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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