Redemption at Hand for Small Businesses in Debt

Small businesses rode a wave of easy credit in the first decade of the 21st century, until the era of lax lending came to an end in a financial meltdown that’s lasted nearly two years. In 2010, debt-mired small businesses may get a shot at redemption.

Just how much debt is small business in? It’s difficult to get an exact number, as private companies don't readily divulge their borrowing details. But one window into this world of red ink is the Federal Reserve’s figures for outstanding debt for noncorporate businesses, since noncorporate companies tend to be smaller entities. Its numbers show that noncorporate business debt exploded between 2006 and 2008, jumping from around $3 trillion to $4 trillion. The sector hasn’t had much success paring it back either: In the third quarter of 2009, debt topped $3.8 trillion.

Of the 60 percent of small businesses that have borrowed money, most remain able to service their debts, says William Dunkelberg, chief economist at the National Federation of Independent Business, a small business lobbying organization. But a number of business owners clearly ended last year deep in debt trouble.

As 2009 came to a close, business loan delinquencies continued to grow. A study conducted by commercial loan risk management firm PayNet showed that nearly 1 percent of companies with capital equipment loans were at least 180 days delinquent in November 2009, a figure that’s been rising for 22 straight months. In all, the study revealed that more than 4 percent of owners were over 30 days delinquent with a payment.

The end result for many small businesses unable to repay their debt is bankruptcy or business closure. Last year, record numbers of businesses sought bankruptcy protection, according to data from the administrative office of the U.S. Courts. In the first three quarters of 2009, there were over 45,000 business bankruptcy filings, more than the entire number of filings in 2008. In the third quarter, more than 15,000 businesses sought to reorganize under Chapter 11 bankruptcy protection, up 32 percent over the same period in 2008. Companies filing to liquidate their businesses under Chapter 7 rose 36 percent through the third quarter of last year, compared with the third quarter of 2008, to nearly 10,800.

“Usually the bankruptcy rate doesn’t peak until a couple of years after a recession is over,” says Dunkelberg.

That doesn’t bode well for struggling businesses, and indeed the debt picture has never looked bleaker for many small companies. But other forces, both micro and macro, indicate that the situation may improve as the year progresses.

According to NFIB’s December 2009 “Small Business Economic Trends” survey of its members, business owners say an improving economy and uptick in sales will help them dig out of debt.

Evidence suggests that they may get their wish. The nation’s gross domestic product is expected to break out of its slump and grow about 3 percent this year, a recent survey of 56 economists found.

Sales growth will accelerate as the year goes on, says small business economic advisor Bill Conerly of Conerly Consulting. “We probably hit bottom six months ago,” he says. And there’s a silver lining in all those bankruptcies that have occurred and are likely to continue this year and next: less competition, which also drives more sales.

Another factor that could help debt-strapped business owners is a revival in lending, which would give owners a better shot at consolidating existing debts or refinancing loans to get better terms. Though the U.S. Treasury Department reported that the top 22 small business lenders shrank their small business portfolios by $1 billion in November compared with October, 5 of the banks reported that they increased their small business lending.

Perhaps, though, the best option for small businesses facing debilitating debt isn’t to rely on macroeconomic forces, but rather to take matters into their own hands, an approach used by Los Angeles-based Jumbo Music, a music production company owned by composer Jonathan Grossman. A few years back, Jumbo was earning more than $500,000 a year by providing music for a major network TV series. Grossman employed a full-time assistant and about seven other musicians.

Then the show got canceled, and all three of the subsequent projects Grossman worked on fell apart. Grossman started using his business’s bank lines of credit to cover needed musical equipment purchases. By mid-2009, Jumbo Music was $140,000 in the hole, and close to falling behind on payments. Grossman’s home had lost value in California’s real estate collapse, so there was no home equity to tap.

“I felt like I had no options,” he says.

Grossman sought out professional help from Consumer Recovery Network, a national debt counseling firm. He learned that at least one economic factor was working in his favor: Cash-strapped lenders are more open to renegotiating existing loans so they can clear their books of bad loans.

“Creditors and lenders are more willing to negotiate than I’ve ever seen in the past,” says Gerri Detweiler, credit advisor at Credit.com. “Some creditors are settling debts for 20 cents to 50 cents on the dollar.”

Grossman employed that strategy, offering his bank $20,000 to settle one $95,000 line of credit. A negotiation ensued, and he ended up paying $25,000 from a liquidated IRA account to resolve the debt. He closed the deal on December 31, benefiting from the credit manager’s need to end his year with some of his bad loans off his books. Grossman expects to pay off the remainder of his debt shortly.

Grossman’s strategy won’t work for all small businesses and will vary by lender and geographical location. Expect lenders in hard-hit regions of the country to stay open to settlement offers longer, says Dunkelberg of NFIB. That party may be already over in places such as Texas, where the downturn was less pronounced. But banks everywhere that are overleveraged in real estate loans and are desperate to diversify their loan portfolios may be willing to settle.

Business reporter Carol Tice contributes to several national and regional business publications.