A business loan is the most common form of finance for small businesses, particularly in the early days. But what happens if the business does not take off as you had hoped, or it falls into a slump and you cannot afford to repay the loan?
In this guide, we’ll take a look at the potential consequences of failing to repay a business loan and the steps you can take to avoid them.
What are the Common Causes of a Default on a Business Loan?
To qualify for a business loan, relevant eligibility criteria must be met and you will have to go through a stringent application process. However, despite ticking the lender’s boxes, unexpected events can occur that can lead to missed repayments and loan defaults.
Common causes of loan repayment problems include:
- Poor cash flow due to late payments from customers
- A fall in the demand for products and services
- Financial mismanagement
- Unexpected bills or damaged equipment
- Staffing problems
- A shortage of raw materials that impacts output
- Seasonal sales fluctuations
These are just a few of the unexpected challenges that can cause business owners to miss a payment on a loan. In most cases, you can make up for one or two missed loan repayments once the business’s cash flow situation is back on track. However, it’s not always so easy to turn the business’s finances around. If you miss multiple loan repayments, that could lead to a default on the loan, which is when you’ll see a dramatic escalation in the action that’s taken against you by the lender.
What’s the Difference Between a Missed Payment and a Default?
A missed business loan repayment will be recorded on your company’s credit file, but as long as it’s a one-off, it’s usually not something that you need to worry too much about. The lender will typically get in touch to discuss the missed payment, ask you when it will be made and find out what’s going on in your business. However, as long as all future payments are made on time, the impact should not be too great.
A default occurs when you have missed multiple debt repayments. Three to six months of missed repayments is a common benchmark to trigger a default. This is extremely serious and fees and charges will be added to your account and the full loan amount will become due. From this point, there are three ways the situation will usually be resolved:
- You will set up a new payment plan with the lender to repay what you owe plus the additional charges and fees.
- The lender will seize business assets provided as collateral, or personal assets in the case of a personal guarantee, to recover the loss.
- The lender will petition the court to force your company into liquidation to try to recover as much of the loan as possible.
What Should you do if you Cannot Make a Loan Repayment?
If you know that you’re going to struggle to make a loan repayment before it is due, you should contact the lender to let them know. Lenders don’t like surprises and there will usually be more options available to you if you give them forewarning rather than keeping them in the dark.
It’s in the lender’s interests for you to repay the loan, so they will usually be willing to work with you to renegotiate the terms of the deal. That could be by accepting reduced monthly repayments over an extended term, by negotiating a reduced but immediate in-full repayment or potentially by pausing your repayments until the business is back on track. This shows commitment and responsibility on your part and will stand you in good stead with the lender.
What are the Costs Associated With Missing a Loan Repayment?
Depending on your lender and the terms of your loan, missing even one loan repayment could incur additional interest charges, fees and fines. For example, failing to make a payment on time could result in a late payment charge that’s a percentage of your monthly instalment. You may also be required to pay the administrative costs the lender incurs by notifying you.
Although this may not be a large amount initially, with repeated late or missed loan repayments, the costs will quickly add up. It also erodes the lender’s confidence in you, which increases the likelihood that it will take more serious action by notifying you that you have defaulted on the loan.
What Happens if you Default on an Unsecured Business Loan?
An unsecured loan is a funding solution that does not require any business assets to be given as collateral. That means, if the company cannot repay the loan, those assets cannot be seized by the lender to recover their loss.
If you are a company director taking out an unsecured loan and you have no track record of borrowing, the lender may ask you to sign a personal guarantee. If you agree to sign a personal guarantee and the company cannot repay the loan, you can become personally liable for the repayments.
If you find yourself in the position that you cannot afford to repay an unsecured business loan, the likely consequences are as follows:
- The first response from the lender will usually be to chase the missed payments in writing. That’s likely to include warnings that if the payment is not received by a certain date, additional fees and interest charges will apply. The lender will also inform the credit agencies that payments are late and this will be held on your company’s credit rating for six years.
- If no payment is made, the lender is likely to pass the handling of the case on to a debt collection agency. They will try to make contact with you over the phone, by letter or in-person to recover the debt on the lender’s behalf.
- If you do not respond to the debt collection agency, fail to make the payment or do not agree to a payment plan, the lender is likely to take out a County Court Judgement against you. This will remain on the company’s credit record for six years and will make it difficult to secure affordable funding during that time.
- At this point, the situation is critical. The lender will be able to issue a winding up petition to your registered business premises to inform you of its intention to close down your business if payment is not made. After just seven days, the winding up petition will be advertised in the Gazette, which will let banks and other creditors know that your business is in the process of being forced into compulsory liquidation.
