Digging out of business debt really isn't all that different from pulling yourself out of personal debt.
While most people consider some debt to be healthy, too much debt is certainly not good for a small business. It acts as a weight around your ankle, holding you back from accomplishing your long-term financial goals. Serious debt is something that creeps up on a lot of business owners, you’re not alone.
But how can you possibly ditch your debt?
Business debt and personal liability
When serious debt is an issue, the first thing most business owners want to talk about is liability. What debt is exclusive to the business? And what, if anything, are you personally liable for? While there isn’t a straightforward answer to these questions, you should be able to determine, relatively quickly, what business debt can affect you on a personal basis.
For starters, if you’re operating a sole proprietorship or act as an independent contractor, you and your business are legally considered the same thing. You owe every penny that your business can’t pay, which means creditors can come after your personal assets when all of the business assets have been seized.
In most cases, general partnerships operate the same way. However, there’s an interesting difference. Because both you and your partner(s) are 100 percent liable for business debt, creditors can take money from any of the partners. That means if all of your partners are broke, creditors can seize 100 percent of the debt from your personal assets.
The benefit of operating under a corporation or LLC is that you and your business are considered separate legal entities. Creditors can’t touch your house or personal assets. But as always, there are some exceptions.
Creditors know that a corporation or LLC’s stakeholders aren’t liable for the debt. They’ll often require business owners and partners to sign personal guarantees; these promise they’ll satisfy the debt if the business is unable to do so. If you’ve signed any personal guarantees on your business debt, you are, in fact, liable. It’s also possible that you’ve offered up your house as collateral for a loan. Unfortunately, there’s no easy way of getting around this.
There are some other unique situations that could make you liable for personal debt, but this covers the most common issues. And regardless of whether or not you’re personally liable for your small business debt, it’s smart to start thinking about ways to dig yourself out. Debt can constrict your company’s ability to grow and can come back to haunt you, both personally and professionally.
6 tips for digging out of serious debt
Digging out of business debt really isn’t all that different from pulling yourself out of personal debt. You have to find a way to spend less than you make and put the remaining money towards your debts until they’re paid off.
Don’t confuse the simplicity of the objective with effortless execution, though. It’s going to take some hard work, so roll your sleeves up and let’s get started.
1. Check your credit report
The very first thing you need to do is get the lay of the land. It’s impossible to tackle any issue, including debt, if you don’t first have all the information and understand the facts.
One specific thing you’ll want to do is check your credit scores and reports. Even small things dramatically affect a credit score and you need to have a clear picture of what’s happening. This means reviewing your personal score, as well as analysing your business score.
While your credit score is a quick analysis of where you stand on a uniform ranking scale, a credit report actually shows you what sort of accounts you have open. As a result, you can clearly see what debt you have and begin to create a game plan for attacking it.
2. Snowball debt payments
Paying off debt is psychological as much as anything else. If you get aggressive with your debt, yet fail to see results, you’ll likely throw in the towel. On the other hand, if you start to gain some traction and see some debts disappear, the momentum builds. That’s why many financial experts suggest snowballing your debt payments.
In order to snowball your debt payments, you start by listing off your debts smallest to largest. (Note: This is contrary to the traditional route of ranking debts from the highest to lowest interest rate.) With these debts ranked, you start chipping away at your debt in order.
Because you’re tackling your smallest debts first, you start to see some “wins” immediately. You get rid of a $500 debt here, a $3,500 debt there and a $7,000 debt over there. Sure, you still have the $50,000 equipment loan and $350,000 mortgage, but you’ll eventually get to those. For now, you’re cleaning things up so that you’ll have the focus and motivation to deal with the bigger debts when the time is right.
3. Negotiate with creditors
Sometimes it’s helpful to look at debt from the perspective of the creditor. If you’ve ever had a client or customer owe you money for a long period of time, then you know what it’s like. At some point, you count the debt as a loss and assume you’ll never see it. Thus, if that client were to contact you months later and offer to settle for a lower amount, you’d likely accept.
The same is true with your own business debt. If you have delinquent debts that you can’t afford to pay in full, contact the creditor and offer to settle for a percentage of the total amount. Most will negotiate and accept a lesser amount, just to get you off their books.
4. Hire your spouse
Unless you suddenly see a massive increase in revenue, you’ll have to find a way to cut costs in order to free up money to pay off debt. You can do this in a variety of ways, but one clever strategy is to hire your spouse.
This strategy only works in certain situations, but can be enormously helpful when it does. It works like this: You find a position in your company that your spouse can fill. Instead of hiring someone like you usually would, you put your spouse in that position and pay a percentage of the going rate. If you would have paid a $45,000 salary, maybe you only pay $20,000. Sure, it has a temporary effect on your personal household income, but it frees up a couple thousand dollars per month that can go towards paying down debt.
This strategy obviously only works as a short-term fix -- and you need an agreeable spouse who is willing to sacrifice time and money for the good of the company -- but it is effective.
5. Chase down late paying customers
Maybe you have some late paying customers of your own who have unpaid debts. Now’s a good time to chase them down and collect what you’re owed. Again, you might be willing to settle for 50- or 60-cents on the dollar if means collecting on a debt that you know you won’t see in full.
You can turn around and use this money to pay down your own debt. It’s a win-win situation for everyone involved.
6. Sell off assets
One proactive option is to sell off some assets to pay off your debts. Spend some time thinking about your business and its processes. Are there certain things you could do differently without impacting the quality of goods or services you provide? You might find that you can sell a piece of expensive equipment and buy a cheaper, used version without much of a drop-off. Get creative and you might discover some options here.
Shift your mentality regarding debt
We live in a country where debt is praised. Whether it’s personal debt or business debt, people love spending money they don’t have. Sometimes it’s necessary -- such as when you’re trying to scale a business -- but much of the debt companies take on is foolish.
As a business owner, entrepreneur and individual, it’s time to shift your mentality regarding debt. It’s a myth that large purchases require debt and you need to get this concept out of your mind. Just ask Dave Ramsey, who has built an eight-figure business empire without incurring any debt. He rents until he can pay in cash, outsources to avoid debt and buys used instead of new to save a considerable amount of money.
As Ramsey explains, “The best way to grow your business is to take a lesson from The Tortoise and the Hare. Slow and steady always wins the race. You don’t need to borrow money to make it big. Instead, save for what you need and then expand. It lowers risk and minimises mistakes. And that’s the truth! No myths allowed.”
Debt might not be evil, but taking on too much debt will hold your business back and lead to a lot of stressful, sleepless nights. Now’s the time to get a grip on what’s happening and start clawing your way out. It might take years, but you’ll eventually experience the freedom that comes with owning a business that isn’t controlled by creditors.
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