How Not to Borrow Money When Your Business Is in Financial Trouble

Finance tips for your struggling business: what to avoid.

When you've sunk money and sweat into a business, of course you don't want to lose it -- and as a result, you might be tempted to try some tactics that could cause you serious financial trouble in the long run. Don't want to make matters worse by converting your business problems into personal liability problems, or by borrowing money such high interest rates that your business won't be able to survive it. Here are some financing options that most small business owners should avoid.

Think Twice Before Using Merchant Cash Advances

Another type of financing for small businesses that make credit card sales is known as a merchant cash advance funding. It isn't appropriate when you're in financial trouble, however. It typically works like this: the cash advance company (AdvanceMe is the first and most reputable company in this field) buys your future credit card sales, advancing you a portion of the anticipated receipts. You authorize the company to automatically take a portion of your daily credit card sales through an agreement with your credit card processor.

On the plus side, if your credit sales don't end up being enough to pay back the loan, some advance companies have no recourse against you, as long as you don't switch credit card processors, because your personal guarantee is not required. The down side is that cash advance companies charge high fees, which often work out annually to as much as 25% or even 50% of the value of each advance.

Paying such high interest usually makes sense only if you're investing the money in something with a high rate of return, so that you can easily pay the fees. So you shouldn't go this route to pay regular bills, though it might make sense in an emergency. But if getting a merchant cash advance is your only hope of surviving beyond a month or two, it's probably time to think about closing your business down.

Try Not to Max Out Your Credit Cards

If you have nowhere else to get cheaper money, you may be tempted to borrow heavily against your credit cards. For three big reasons, this is usually a poor idea. First, interest rates are typically astronomical, as are late fees and an assortment of other penalties. Second, credit card debt is a personal obligation, so even if your business is organized as an LLC or corporation, if it fails, you'll be obligated to repay the credit card companies. (By contrast, unsecured business debts of a corporation or LLC are not your personal responsibility.) Third, borrowing heavily against credit cards usually means other strategies to raise cash have failed, a strong signal that your business can't be saved and you are pushing yourself closer to bankruptcy.

Weigh the Pros and Cons of Borrowing Against Your House

Given the current reality of depressed house prices and tight credit, and especially if your business is losing money, you may not qualify for a second mortgage or a home equity loan. But even if you do, think at least three times before doing so.

Taking money out of a good house to put it into a questionable business makes sense only if you really have a no-nonsense plan to return your business to profitability. Especially if your business is a corporation or LLC, meaning your business and personal debts are separate (see Nolo's article on the business vs. personal debts), borrowing against your house risks taking money out of a relatively safe and legally protected personal investment to move it into an already troubled business.

If you operate as a sole proprietor or have already personally guaranteed LLC or corporate debt, you might think it makes sense to borrow against your house (at least compared to maxing out credit cards), because your personal assets are already on the hook to pay business debts and the interest rate will be far lower. But there is a very important potential downside. By borrowing against your house you are turning an unsecured debt into a secured debt, which means that, especially in states with almost unlimited "homestead" exemptions (Florida, Iowa, Kansas, Massachusetts, Oklahoma, Rhode Island, South Dakota, and Texas), you are essentially giving up your state's homeowner protections. If you can't pay the home equity debt, you could lose your house. See Nolo's article on how the homestead exemption works.

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