In many ways, a business loan can be a savior for an entrepreneur who needs financing.
Small business loans can help you get out of a cash crunch, purchase game-changing (but expensive) equipment for your business, or help you seize an opportunity that will move the needle for your business.
While debt financing is an important resource for small business owners, small business loans need to be handled with the utmost care—they can have a huge positive or negative impact on your business’s financials.
But as a small business owner, you know better than anyone—running a small business is risky. Any sort of fluctuation can cause a setback and a missed loan payment.
What happens when you miss a couple (or maybe more) of your business loan payments?
Here’s what small business owners need to know.
What Happens When You Miss a Couple of Loan Payments?
Running a small business is a variable game.
And for things to run smoothly, you might feel as though everything needs to fall exactly in place.
One missed invoice payment on a customer’s end or even a burst pipe in your storefront can all of a sudden put a dent in your business’s wallet. Or, in the larger scheme of things, an economic recession or industry fluctuation can put strains on your financials.
When these unexpected costs and financial troubles arise, it’s tough to stay on top of your business loan payments at the same time.
When you start getting behind on your loan payments, your business loan will be considered “in default.”
Each small business lender will consider your business loan in default at different points—some after the first time you miss a payment and some after a few recurrent missed payments. (To find out exactly when your specific lender considers your loan to be in default, try reaching out to them directly about their policy.)
Once your business loan is in default, you can absolutely expect your business lender to reach out to you regarding your one or multiple missed payments. They’ll not only ask for a reason why you’ve missed payments, but in some cases, they’ll offer assistance or adjustments in terms that could help you more realistically reach your payments.
The way lenders handle this scenario will, again, vary from lender to lender.
Kabbage, for instance, will have one of their account management professionals work with you to find a solution that will help you make your loan payments. As another example, Lending Club will give you a 15-day grace period for making up your payment without incurring any penalties. And finally, a lender like OnDeck (that automatically deducts payments from your business’s bank account) will consider your payment delinquent if they can’t draw sufficient funds—but will help you by renegotiating terms and payment amounts so that you can pay the loan back in full.
Hopefully, working with your lender will help your business bounce back after a couple missed payments—allowing you to start repaying your debts again.
In this scenario, your business credit score will likely take a hit from your missed or late payments—almost all lenders report defaults to the various credit reporting bureaus. The worst consequence is that your business credit score can go down, making it harder and more expensive for you to secure other credit accounts—like future loans or business credit cards—in the future. Or you might find that your lender charged late payment fees to your account each time you missed a payment.
But for the most part, you can be on your way once you’ve made up for the late payments and are back on the ball.
What Happens When You Cannot Pay Your Loan Back in Full?
Hopefully your business rebounds from a missed loan payment with not too much damage done to your credit score or funds lost to missed payment penalties.
But what if things continue to go south and you can’t possibly repay your business loan in full?
While lenders will try to work with you in the most helpful way possible, more and more missed payments will result in more aggressive collection practices from your lender.
And after a certain amount of days (depending on the lender), your business loan will be considered a “charge off”—meaning that the lender doesn’t expect that you’ll ever pay your business loan back.
In this worst case, lenders will take measures to recoup their losses incurred by your loan default.
Just how—and how much—they collect after a business loan default depends on a few circumstances of your loan.
Secured vs. Unsecured Business Loans
If you can’t pay your loan back, the first thing to consider is whether your loan was a secured business loan or an unsecured business loan.
Collecting on Secured Business Loans
Secured business loans are backed by some sort of valuable asset as collateral—a house, savings account, car, jewelry, equipment, accounts receivables, etc.
In the case that you can’t repay a secured business loan, lenders will seize any and all (depending on your loan agreement) of whatever you offered as collateral to recoup their losses.
An example of this is an equipment loan. With equipment financing, the equipment itself acts as collateral for your loan. If you miss loan payments to the point where you’ll never be able to repay your loan, the lender can simply seize your equipment to make up for what’s lost.
Collecting on Unsecured Business Loans
If, on the other hand, you didn’t offer collateral against your small business loan, you have an unsecured business loan.
While you technically don’t have any of your valuable assets on the line, that doesn’t mean lenders won’t go through a collection process to recoup their monetary losses.
In some default cases, a lender will handle judgments itself. Some, however, will go to a collections agency to hand over the collections process.
It’s also important to note that if you have an unsecured business loan, odds are your personal and business assets are on the line in some way.
That’s because oftentimes unsecured business loans come with personal guarantees.
Many different types of personal guarantees exist. But generally speaking, a personal guarantee is a legal agreement that lets the lender you’re working with seize any of your personal assets until they’ve fully recouped their losses. A personal guarantee doesn’t stake claim on one type of asset specifically, but it gives a lender the right to seize any asset until they’ve made their money back.
There are limited and unlimited personal guarantees—and you’ll want to know which one you’re working with. (As the name suggests, an unlimited personal guarantee gives a lender full reign to collect your assets when you default.)
But know that in the case that you can’t pay back your unsecured business loan and are held to your personal guarantee, you could stand to lose any and all of your personal assets.
One more factor that goes into how a lender collects defaulted loan payments is whether your business is subject to a lien when you take out a small business loan.
A lien is a legal claim that can be written into you loan agreement, allowing a lender to acquire and sell your business’s collateral and assets if they can’t collect the full loan payment from you.
There are a few different kinds of liens, but a blanket lien is the one you should be most wary of if you default. It’s the most encompassing kind of lien, giving the lender the right to seize almost every kind of asset and collateral a borrower has to recoup their losses.
In the case that you default on your loan payments with a lien on your business, the consequences of a blanket lien can be severe.
How to Avoid Falling Behind on Loan Payments
If you find your business slipping into the red, the best practice is to be fully upfront with your lender.
Let them know beforehand (or as soon as possible) that you won’t be able to make this week or month’s loan repayment.
By being proactive and fully transparent about the situation, your lender will be more willing to work out a situation in which you won’t default on your loan payments, and they’ll eventually get back the money they lent you.
After you work through the financials and agreements with your lender, hopefully you can make it back to clear waters.
Loan defaults are a bleak and scary picture—we know.
But it’s important that borrowers are fully aware of the consequences of missed loan payments.
Always make sure that you’re taking on a business loan that you can afford and practicing solid borrowing habits when you take on business debt.
And if you start to slip on your loan payments, act quickly and responsibly so as to avoid these worst cases!
This article was originally published on the Fundera Ledger on March 16, 2017.