As reported on Inc.com:
Any business leader can find themselves confronting circumstances where their company has more debt than it should. I’ve written before about the appropriate level of debt for companies to target, which is generally a ratio of debt to profit. When that debt ratio begins to go upwards of four to five times profits, things can get extremely uncomfortable. Suddenly, you can find that all your excess cash needs to go toward serving that debt. Worse, if you don’t have the money to pay your lenders, you could find yourself in a default position, which puts the entire business at risk of failure.
That’s why it’s always good advice for cyclical businesses, especially those tied to the seasons, to carefully manage their debt load to avoid falling into this kind of scenario during their down-cycle.
You might also find yourself in a position like this through no fault of your lender either — as no bank would ever intentionally put you into a situation where you couldn’t pay back your loan. What typically happens is that a change or downturn in the business turns what used to a reasonable amount of debt into a nightmare, something that many businesses might be confronting because of the pandemic. An overly aggressive private equity investor can also load up a business with uncomfortable levels of debt.
The question is, if you do find yourself in a scenario where you have more debt than you should, what can you do about it? Here are a few options for you to consider:
1. Renegotiate with lenders.
One of your first moves should be to set up a conversation with your lenders where you can discuss the situation openly. Hopefully, you can mutually agree on better terms, such as extending out the timeframe for paying back the loan or trimming the payment amount to a more manageable level you can afford with a balloon payment later, when the business can pay.
2. Refinance the debt.
It’s possible you could use the opportunity to talk to your lender about refinancing or even consolidating your debt at a lower interest rate with lower payments. The idea would be to put the business in a better position to recover and pay back that loan over time. Unfortunately, the time to refinance is not when you are in a dire financial position.
3. User customers for financing.
One of the ways you can deal with your debt is to change the payment terms with your customers to bring in cash from them sooner, which you can then use to serve your debt. You can also change payment terms with your suppliers, pushing out the payments to longer terms. This is only a short-term solution, but it can help to plug the hole in your cash flow until the business fully recovers.
4. Sell equity.
You might have the option of selling shares in your company, possibly to your lender or a third party, to alleviate debt and generate cash. The downside, of course, is that it will dilute your position and that of your other shareholders. And you might not get the best valuation from your investors, who could be buying the stock at a steep discount.
5. Sell part — or all — of the business.
If selling partial equity is not an option, you might be forced to consider to selling part of the business, or even the whole thing. One option could be splitting off a division or product line that could be highly valuable to a competitor. While that would be a painful option, it could provide the escape hatch you need to avoid having to sell the whole operation–while also generating the cash needed to pay off some of your debt.
A final option to consider when you run out of assets to pay back your debt is to file bankruptcy. While some believe bankruptcy means the end for a company, an intelligent and strategic restructuring plan can serve as a great new beginning for a business.
The whole idea is that you can cut your debt, paying dimes on the dollar or maybe even zero, as a way to bring your business through to the other side. But bankruptcy is something you need to plan for because it’s expensive. You can’t wait until your final dollar to consider this option. You will need significant resources, maybe even millions of dollars, to pay the lawyers to help you through the process.
The upside of that investment is that if you bring a judge a well-thought-out plan, many times you can control the outcome of those rulings. The key idea is to come up with a plan that shows how the business can live to fight another day and come out stronger on the other side.
Personally, I hope you never have to consider any of these options. That’s why it pays to keep an eye on your debt levels. But if you find yourself in a highly leveraged position and you’re not sure how you’re going to make the next payment, consider some of the options here to see how you might get through your dark days and through to the sunnier days ahead.
Author: Jim Schleckser
Date: 2021 02 16
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