Debt can be a burden for any small business owner, especially when you have multiple forms of high-interest debt that you have to keep track of and that could slow down your cash flow. One of the ways to simplify this problem is to take out financing to consolidate your debt and, hopefully, save you money by lowering the interest and fees you are paying on your existing debt.  However, as with any type of financing, there are pros and cons business debt consolidation – so when is the right time to consolidate your debt?

Why Consolidate Business Debt?

There are two general reasons you would want to consolidate your business debt. The first one is to save money on interest rates and fees. If you are paying high interest rates on a business credit card and a working capital loan, for example, you should consider consolidating those debts into a lower interest-charging business line of credit or loan. This will save you a significant amount of money on the cost of capital and fees.

The second reason is to simplify. If your business is on the hook for multiple sources of debt such as business credit cards, equipment financing, and working capital loans, your life as a business owner could be made much simpler (and more affordable) if you consolidate those into one financing option and one debt payment.

What are the Best Financing Options for Business Debt Consolidation?

Before you dive into the question of whether you should consolidate your debt, it’s important to know which financing options generally offer the lowest interest rates and the terms that go along with them. Those options are:

SBA 7a Loan

SBA 7(a) loans are offered by authorized lenders that include traditional banks and alternative lenders. These loans are backed by the US Small Business Administration and typically offer the lowest interest rates. Much like a bank loan, these loans provide a lump sum of cash upfront in exchange for a pre-agreed upon monthly payment.

7(a) loans generally require excellent credit scores and a lot of paperwork as part of the application process. If you have an existing bank loan and believe you may qualify for a 7(a) loan, this could save you money on interest payments,

Traditional Business Loans

A traditional business loan – or term loan – is offered by both alternative lenders and traditional banks. These loans are much like SBA 7(a) loans but typically charge slightly higher interest rates. A traditional loan is a good option if you are seeking to consolidate debts such as an outstanding balance on a business line of credit and a business credit card or equipment loan.

Business Line of Credit

A business line of credit gives you access to a predetermined credit line and only charges interest on the amount you draw. The interest rates for business lines of credit are generally higher than traditional loans and SBA 7(a) loans, but this could be a good option if you’re seeking to consolidate outstanding balances on high-interest business credit cards and working capital loans.

Factors to Consider Before Consolidating Your Business Debt

There are multiple financing options to choose from if you have multiple forms of high-interest debt, which may include business credit cards, business lines of credit, or equipment financing. If you are thinking of consolidating your debt, however, there are several factors to consider:

Have interest rates gone down?

Interest rates on your loans and business lines of credit are strongly dependent on the federal funds overnight rate, which can be changed eight times a year by the US Federal Reserve Bank. If the rate has gone down since you took out your traditional loan or business line of credit, you may want to consolidate to save money on the cost of capital.

Which business financing options have the most favorable interest rate?

There’s little point in consolidating your debt if it’s not going to save money. If you’re paying high interest rates on debt products such as business credit cards or working capital loans, you should consider consolidating that debt into lower interest rate products such as traditional business loans, SBA 7(a) loans or business lines of credit.

What type of financing products offer you the most flexibility?

If you’re looking to consolidate your debt, carefully consider what type of flexibility you are looking for in terms of repayment options. For example, a business line of credit is a highly flexible tool in terms of when you can borrow, but it may have a stricter repayment requirement than a traditional loan or SBA 7(a) loan. Consider the type of flexibility that best serves your needs.

Have your credit scores improved enough to notch a lower interest rate?

As a small business owner who requires debt to operate your business, you should always keep a close eye on both your FICO (personal credit score) and business credit scores. If you have an outstanding bank loan or business line of credit and your credit score has improved since you took them out, you may want to consider debt consolidation as you may be able to notch a lower interest rate.

How will you adjust your business spending once you’ve consolidated your debt?

