settlement of multiple debts with a single loan. If you want to consolidate your loan, you must merge multiple loans. You can not consolidate a single debt, but you can refinance a single loan.

Existing Lender

Debt refinancing requires a business to take a loan again from its debt provider after full debt settlement. Business debt consolidation does not require a business to obtain a new loan from an existing finance provider.

Time of execution

If you consider debt refinancing, you will need to wait till the end of the existing debt period before you can discuss refinancing the debt again.

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How to Get a Business Debt Consolidation Loan

Debt investors are different from one another, and they have different risk appetites. So, you should consider evaluating yourself in some aspects and cross-checking some documents if you want to obtain business debt consolidation loans.

Credit Rating

A good credit rating is a straight and solid way to secure a business debt consolidation loan. What is considered a good credit rating will vary from one debt provider to another, depending on the risk appetite. But a high credit rating like A+ will guarantee a business a loan.

Consultation with an underwriting team

An underwriting team assists the business in confirming if they are suitable for a debt consolidation loan. It would help if you considered structuring a consultation with an underwriting team to consider your chance of getting a business consolidation loan.

Submission of Financial documents

You will probably be required to submit the following documents for evaluation to obtain a loan from a loan provider.

  1. Statement of cash flow, Statement of financial position, and several years’ comparative statements of profit or loss and other comprehensive incomes.
  2. Property, Plants, and Equipments schedule
  3. Personal Financial Statement
  4. Forecasted on estimated future sales
  5. List of all existing debt of the business.

Financial documents reviewed by the debt provider

The financial documents were not submitted for submission’s sake. They will pass through an initial review by the debt provider. After the review, a notification will be sent to you if you scaled through the stage or not. Most debt providers will send a pre-qualification letter that contains the loan terms and conditions.

The final step is to ascertain original loans, asset ownership, and 1-year payment history. It is the responsibility of the debt provider to cross-check the few documents mentioned. You can sign the final documents required to be entitled to your business consolidation loan.

Is a small amount of business debt worth consolidating?

Firstly, before you decide whether it is worth consolidating those small business debts, you must understand the advantages and disadvantages of a consolidated business loan.

Advantages of business loan consolidation

Increased Credit Rating

Having many small business loans in your debt structure could pose a problem with managing repayment. A poor repayment problem is detrimental to a business’s credit rating. If all these debts are consolidated and replaced with a single well-managed loan source, it will positively affect the business credit rating.

Lower cost of debt

When debt consolidation is properly planned and negotiated, it will reduce the business’s total interest payments.

Efficient Cash Flow Management

The interest payment is an expense to the business; if it is reduced, it is a cost-saving. Savings will contribute to income to make purchases to generate additional cash flows from operating activities.

Convenient Repayments Structure

A single repayment will be more convenient to manage than making payments for a different form of loan liabilities and internet payments. It will reduce the amount of time needed to estimate durations or the price of bond sensitivity.

Disadvantages of business loan consolidation

High cost of debt

There’s no perfect correlation that business loan consolidation will lead to reduced interest rates. The ability of a company to secure a consolidated loan with a lower interest rate depends on some factors considered above, like credit rating.

Cash flow issue might not be unaffected

We can expect that a consolidated loan will result in more cash flow utilization. This situation is not always the effect.

Fresh repayment period

Consolidated debt loans are fresh loans that will create a fresh start for the business. The loan will extend to the term agreement, and you need to start settling loans from the first payment again.

Which Business debt consolidation option is the best to consider?

For business consolidation purposes, you might want to consider a few options available to obtain debt worth considering. You should consider your situation, and decide on the one that best suits your condition.

Traditional bank loans

Banks and institutions are the best places to secure a consolidated loan. These banks are everywhere and ready to provide loans for your business. Traditional banks include Bank of Montreal, Royal Bank of Canada, Bank Of Nova Scotia, and Canadian Imperial Bank of Commerce. The cons with accessing these banks are that you may need a good credit rating and perhaps be required to be in business for a specific time.

Small Business Administration (SBA) loans

SBA is a loan backed by the federal government’s support. Due to the government backing, debt providers are willing to extend loans to small businesses. SBA is a good alternative source of debt fiance compared to traditional bank loans. The cost is debt is as well competitive with the normal bank loans. It is also enticing that some SBA does not require collateral.

Alternative loans

This form is provided mostly online by different online platforms for businesses. Online debt providers include private lenders, funding circles, crowdfunding (peer-to-peer), and leading clubs. Alternative loans grant businesses access to the forms of loans that traditional banks and small business administration can not provide.

