Secured Debt Workouts

images (1)What is the difference between a secured loan workout with traditional commercial financing one done with SBA financing?

Simply put, the involvement of the SBA. A traditional commercial loan is based solely on the value of the business collateral and the perceived ability of the guarantors to repay the loan.  There is no SBA guaranty backing the loan in the event that the business fails and needs to be liquidated.  What this means is that the risk is shouldered by the bank rather than the SBA.

What does this mean for distressed borrowers with traditional commercial financing?  Can they still do a workout?

Business owners with traditional commercial financing can still go through a workout, a modification, or a reorganization.  However, because the bank does stand to lose more than they would under a SBA financing relationship, it is important that a business owner be aware of the Pros and Cons of of doing workouts with these types of lenders.

PROS:
Timing: Because all decisions can happen at the bank level without the need for involvement from the SBA, a workout or settlement can conclude much more quickly than the typical SBA loan.
– Flexibility: A bank without a SBA guaranty may allow more temporary payment relief in the forms of forbearance or modifications than a SBA loan would because they have no fear of losing their guaranty and having every incentive to keep the loan out of liquidation.

CONS:
– Valuation of Assets: Under a liquidation scenario a bank with no SBA guaranty has an incentive to seek out a higher value for the assets that act as underlying collateral for their loan.  While the intension of paying down the deficiency balance to a higher extent is good, the outcome many times is that the opinion of value of the business assets makes them unmarketable to third parties.
– Personal Guaranty Settlements: Without the SBA guaranty in place to absorb much of their losses, the bank will likely look for a larger amount in order to settle the guarantor’s personal obligation.  Without the SBA involvement, the lender does not have to follow SBA procedures for reviewing Offers in Compromise.  They instead get to review any settlement through their own set of criteria.  This criteria for ability to repay will likely result in a higher settlement when compared to a SBA settlement because it will include things such as measuring the amount of wages that could be garnished from the guarantor over their projected remaining working lifespan.

Understanding these pros and cons can better help the business owner set and maintain the correct expectations.  While their personal guaranty settlement may cost them more, the time and the flexibility the bank will offer will often remove the need to conduct a personal guaranty settlement in the first place.  In the event where the personal guaranty is addressed, the lenders still have an incentive to settle over receiving a discharge in bankruptcy, so their calculations are often not so high that settlement is impossible.  They are however, typically more costly than loans that are accompanied with a SBA Guaranty.

To understand if a workout or modification is the right thing for your business, you should first do an assessment of the value of the business assets and the guarantor’s personal assets.  With that in hand, you should seek out professional advice as to whether either alternative is feasible given your circumstances.

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