If you’re looking to consolidate your debt, it’s important to plan on how you’re going to manage that debt afterwards. For example, in your personal life, if you consolidate the debt on your high-interest credit cards into a lower-interest-rate personal loan, but afterward you keep spending on those credit cards, your debt is going to once again become unmanageable. The same thing applies when you consolidate your business debt. If you consolidate your debt on a business line of credit or business credit card into a traditional loan, for example, it’s important to make sure your debt stays manageable afterwards by limiting your spending on your card or business line of credit.

Pros and Cons of Business Debt Consolidation

If you’re seeking to consolidate your business debts, you should carefully weigh the pros and potential cons of doing so.

Pros of business debt consolidation

• Saving money. If done correctly, consolidating your business debts can substantially lower the interest rate you’re paying on your debt. Lower interest payments can improve your cash flow and free up money to use on other parts of your business.
• Improving your credit score. By consolidating your debts, you’re effectively zeroing out the balances on any outstanding debts you may be carrying into one debt, which will improve your credit score, and credit bureaus generally don’t look favorably on too many outstanding debts.
• Simplifying your payments. As previously stated, having to manage multiple debts can become a burden. Simplifying your debts into one payment can save you time and headaches.

Cons of business debt consolidation

• The payment period could be longer. If you’re seeking to consolidate your debt into a loan, the time it takes to pay off your debt could become longer, depending on the terms of the bank or 7(a) loan.
• The payment amounts could increase. Consolidating your debts into one financing option could increase the amount you owe every week or month, even though you’d be paying a lower interest rate. For example, while high-interest credit card debt isn’t pleasant, credit cards typically allow you to make a minimum monthly payment, whereas the monthly payment on a loan is a fixed amount.

How to Consolidate Business Debt

If consolidating business debt seems like the right move after comparing the pros and cons, then the next step would be to prepare for the application process. Here’s how to consolidate business debt:

Assess Your Business Debt

Take all of your business debt into consideration. Not only will this help you determine the best type of financing for your business, but it also shows the total scope of your debt that you intend to cover. Once you’ve taken an honest account of all your business debt, you can affectively choose an option for consolidation.

Explore Financing Options

With your debt load in mind, compare different financing options with different lenders. When looking at lenders, be sure to choose a bank, credit union, or online lender that has experience working with businesses in your field. Then compare interest rates, terms, and repayment schedules for each type of financing you’re considering.

Submit Your Application

Once you’ve selected a financing option, gather the necessary documents and submit your application. Aside from providing personal and business credit scores, revenue, expenses, and other business finances, you may need to submit your existing debt obligations.

Pay Off Old Debt and Manage Your New Financing

Upon approval, use the funds from your new financing to pay off your old business debts in full. Pay close attention to your new financing and repayment plan to avoid falling back into a bad debt situation. Stay organized, make timely payments, and monitor your cash flow to ensure financial stability moving forward.

Carefully Consider Your Debt Consolidation Options

Consolidating debt could save your business a significant amount of money if you are stuck with multiple, high-interest debts. However, it’s important to carefully consider what your options are when consolidating your debt, and which financing options offer you most flexible payment options and interest rates.

For small business owners, getting the capital you need through a bank loan to maintain and grow your business can be a lengthy and difficult process, especially over the past two years as interest rates continue to rise and traditional banks have tightened their lending requirements as a result. Small business loan applicants must have excellent credit and a strong cash flow to even be considered for a loan. 

There are, however, certain financing products that have risen to prominence that allow small business owners access to working capital without having to face difficult requirements, give up equity in their business, or fill out lengthy paperwork. One of those products is revenue-based financing, an alternative way to get funds based on your business’s future revenue.

What is Revenue-Based Financing?

Revenue-based financing – sometimes referred to as sales-based or royalty-based financing – is a unique funding method in which a financing “fronts” a lump sum of cash to a small business in exchange for a predetermined percentage, or “factor” of that business’ future sales. In essence, the financing company is purchasing a business’s future sales at a discounted rate.

Let’s say that a financial institution, typically an alternative lender, fronts $100,000 in a revenue-based financing deal to a small business with a factor rate of 1.2. That means that, over time, the business owner will pay 20% of their sales on a daily, weekly or monthly basis back to the financing company until $120,000 has been paid off. There is no set date for when the payments end, they only end until the owed amount has been paid. 

