Another day, another headline about a possible recession. Whether or not an inverted yield curve or Chinese tariffs ultimately lead to a recession is anyone's guess, but there is no debating that the possibility of a recession has become a real topic of discussion. While none of us has a say in the direction of the overall economy, I see no downside in hoping for the best but preparing for the worst. So, even if your small business's SBA loan payment isn't an issue right now, sometimes life can turn on a dime. Just ask anyone who was in business in 2008.
When the great recession hit in 2008, it left a trail of small business carnage that I'll never forget. I was working for the largest SBA lender in the country as an SBA loan underwriter (for all of a month) when suddenly the company stopped lending. After a few weeks of twiddling my thumbs, I got a tap on the shoulder. The workout department could use a hand. As I'd soon come to find out, they needed more than a hand. They needed hundreds of hands to deal with their crumbling SBA loan portfolio.
In the event that another recession does rear its ugly head and you find your business floundering, there are three important facts every SBA borrower needs to know:
Talk to your bank about your loan payments (not the SBA)
Even though it's called an SBA loan, it's your lender that makes the day-to-day servicing decisions about your small business loan. That means when you have a problem, like struggling to afford your payment, you'll need to plead your case to your banker.
There are typically two types of assistance that a lender can offer: a modification or a deferment.
- A modification most frequently comes in the form of a term extension, meaning the maturity date can be extended. By extending your loan maturity from five years to 10, a permanent reduction in your monthly payment would follow.
- A deferment, on the other hand, is more short term in nature. Most often deferments are available for three to six months (occasionally up to twelve). Deferments are intended for short term blips like a water pipe burst that shuts you down for a month or a major order that sucked up all your working capital.
When you speak with your bank, there are few things to remember:
- You get more flies with honey than you do with vinegar. In other words, be nice. It helps. While there are certainly times when you should push back on the lender or take an aggressive approach, that shouldn't be the default mode. Be courteous, return calls promptly, get the lender the information it needs on a timely basis. Making your lender's life easier can never hurt. Sure, they may ultimately be a jerk or incompetent, but I always go in hoping for the best. If being kind and responsive doesn't work, you can think about shifting tactics later.
- Your workout officer doesn't work in a bubble. They likely report to someone who makes the final decision. So when they ask you seemingly pointless questions or for unneeded paperwork, keep in mind that they may not be asking because they want to, but because they have to.They are the ones who hold the power, so if you have to eat a little crow by running down some pointless information, I say it's better to grin and bear it than pick a fight over that one.
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The SBA will consider settlements
Modifications and deferments are great for blips and hiccups, but when a business is bleeding cash with no end in sight, a deferment is akin to a band-aid on a broken leg – simply not enough. In many cases, the only way to stop the bleeding is to pull the plug on the business. It's never an easy decision, but, often, it can be the right one.
Once your business closes, ideally that would be the end of it. Unfortunately, it's not. The overwhelming majority of SBA loans require personal guarantees, which means that even if your business is closed, the onus falls on you personally to make good on the debt.
While the bad news is that you're potentially on the hook for a significant sum of cash, the good news is that the government understands that they can't get blood from a stone. That's why the SBA is willing to consider settlements, a process known as "offer in compromise" (OIC).
It's important to note that an OIC is not a right and not everyone is eligible. The list of all the factors that determine whether the SBA will consider some amount of forgiveness is lengthy, but the important thing to know is that a borrower must demonstrate financial hardship and an inability to repay the debt over a reasonable period of time.
Settlements are based on a few broad concepts:
- A settlement should bear a reasonable relationship to the amount recoverable through enforced collection. To put it in more understandable terms, the SBA compares your offer to the amount they think they could get if they sue you. Can they levy your bank account or garnish your wages? If so, you'd better consider those things when devising your offer. If you don't have assets that can be garnished that helps, but it doesn't mean you are off the hook.
- Don't lean too much on the point above. You can't simply thumb your nose at the lender because all your assets are sitting in a 401K. In order to qualify for a settlement, you must demonstrate financial hardship and a lack of ability to pay. This means that even though they may not be able to force you to crack open your piggy bank, it may still be required if you hope to settle. It may not feel fair, but it's the reality that I've come to know in 10 years of working on the SBA offer in compromise.
The amount you settle for will be directly tied to your personal financial situation. There is no arbitrary percentage that will make them say yes or no to an offer. The bank and SBA will require full financial disclosure, including a special personal financial statement (SBA Form 770), tax returns and bank statements.
You should be aware that if you fail to work out a deal with your lender or the SBA, the treasury will base their settlements on an arbitrary percentage. Also, keep in mind that settlements are based on what you can afford, not simply what will be convenient for you. The SBA will want their pound of flesh, so don't expect it to be easy or cheap.
Settlements come with strings
While settling your debt is a positive thing – for both your finances and your psyche – it's not all rainbows and unicorns. While most people proceed with an OIC despite the following annoyances, they are worth knowing about:
- SBA debt forgiveness may be taxable. If a lender forgives a portion of the debt, it may result in you receiving a 1099. There is at least one exception, which the IRS outlines in this document.
- Your credit may take a hit. The SBA sometimes reports settlements to the credit bureaus. You may be able to dispute it (a few of my customers have done this successfully) on the basis that it was not a consumer debt.
- You'll land on a government "blacklist." The government maintains a list of borrowers who have defaulted on various obligations called CAIVRS (Credit Alert Verification Reporting System). If you are on this list, you'll likely have trouble landing another SBA loan, an FHA mortgage or federally-subsidized student loans.
While nobody takes out an SBA loan expecting their business to fail, it happens every single day. If a recession hits, you may just find yourself in that very situation. Is it a fun situation to navigate? Decidedly not. But the good news is that if your business begins to struggle and you're contemplating shutting your doors, settling your SBA loan might be an option for you.