OnDeck

Ondeck is a firm of other alternative loans that provide access to fast funding with flexible requirements. If you’re in a business of up to 12 months, you might want to consider OnDeck. Terms range from 3 months to one year and a half. You will need a personal credit score of 600 to qualify for this loan and a minimum annual revenue of $100,000.

Understanding due diligence by debt providers

Due diligence is a process that involves personal research by the debt provider to confirm information and details that they received. It is a necessary step that enables debt providers to understand their clients’ creditworthiness before making loan arrangements. An investigation will cover asset ownership and other aspects of the business. Most debt providers will send a commitment letter to your business if it scales through the due diligence stage.

Business debt consolidation and value of a business

The value of a business is a function of the cost of capital. The value of a company is at its maximum when the coat of capital is at a minimum. Debt is a cheaper source of finance than equity, and it’s cheaper with tax savings. Whenever Business debt consolidation results in lower interest rates, it will increase the company’s value.

It is important to understand why reducing the cost of debt is essential. Do not forget that reducing finance costs is not the only benefit of debt consolidation. It includes convenient repayment and all. If a consolidated loan results in lower finance costs, does it affect the business’s value? A straight answer is Yes! Both the traditional view and the modified Modigliani-Miller propositions support this assumption.

The traditional view and the modified Modigliani-Miller propositions of capital structure proved the relationship between the cost of capital and business value. The value of a business is at the maximum when its cost of capital is at its minimum. A business with a lower cost of capital will have more value than the same business with a higher cost of capital.

The cost of capital of a business comprises the cost of both debt and the cost of equity. To factor these costS into estimating the value of a company, we consider the weighted average cost of capital (WACC). The Total after-tax earnings of a company over its weighted average cost of capital equals the business’s value. Note that the cost of debt from the business perspective is the after-tax cost of debt.

What is the effect of an increase in business debt?

The effect of an increase in business debt is an increase in the cost of equity. Although it is beneficial that business debt consolidation results in a lower cost of debt, it will consequently increase the cost of equity. The cost of equity comprises dividend payment and an increase in capital gain. The cost of equity is the return required by the shareholders, known as the business owners.

Owners of businesses expect a return that compensates for the risk of any business they invest in. The more risky a business is, the more the required return on the shareholder’s fund. Many factors could increase business risk—the nature of the business, Investment project, Management ability, and many more. Debt in the business capital structure is a form of risk.

Whenever a business is granted a loan, there is an exposure to the risk of default in repayments. A loan can be secured or unsecured. With respect to the form, the loan may be taken. The business’s creditors have the right to initiate a legal proceeding against the firm in case of default by the business. If the business cannot meet its liability, it will be declared bankrupt by the court.

The equity owners are aware of the risk that more debt will create, and a higher cost of capital is required to compensate for this risk. It is noteworthy that despite an increase in the cost of equity, the benefit of the cheaper debt will offset the increase in the cost of equity. We can conclude that the cost of equity in a business with debt is higher than the cost of equity in a business without debt.

Business Debt Consolidation Conclusion

A business debt consolidation is a single form of multiple loans in a business capital structure. Also, it’s not the same as loan refinancing. Consolidation of loans should result in cheaper interest payments and be aligned with business objectives. Lastly, a link exists between sourcing for loans with cheaper costs and an increase in the company’s value. A lower finance cost will result in an increase in the value of the business for its owners.

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September 13, 2022
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FAQs about Business Debt Consolidation

Does business debt consolidation negatively affect my credit rating?

Suppose you fail to make prompt payment of your loan liabilities. If you assume more debt into your debt structure or utilize your credit poorly and inefficiently, debt consolidation will negatively affect your credit rating.

Is it worthwhile to consolidate business loans?

It is a good business strategy to adopt business debt consolidation in most cases. It will be very beneficial if a business can access a consolidated loan that results in a lower new cost of debt.

How long does it take to apply for business debt consolidation?

The duration required to apply for a business debt is not static. It depends on your financial position and the lender's diligence procedures. Most lenders have a structured approach to due diligence, which is a positive signal for application periods.

Is it possible to consolidate business debt?

Yes, you can consolidate your business loan. Business debt consolidation enables you to consolidate your loans. With a sufficient loan from a business consolidated debt provider, you can settle off the small loan of your business.

Is there any disadvantage to obtaining a consolidation loan?

A business debt consolidation loan is also a Loan. Although it provides various benefits to the business, it also has some disadvantages as a loan. The provider of debt can sue your business if you default on payment. Lenders also have access to company assets if it's a secured business loan.

Can I consolidate my business's debt with a bad credit rating?

It is possible for business debt consolidation with a bad credit rating. It might be challenging to see a good loan term due to the risk attached to such a loan. All benefits to consolidated loans will apply to your business, but you might need to compensate for the risk with a high-interest payment.

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