Unlike a traditional small business loan which requires fixed payments, there are no fixed monthly payments in a revenue-based financing arrangement. If sales go down, the factor rate won’t change, but the amount being paid back will go down since you’re paying a percentage of your sales to pay back the “fronted” amount.

Why and When Revenue-Based Financing is Needed

Since revenue-based financing is more expensive than a loan or line of credit, it is not for everyone. If you’re seeking to invest in the long-term growth of your business by adding more space, increasing inventory, or hiring additional staff, then a bank loan is a very good financing tool if you qualify. 

Revenue-based financing, however, is a great form of financing when you need cash quickly for immediate expenses, short-term growth targets and emergencies. While it is more expensive than a bank loan, it is also easier to qualify for if your business has a strong sales history or can otherwise demonstrate the ability to produce future sales. Generally, you want to make sure your small business is making enough in sales to remain profitable under the terms of a revenue-based financing agreement. Also, since the approval for revenue-based financing is largely dependent on sales history, the financing company will typically place less weight on your personal credit during the underwriting process. 

Here are just a few examples of when businesses could use revenue-based financing:

• A small construction company is awarded a large contract but needs cash quickly to purchase inventory and hire additional workers. That small business can receive $700,000 through revenue-based financing to fulfill the obligations set in the contract. If the contract is worth $2 million and the company has a factor rate of 1.2 and must pay back $840,000, the revenue-based financing deal would be well worth it, especially if the construction company does not qualify for a bank loan or line of credit.
• A small, two-year-old retail store borrowed money from investors when it launched and has produced $250,000 in annual sales. That business needs cash to expand but doesn’t want to dilute its earnings with additional investors. Since most lenders would reject an application for a bank loan from a company that’s only two years old, that small business owner can borrow $50,000 through a revenue-based financing deal and use those funds for immediate expansion, while slowly paying back the money through increased sales due to expansion.
• A small software firm is seeking to quickly develop and launch a new product that is expected to increase sales by 20%. However, the owner does not want to pull capital away from other units to pay for the $250,000 in marketing, research, and development that it will take to launch the new product. With a revenue-based financing deal, the firm can get those funds quickly, and the sales of the new product will exceed the cost of capital in the revenue-based financing deal.

Essentially, the rule of thumb for revenue-based financing use is that the cost of the funds you receive in the agreement should be covered by the growth opportunity you are funding while still giving you profit.  The idea being that, without the funding, you would not have been able to move forward with your project and would have lost all of that potential revenue. 

How is Revenue-Based Financing Different from a Loan?

While revenue-based financing does front your business money, it differs significantly from a traditional business loan. The most significant differences are:

Easier to obtain.

The biggest difference between a loan and a revenue-based financing deal is accessibility. Obtaining revenue-based financing is substantially easier than obtaining a loan. A bank loan usually requires:

1. A good to excellent credit score;
2. Several years in business;
3. A strong cash flow; 
4. In some cases, a business plan presentation, and
5. A compelling plan on how you will use the proceeds of the loan.

The qualifications for revenue-based financing, however, are considerably less since this form of financing relies heavily on the strength of your sales. When you apply for revenue-based financing, you will often only need:

1. A fair credit score in the mid-600s, depending on the lender;
2. Typically two years in business, and
3. A strong sales history. 

No default risk.

With a traditional loan, you must pay back the borrowed amount with interest over a predetermined period. If you fail to make your payments in that confined time frame, you will default on your loan. With revenue-based financing, you don’t have this same risk of defaulting. Instead, you will keep paying the pre-agreed-upon percentage of your future sales until the money that’s been fronted to you is paid back. If sales are low, your payment amount is smaller.  If sales are great, your payment amount is larger.

Quicker funding.

Loans from traditional lenders often take time to obtain – sometimes weeks – especially if you’re trying to get a SBA 7(a) loan. Revenue-based financing is typically offered by alternative lenders and non-bank financing companies and requires less paperwork than traditional lenders. In the case of revenue-based financing, the application is far simpler than for a loan, and funding can come in as little as 24 hours. 