- Once the banks see the advertisement in the Gazette, they will freeze your company bank accounts, That will make it very difficult to make the loan repayment even if you wanted to. The winding up petition will be heard by the court and if the court sides with the lender, a winding up order will be made which will instantly force your company into liquidation.
- A liquidator will be appointed and the assets of the business will be sold to repay the creditors, including the lender. If no personal guarantee has been provided by the company directors, any debt that remains unpaid following the company’s liquidation will be written off. If a personal guarantee has been signed, the lender could take action against the company directors to recover the balance of the loan and personal bank accounts, vehicles and even your house could be at risk.
What Happens if you Default on a Secured Business Loan?
A secured business loan is one that’s secured by the assets of the business or the company directors personally. If the business cannot repay the loan, the lender has the legal right to seek possession of and sell the assets to recoup their money. As the loan is secured against an asset such as property, vehicles or machinery, the risk for the lender is reduced, which typically translates into lower interest payments and wider eligibility criteria.
This is likely chain of events if you default on a secured business loan:
- As with an unsecured loan, the first action by a lender will usually be to write to you chasing payment and warning of late payment penalties and additional interest charges. They will also contact the credit reference agencies and the late repayments will stay on your credit record for six years.
- If no payment is forthcoming, the lender will usually pass the case on to a debt collection agency. They will contact you to try and negotiate the repayment of the loan, either in full or via a payment plan. If they are unsuccessful, a County Court Judgement (CCJ) may be issued against you, which will do serious damage to your credit score.
- Once every effort has been made by the lender to collect the payment by other means, it will have no choice but to call upon the security that was used against the loan. The lender will be able to take possession of and sell the assets that have been given as security to recoup their loss. If the security you’ve given is your home, the lender will need a court order before they can take possession of it.
What Happens if you Cannot Repay a Loan With a Personal Guarantee?
Due to the additional risks associated with unsecured loans, lenders will often ask for company directors to provide a personal guarantee. That allows the lender to pursue the company director personally for the loan repayments if the company cannot make them. Exactly how personal guarantees are enforced will depend on the lender and the terms of the agreement. However, it’s important to note that lenders are not legally required to exhaust all enforcement options against the business before pursuing a director personally.
If you cannot repay a loan with a personal guarantee, the creditor’s first priority will be to negotiate settlement terms. If a settlement cannot be reached, the creditor may issue a statutory demand or County Court Judgement (CCJ). With your personal assets at risk, at this point you must not bury your head in the sand.
The only way to get out of a personal guarantee is to renegotiate the terms of the loan, come to an agreement to repay the loan or go bankrupt. A lender can still pursue you for the repayment of a business loan with a personal guarantee after the company has been liquidated, which could have disastrous consequences for you personally.
What Should you do Before Defaulting on a Business Loan?
As you can see, defaulting on a business loan can have very serious consequences for your company, and in some cases, for you personally. It will appear on your business’s credit report for many years after the default and make it difficult to source credit and run the business effectively.
If you cannot afford to repay a business loan, you may think a default is inevitable. However, there are a number of things you can do.
- Talk to your lender
Your first step should always be to pick up the phone and talk to your lender. Taking enforcement action against you takes time and costs money, so the lender will almost always try to find an alternative solution if they can. That could be by temporarily reducing your payment amount or by negotiating new loan terms.
- Ask to defer the loan
Deferring the loan postpones repayment for a few months to give you some breathing room so you can work on improving the company’s financial position. A deferment will not be recorded on your company’s credit file but interest will continue to accrue, so in the long run, the loan will cost you more.
- Refinance the loan
Refinancing a business loan could prove to be an effective way to raise funds to repay the debt. You will need to find a cheaper deal with reduced interest rates or longer payment terms for this method to be effective. Some businesses have used the government’s Bounce Back Loan Scheme for this purpose.
- Negotiate a company voluntary arrangement
An inability to repay a business loan is a good indication that your company is on the road to insolvency. In that case, a company voluntary arrangement (CVA) could be an effective route out of trouble. A CVA is a formal insolvency procedure that gives you more time to repay debts such as unsecured bank loans. A licensed insolvency practitioner must be appointed to draw up repayment proposals that are put to your creditors. If the proposals are agreed, you will be given between two and five years to repay your outstanding liabilities, including unsecured loans, in monthly instalments. During this time, you will be free to trade and be protected from legal action taken against you by your creditors.
Are you Struggling to Repay a Business Loan?
At Company Debt, our licensed turnaround practitioners have experience successfully renegotiating personal guarantees and agreeing settlements with lenders. We can also help you arrange a CVA or put your company into liquidation via a CVL. Please get in touch with our experts for a free, no-obligation consultation to discuss the best way forward.