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Brief Background

Can Businesses Benefit From Debt Consolidation?

Businesses are allowed to file for bankruptcy protection as well as individuals but many individuals get into problems because their business is failing and they’re liable for many of the business debts. Some businesses are just sole proprietorships, others are partnerships and still others are corporations.

It’s wise to review your financial options with an attorney before you consider filing for bankruptcy because pursuing debt consolidation and looking at other options could prove to be very beneficial.

Individuals who have a sole proprietorship or a business partnership usually can file a Chapter 7 or a chapter 13 because they are individually liable on the debts. Separate legal entities, such as corporations, operate under special bankruptcy rules.

The legal entity may be able to file a Chapter 7 in which the business is essentially dissolved and the assets are sold to pay the debts. The legal entity may also be able to file a Chapter 11 bankruptcy.

Combining multiple business debts

Debt consolidation is a way of combining multiple debts into one lump sum debt. The new consolidated debt takes the place of the old ones. New debts can be unsecured or they can be secured.

Secured debts mean that the debtor gives some collateral to get the loan. There are advantages and disadvantages to debt consolidation.

For debt consolidation to really work for a business, it has to be more than just adding up all your monthly bills and paying off one of them. The key behind debt consolidation is to get better payment terms than you’re currently paying. There are two main terms that can be better:

Debt consolidation can be arranged by the debtor himself/herself, by an attorney or by a debtor consolidation service. The advantage for the debtor who arranges the debt consolidation on his own is that the he or she saves the cost of the legal fees or the service fees.

In the latter two cases, the debtor also has to shop around to find the right lawyer and an honest and skillful debt collection service. The advantage of using a lawyer who helps businesses with debts, or a service is that they’re more inclined analyze your debt situation objectively and they will also most likely have better contacts for arranging a new longer loan term.

Advantages of Debt Consolidation

Debt consolidation is private and doesn’t go on your credit report. A bankruptcy on the other hand – chapter 7 or chapter 13 – is a public matter and does go on your credit report. The negative credit rating will affect your ability to get new credit down the line, at least until the bankruptcy is removed from your credit report.

It takes 10 years before bankruptcies are removed from credit reports so discovering all your options when it comes to a business debt is the optimal path to go on.

Note that this isn’t to say that a debt consolidation won’t be reported to the credit bureau but they rarely will if ever, reduce your credit score.

Consolidating business debts makes it easier to make the payments and allows you to only have to worry about one creditor instead of working with multiple creditors at the same time.

Disadvantages of debt consolidation

Debtors often have to put up collateral to get a new consolidated loan. If they don’t make the loan payments on time, the creditor can repossess the collateral that was provided too – it’s not always the case, and we would put up a fight against this move but under certain circumstances it can be done.

If the collateral is a building or business equipment, in most cases the repossessing the building (place of business is purchased) effectively ends the business.

There are also hidden costs to look out for. In the example of extending the $1000 loan for 5 years, the creditor may reduce the loan to $500 a month but it may not be for the 10 years previously mentioned. It can be for more than 10 years which is then an extra cost for the debtor.

There can be tax consequences too. The renegotiation of the debt may mean you have more income to declare for tax purposes. In cases like this, it’s best to consult with a lawyer before you get the new loan so the lawyer can review the tax issues for you.

Business debt consolidation vs. business bankruptcy

Debt consolidation can be difficult to obtain in certain circumstances. For instance, if a business owner is behind on multiple debts, just combining those debts into a larger payment may not improve the situation unless they can renegotiate the terms.

Advantages of bankruptcy

A bankruptcy creates an automatic stay which means the debtor can focus on the finances instead of calls and letters from collection agencies and/or legal actions by creditors.

With debt consolidation. the debtor does not gets a fresh start like they do in bankruptcy. Instead, the they have to continue to pay the one larger bill. With a bankruptcy, the debtor does gets a fresh start and can begin rebuilding their business again.

In a chapter 7 bankruptcy for individuals with a sole proprietorship or partnership, all the underlying unsecured debts are discharged. If the debtor didn’t use any collateral to get the business loans, then chapter 7 will eliminate those business debts.

In a chapter 13, the individual can pay the secured business debts over time and pay just a small percentage of the unsecured business debts. Most of the times chapter 13 does seem like the sweeter option and quite often is especially for businesses.

The disadvantages of Bankruptcy

A bankruptcy does go on the debtor’s credit report and it does affect the debtor’s ability to get new credit. Although in the end a bankruptcy will give you a fresh start and a new chapter in life, the act of paying off a long term and consolidated loan can feel much more fulfilling and be much more easier than going through the whole bankruptcy process.

In the end, your best bet is always to take some time out and speak with an attorney because they understand the law much more than you can and will generally lay out the best options available to you. The choice is yours.