Revenue-based financing is more expensive.

While revenue-based financing has some unique advantages over traditional loans, small businesses must keep in mind that generally, factor rates are more expensive than an interest rate on a loan, so it’s important to carefully weigh the pros and cons of each before deciding on the type of financing to apply for. 

Revenue-Based Financing is Changing the Lending Landscape

Data indicates that with the advent of alternative lenders (the predominant financial institutions that offer revenue-based financing), this type of funding has changed the landscape of the small business lending market over the past 15 years. While revenue-based financing has been available to small business owners for the past two decades, it has gained massive popularity as an alternative financing source for small business owners who need funding quickly and may not have all of the qualifications for a loan or do not have the time required to wait on approval for a small business loan.

During periods over the past 15 years when loan requirements from traditional banks tighten and bank loans become harder to obtain, revenue-based has soared in popularity. According to the Federal Reserve of St. Louis, in 2010, two years after the Great Recession, the volume of revenue-based financing grew to $524 million – nearly double the amount from three years prior.  According to a study conducted by Benziga Research, the global revenue-based financing market size was valued at $2.8 billion in 2022 and is forecasted to grow to $4.9 billion by 2028. 

Economic Woes Bolster Revenue Based Financing

Rising interest rates since March 2022 coupled with rising inflation since the end of the COVID-19 pandemic, caused the cost of capital on bank loans to skyrocket and traditional banks to demand higher borrowing standards such as excellent credit scores and higher cash flows than in the past. 

According to the Federal Reserve, applications by small businesses for bank loans and lines of credit decreased from 89% in 2020 to 72% in 2022. Approvals for loans and lines of credit dropped to 68% in 2023 from 76% in 2020. In the Federal Reserve’s latest study, 10% of small businesses that applied for financing in 2022 sought revenue-based financing. That figure was up from 8% in 2020 – when interest rates were very low – and 9% from 2019.

Additionally, approval rates on small business loans and lines of credit have decreased dramatically, making an alternative lending option such as revenue-based financing all the more attractive. Approval rates by traditional banks were 83% in 2019, the year before the COVID-19 pandemic, and fell to 68% at the end of 2022. 

Pros and Cons of Revenue-Based Financing

As much as revenue-based financing can be an extremely valuable financing tool, it must be emphasized that this type of funding isn’t for everyone nor for every situation, as it’s more expensive than a traditional bank loan and line of credit. However, while bank loans and lines of credit are excellent financing tools, they often carry high borrowing requirements and, therefore, may be difficult to obtain for some small businesses. 

Revenue-based financing is a great funding tool under the right circumstances, but it does have potential downsides. It’s extremely important for any small business owner to closely examine the pros and cons of revenue-based financing before choosing this as a financing option. 

Pros of Revenue-Based Financing

• Revenue-based financing is easier to obtain than a loan or line of credit. Since the main requirement is a strong sales history, you don’t need an excellent credit score or three years in business to obtain revenue-based financing.
• There is no default risk since payments are based on a factor of future sales.
• Business owners don’t have to give up equity to obtain revenue-based financing like they would with private equity.
• revenue-based financing is a good way to boost your short-term cash flow without having to meet the often stringent requirements of bank loans or lines of credit. 

Cons of Revenue-Based Financing

• revenue-based financing is more expensive than a loan. Depending upon the strength of your sales and your credit rating, the cost of capital can be significantly higher than a loan or line of credit. 
• In a typical revenue-based financing arrangement, the payments you make are variable and based upon how strong your sales are. Therefore, if sales are slow, the payment arrangement can last for an extended period of time. 
• You may get rejected for revenue-based financing funding if you don’t have a strong sales history. 
• You need a strong cash flow to obtain revenue-based financing funding. For bank loans, most lenders will closely examine your cash flow to see if you qualify. Revenue-based financing providers mostly focus on your sales history. Therefore, if you have high monthly expenses and don’t adjust them to make a revenue-based financing arrangement, your business could lose money since you are giving up a percentage of your sales in a revenue-based financing deal.  

