When used poorly, business debt can cause irreparable harm to your business. Understanding the difference between good and bad business debt is crucial so you can learn how to use it for your benefit. 

Anyone can take a shot at becoming self-employed and becoming their own boss. Unfortunately, learning the financial ins and outs of a business is not as easy.

Starting and running a successful business is challenging. Not knowing what liabilities you are taking on is one of the main reasons why so many entrepreneurs are struggling with mounting business debts.

17,051 business bankruptcy cases were filed in the U.S. in 2023. Not knowing how to deal with debt when you want to wind down the business is another challenge faced by many business owners.

Read on to learn more about the basics of business debts, how much debt you should be carrying, and how debt solutions can help when debt becomes overwhelming.

What Is Business Debt?

Business debt is any money that you have borrowed for your business needs. It can be in the form of a business loan, money borrowed from family for retail space, or anything else.

Personal debt and business financing can be easily confused depending on how you keep your books and run your business. But any money that you borrow to start your business or to keep it afloat is considered to be business debt.

In certain cases, you will be personally liable for small business debts, such as:

  • You are a general partner or a sole proprietor.
  • You do not maintain your LLC or corporation and do not have limited liability protection.
  • You do not make business tax payments.
  • You have provided a personal guarantee for business debt.  

If you are personally liable for any debt you take on for your business, you’ll be responsible for paying it even if your business fails.

What’s a Healthy Level of Business Debt?

Generally, a medium-sized business should have a debt ratio below one. A debt ratio is a metric that calculates the relationship between the total assets and total debt of a business.

72% of all small businesses have an unpaid debt. 40% of businesses have outstanding debts of over $100,000.

A high debt ratio can make it difficult for you to get new business loans. It's important to monitor your financial health and reduce the amount of your company’s debt.

You should also be aware of your business’s debt threshold. This is the maximum debt your business can comfortably carry.

For most businesses, the debt threshold is a coverage ratio of two times or more. The coverage ratio measures the ability of your business to make debt repayments.

It can be calculated by dividing your EBITDA (earnings before interest, taxes, depreciation, and amortization) by your debt payments.

If you have a higher coverage ratio, you’ll be less likely to default on your debt payments. 

What Are Examples of Business Debt?

Not all business debts are the same. Here’s a deeper look into good and bad business debts.

Examples of Good Business Debt

Here are a few examples of what good business debt looks like.

Business Loans

When you borrow business debt loans to increase the revenue or margins of your business, it’s good business debt.

Mortgage

When you pay off mortgage debt, the property can be worth a lot more than the purchase price. Mortgage can help you increase your net worth, so it is a good business debt.

Examples of Bad Business Debt

Here are a few examples of bad business debt:

Debt To Pay off Debt

If you take on debt to pay off existing debt without a proper plan, you’ll still be left without the cash flow to pay for it. It doesn’t have a positive impact on the bottom line of your business, so it is a bad business debt.

Cash Loans

These loans typically come with high interest rates. Unless you are using it to boost the revenue of your business for the short term, it is a bad business debt.  

What Happens to Debt When a Business Closes

What happens to business debt when you go out of business will depend on the type of debt you owe and the structure of your company. 

Debt is a common pain point for companies that do not have an exit strategy. 2 in every ten small businesses fail within their first year, and another 5 in every ten small businesses fail within the first five years. 

Once the decision has been made to close the business, you’ll have to take certain steps to formally close the business at the state level. You’ll continue to incur taxes until you formally dissolve the company with the federal, state, and local governments.

Here’s how business debt will be treated after the closure of your business:

  • Every business will have different tax liabilities. If you have any employees, you’ll be required to submit payroll taxes. You’ll also need to file a final tax return to finalize any obligations with the IRS.
  • Your creditors will have different rights based on the state you reside in. In some cases, you may be subject to collection activities and civil lawsuits if you are unwilling to negotiate a settlement.
  • If you are a sole proprietor, you may be personally liable for any tax obligations and outstanding debts for your business.
  • If your business operates as a partnership, you’ll also be personally liable for your business debts.
  • If you operate under a limited liability partnership, you’ll have more protection against liabilities.
  • Limited Liability Companies also offer personal liability protection from business debts and liabilities.

4 Ways To Get Business Debt Relief

If your business has been struggling to stay afloat due to mounting debt, you may be tempted to sell or close the business. Consider these business debt relief options before you take a drastic step.

1. Debt Consolidation

Business debt consolidation can make repayments easier for borrowers by consolidating all their credit cards and bank loans into a single payment. You’ll only be dealing with one lender instead of several.

A business debt consolidation loan can replace your higher-interest debts with a lower-interest rate loan, so you’ll be saving thousands of dollars in interest charges.

The new loan can be secured or unsecured. If you have any business assets, a secured loan can help you get an even lower interest rate.

If you don't have enough documentation for a business loan, there are a few financing options you can choose from, like short-term loans, merchant cash advances, a line of credit, or invoice financing.

Choosing to work with a merchant cash advance company can provide immediate funding in exchange for a percentage of your future sales. This can be a valuable option for businesses that require quick access to capital; however, it’s crucial to weigh the potential higher costs and the impact on your cash flow before moving forward.

2. Debt Settlement

Check to see if your debt is eligible for business debt settlement. If you have microloans or an SBA loan program and aren’t able to pay back the full amount, you may be able to submit an “offer in compromise.” 

A debt relief company can negotiate with your lenders on your behalf to reduce the amount of debt you owe. It is possible to reduce your debts by 50% before fees.

This will help you pay off your debts faster and settle your accounts in 24-48 months. If you have bad credit and cannot qualify for a low-interest consolidation loan, debt settlement can be an option worth considering. 

3. Debt Management

If you need guidance on how to deal with your business debt, a professional credit counselor can help. Your counselor can review your financial situation and develop a budget and repayment plan to help you succeed.

If you are eligible, your business debts will be enrolled in a debt management program. 

Your counselor can also negotiate repayment terms with your lenders to eliminate or reduce fees, interest charges, and penalties. You’ll then have a monthly payment schedule so you can start paying off your debts. 

4. Bankruptcy

If you have no other options, filing for bankruptcy may be your last resort. Chapter 13 and Chapter 11 are two common options for small business owners. Both of these are debt reorganization methods.

In some cases, you may have to file for Chapter 7 bankruptcy, where you will be required to turn over your business to a bankruptcy trustee. Your assets will then be sold to pay taxes and distribute funds to your lenders.

Consult an experienced business debt attorney for advice and to determine the cheapest way to file for bankruptcy. While it can help you dissolve all your debts, bankruptcy is an expensive and complex process that can seriously impact your credit score.  

Take Action Today To Deal with Overwhelming Business Debt

There are several debt relief options available at your disposal if you are dealing with a lot of business debt. Compare all your options to see how they will affect your business and finances.

TurboDebt is a reputable and experienced debt relief company that can help you lower your debt burden and live a stress-free life.

Contact us for a free consultation today. Our team offers advising, consultation, and planning services to help you find the right solution that fits your financial needs.

Here’s what our satisfied clients are saying about our debt relief services.