If you used SBA financing in order to purchase your business in the last 10 years, there is a reasonable likelihood that the SBA required that the seller finance a small portion of the transaction. This means you did not have to bring that cash or financing to the closing table and instead the previous owner provides the financing and takes a second position note secured behind the SBA note. The SBA does this to offload some of the risk to the seller.
When a SBA borrower enters into default on their SBA payments, it is assumed that the business is also in default on the payments owed to the previous owner. In fact, many SBA lenders will require that the previous owner sign a Standby Agreement, which dictates that is the borrower were to go into default on the SBA loan, or if the SBA lender were to modify or forbear payments in any way, that the Seller and previous owner would agree to standby and cease collecting payments until the time the the SBA debt is being paid as agreed again. These agreements make these seller financed notes high risk and often times put the previous owners in a difficult situation. These people are traditionally not associated with large lending institutions that have large loan portfolios where writing off a debt is not the end of the world. Many of these people had debt on their business when they sold it and so therefore did not receive much of the sale proceeds when they sold their business. Many of them depend on that income and see this portion of the purchase price as their only return on investment for creating and selling the business. Simply put, these people are not banks and treating them as such is not advised in a workout scenario.
That being said, when the SBA lending banks are taking large discounts to the amount owed to them, the seller financier must understand that it is not appropriate for him or her to be compensated in full, and that is more appropriate that they accept a settlement proportionate to that of the SBA settlement. If appropriate review of the seller financed note is completed and a high level of communication is maintained with the previous owner, the difficult end result can be met with acceptance instead of resistance. Having been a business owner, many of these people understand the ups and downs of owning a business. They further understand what has happened in the economy recently and what affect it has had across all industries. A workout plan needs to include fully disclosing the financial condition of the business and the guarantor, the goals and objectives to be met with the SBA creditor, and the potential outcomes. If the previous owner understands these things, they will have little choice but to agree to settle amicably. Alternatively, if your workout plan does not include a plan for the previous owner, you risk the threat of legal challenges that could greatly delay the workout and settlement process, not to mention add costly attorney fees to the process.
ONE FINAL WORD ON SELLER FINANCING: If the previous owner of your business offered seller financing at closing of the business purchase and is now also your landlord, you should seek professional help before attempting to negotiate a settlement, workout, or reorganization. A landlord/seller financier has abilities to interrupt business operations a number of ways that other creditors do not. Couple that with the fact that they will be emotionally involved in your success or failure and it can be a dangerous combination. While your seller financing and your lease agreement are two separate financial obligations, you must understand that if you are in default on one obligation, that this individual will have a financial incentive to call you under default on the other agreement until all default is cured. Workouts with landlord/seller financiers need to be well planned and executed. If you are in this situation and need help, you should seek professional representation.
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Sometimes a business’ secured debt is not the problem. Their secured loans are at reasonable interest rates with reasonable debt service. What causes them pain and distress are their unsecured creditors. Unsecured creditors come in a variety of forms which include vendors, utilities, lines of credit, or investor notes. These types of obligations are not secured by any specific piece or group of collateral and often come with higher interest and shorter repayment terms. For example a debt owed to a vendor/supplier is expected to be paid in full in 30-60 days, sometimes not allowing the business enough time to experience it’s own revenue from the products received from the vendor and in essence inverts the cash flow of the business by making the business owner pay for goods before revenue is realized. When overall revenue is reduced these situations can quickly get out of hand. Vendors and suppliers shut the business off from future shipments which can result in the business not being able to operate and provide products to customers. Creditors holding lines of credit shut off any further credit and demand the line paid in full. Utility companies shut off necessary utilities such as water or power which renders the business useless. If distressed business owners prioritize their secured debt over their unsecured debt in times of reduced revenue, they run the risk of becoming non-operational.
However an unsecured debt workout can solve these problems for business owners. Unsecured debt workouts have a variety of results. It often includes a reorganization of the business to strip the obligations of unsecured debt from the business operation but can take on many forms. Because of the unsecured nature of these types of obligations and a lack of involvement from a governing body such as the SBA, the debt workout has a wide range of flexibility. These unsecured debts can be settled for short of whats owed, amortized over long periods of time to meet the needs of the business cash flow, or they can written off without consideration.
Some things to consider when doing a unsecured workout are:
– Will the secured creditors participate in a reorganization if necessary? Reorganization of the business is often part of an unsecured debt workout. Before entering into negotiations, a business owner should communicate their plan with their secured creditors in order to assure their cooperation in the transaction. Not doing so could result in default under the secured loans.
– Determine which vendors/creditors are crucial to business operations: Unsecured debt workouts often require multiple approaches working simultaneously with multiple creditors. A business owner should know which of his vendors or suppliers are crucial to business operation. These creditors should be prioritized and an agreement should be established before applying any company resources to any other obligations.
– Determine which vendors/creditors are replaceable: Understanding which vendors or suppliers can be replaced easily within the market by a competitor opens many options for a distressed business owner. Establishing a new vendor relationship with a different vendor before entering into a negotiation with a current vendor/creditor allows the business owner the piece of mind that the creditor will not be able to impact the performance of the company.
– Identify debts secured by a personal guaranty: Just because a debt is not secured by the business assets does not mean it is not secured by a personal guaranty from the business owner. Identifying which debts are personally guaranteed allows the business owner to calculate his or her personal exposure before entering into a workout and negotiation.
Building a workout plan that includes these four areas of interest will offer a distressed company a complete turnaround plan. Left alone, high amount of unsecured debt can trigger business cessation or default with the secured creditors. In order to avoid it, business owners must analyze their situation and create a strategy that will result in debt relief that the business will ultimately require.
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