How to Obtain Revenue-Based Financing

Alternative lenders that operate mostly online offer revenue-based financing funding, so a quick online search can give you an expansive list of providers. Reputable revenue-based financing providers do have requirements for obtaining this form of funding, including

1. A credit score in the mid-600s
2. 2 years in business, and
3. At least $250,000 in annual revenue.

Watch out for Bad Actors

Some states are tightening regulations surrounding revenue-based financing, but it remains a loosely regulated industry. Therefore, when searching for a revenue-based financing provider, you may come across some predatory financing companies that are claiming to be legitimate. When researching alternative financial institutions that do offer revenue-based financing, here are some of the signs you should look for that may indicate a “bad actor”:

• It will offer you funding despite a very low FICO score (under 600).
• It does not have bonafide customer reviews.
• It does not offer strong customer service or is difficult to reach.
• It will try to rush a deal before carefully going over specific terms with you.
• It will try to downplay or gloss over abusive terms of funding, such as exorbitantly high factor rates and transaction fees.
• The lender’s history in business is obscure or difficult to research.

Consult a Small Business Financing Specialist

Many reputable financing companies offer small business financing specialists who can assist you in deciding whether revenue-based financing is a good option for your business, and you should work closely with them. The main thing to do is to examine whether you will be using the funding to increase your profits to the point that you can pay the factor rate and still be profitable. 

You should also go over the timeliness of receiving funding – are you in need of cash right away and have a strong sales history, or are you seeking to borrow funds for long-term growth? Does your sales history justify a revenue-based financing arrangement? Finally, like with any financing product, you need to go over the specific terms of repayment to make sure you can comfortably afford them. 

One of the most important resources you have as a small business owner is your employees, and therefore, one of the most important expenses you have is your ability to meet payroll. What happens, however, when your business hits a slow period or your cash flow is uneven? You don’t want to find yourself in a position in which you can’t afford to pay your employees – this could cause many of them to quit at once and harm your business’ reputation or keep the business from functioning at all.

There are various financing options available to you to help keep your payroll going during periods when your cash flow is tight or customers are slow to pay their invoices.

Fortunately, there are various financing options available to you to help keep your payroll going during periods when your cash flow is tight or customers are slow to pay their invoices.  These options can assist you in meeting salaries, payroll taxes, commissions, and bonuses until your business is in a position to meet its obligations.

Should Financing be Used to Meet Payroll?

At first, taking out a loan or other type of business financing product to meet your payroll may not seem like a good idea, but there are plenty of situations in which doing so will help your business stay on its feet and even help it grow. Here are some scenarios in which using financing is something to consider:

1. Long-term growth plans. If you are seeking to execute a long-term growth plan and need to hire additional staff as part of that plan, you probably don’t have the immediate funds to pay new employees. Financing most likely would come in handy so you can move your business forward without having to worry about how you’re going to pay your workers.
2. Handling large orders or contracts. When your business suddenly wins a large contract or receives a large order, you may need financing to quickly hire additional staff so that you can fulfill the obligations that came with the new order.
3. Seasonal needs. Many businesses make the bulk of their revenue during certain times of the year. For example, a retail shop may make most of its sales during the holiday season. In this case, financing could be used as a convenient way to maintain payroll during slower periods.
4. When customers are slow to pay. Sometimes customers can be slow to pay their invoices, but you still need cash on hand to pay your employees. Short-term financing can conveniently fill the gap between the time you need to meet payroll and the time the customer finally pays up. 

Sometimes Financing isn’t the Best Option

While financing can be an easy option to cover your payroll, it isn’t an ideal choice in all situations. If you find you can’t meet payroll because your business is struggling, then taking on additional debt to meet it probably isn’t such a good idea as it will only exacerbate the problems your business is facing. 

If your business is struggling to the point in which you can’t meet your payroll, financing will only add to your problems. Your best bet in that situation is to assess why your business is struggling and cut expenses wherever possible. This may even involve the painful step of cutting some of your staff. 

What Types of Payroll Financing Are Available?

There isn’t one specific loan product dedicated to meeting payroll, but there are several convenient financing options available to small business owners who need quick funds to cover their payroll obligations. Some of the most popular of these options with small business owners  include: 

Term Loan 

A term loan is a lump sum of cash that is paid back over time with interest – essentially, it’s a traditional business loan. This is a great option if you are looking to implement long-term growth plans and need to hire new employees. A term loan typically offers a lower interest rate than other types of financing, and the duration of the payback period can, in most cases, be pre-negotiated. 

The potential drawback of considering term loans to cover payroll is that they are the most difficult type of financing to obtain – they often require a good- to excellent credit score, and if you’re applying for one through a traditional bank, you will often face a lengthy, paperwork-heavy application process.  

Business Line of Credit

A business line of credit gives you access to a predetermined amount of revolving credit and is a flexible financing tool if your business is seasonal and you need cash to pay your employees during the slow periods of the year. You are only charged interest on the amount you use, and you don’t have to borrow the full amount when you draw on it.

The potential drawbacks of using a line of credit for payroll is that it typically comes with a higher interest rate than a term loan, and some lenders may require tight repayment terms when compared to a term loan. In many cases, you will likely have to renew the line of credit once at least once a year. Both traditional and alternative lenders offer business lines of credit.

Working Capital Loan 

A working capital loan is a short-term loan from a reputable alternative lender that can be used if you’re facing an unexpected cash crunch and need quick funds to meet your payroll. If your business suffered a slower-than-expected month or quarter or had to deal with an unexpected expense, working capital loans typically have less restrictive requirements than a term loan or line of credit, and the payback period is often 6 months or less. 

The potential drawback of using a working capital loan for payroll financing is that it comes with high interest rates when compared to a bank loan or line of credit.

Invoice Factoring 

With invoice factoring, small business owners can receive cash upfront from an alternative lender for their unpaid invoices in exchange for a factoring fee, meaning that the lender gets to keep a small percentage of the invoices when they get paid in full. This is a good option for small business owners who are facing a cash crunch due to slow or late invoice payments and will enable them to meet expenses – such as payroll – while waiting for customers to pay. What may make this option even more attractive is that borrowers are not held to the same lending requirements as they would be with a typical bank loan, and they can get the funding they need quickly.  

The potential drawback of invoice factoring for covering payroll is that it is usually significantly more expensive than a bank loan or a line of credit. Additionally, some lenders might want long factoring contracts, so carefully consider the terms of any deal you have on the table before signing on the dotted line.. 

Revenue-Based Financing

In a revenue-based financing deal, small business owners sell a portion of their future sales at a discounted rate in exchange for a lump sum of cash upfront. This can be a good option for small business owners that have a strong sales history, but who are facing a cash crunch due to an unforeseen expense or other extenuating circumstance that is keeping them from meet their payroll deadline. 

The potential drawbacks of such a revenue-based financing arrangement for payroll is that, like invoice factoring, it can be significantly more expensive than a term loan and, in most cases, you will give up a percentage of your daily sales until you have met your obligation to the financing company. 

Before considering any of these financing options, small business owners should carefully consider why they are currently unable to meet payroll.  This will help in selecting the best financing type and borrowing terms for their situation. 

Obtain Financing Before it’s too Late

As a small business owner, your payroll is one of your most important expenses. If you find yourself in a position to have to borrow money to meet your payroll, it’s important to plan to prevent a situation in which your employees are not getting their paychecks. Not paying them may not only cause them to quit, but it can also hurt your business’ reputation among future potential employees and customers. This can be especially harmful if your business operates in a tight-knit community because word can travel fast that you don’t pay your employees.  

If you have to use financing to cover your payroll, carefully evaluate all of your options and choose the financing that best suits your business and its current situation. This includes choosing the payback option that you’re most comfortable with and the fees and interest rates you’re willing to pay.