A business debt is the monetary obligation of a corporation (debtor) towards another business organisation (creditor). Commercial loans represent arrangements between two parties, where the first party (lender) grants an amount to a second party (borrower) under specific terms and conditions, for a specific period of time. Commercial debt contracts include the written pledge of the borrower to return the amount in full before a particular deadline marked in the agreement. After the contract is being signed by both parties, the corporate debtor is obliged by law to respect and abide this written form, and the creditor is authorised to pursue his right to request payment from the debtor, if he does not provide the total debt amount before the deadline has passed. Breaking the business debt contract, making no difference which side violates the clauses, is considered as breach of terms and is punishable by law. A business debt most often derives from debtor’s need to fund his capital or a project. This can include different material objects or services required for a business growth, company’s inception, even for different employees’ trainings and working programs.
Business debt- profile features
Borrowing in a business-to-business relationship is more complicated and more risky than the standard individual loan, as their size is significantly larger. Generally a business debt is not a problem, until there are one or several late payments. Such delays can eventuate from overdrawn financial accounts, sudden cash flow problems, even business liquidation or bankruptcy.
Generally creditors can grant amounts to borrowers, no matter what is debtor’s monthly property income and no matter what is business debtor’s financial past. However, lenders take into great consideration debtor’s financial past and future income, i.e. debtor’s earnings after the loan has been granted. This is described with the Debt Service Coverage Ratio (source:
), which supplements the so-called risk assessment (ext. link 3). It is considered that ideally this value has to be more than 1 to be approved as optimally positive.
There are organisations in different countries that have marked the percentage rate of companies’ risk categories (e.g. the Federal Deposit Insurance Corporation in U.S., see ext. link 4) and institutions, which provide a personal FICO (Fair Isaac Corporation score, again for U.S.) for each business company. If the creditor determines that the loan will be very risky, he might file larger monthly interest on top of the full debt amount. Generally if the debtor has bad credit history, this is also considered as a risky loan and the creditor will either increase interest or refuse lending the amount.
If a company borrowing an amount decides to tie its debt with a real estate (e.g. office or building, if the firm is the owner of this property), the loan will be known as secured debt and the collateral will be a material object. As a corporate debt meaning, the loan is also known as secured commercial mortgage. If the debtor falls behind with payments and a default occurs, the creditor can request property garnishment of debtor’s business premises. Business debt mortgages are divided into two general types: non-recourse and recourse. The first is only secured by a standard collateral-business debtor’s estate property. If past-due payments occur, the creditor has the right only to foreclose this estate, but after that he is not allowed to file any other claims towards the debtor, if it turns out there is further insufficiency after the foreclosure. The recourse business mortgage is secured not only by a material collateral, but also by a personal guarantee (usually given by the owner of the business organisation). If it turns out the foreclosure does not cover the debt amount, the personal guarantee will serve as a second option for repaying the liability in full.
Refinancing of business debt & CVAs
Business debt refinancing is equal to the consolidation of consumer debts. This process represents conversion of one or more bad debts into one new loan. This is performed with the purpose of obtaining lower monthly interest and improving company’s cash flow. Such debt re-establishment converts old short-term debts into one single liability, which is more long-termed. Although the monetary obligation will prolong in time, this debt reduction method helps business debt companies to increase their income and improve their capital. Business loan refinancing is offered by specialised private organisations, which can not only provide smaller interest, but also lower or even freeze additional charges and fees.
CVAs (Company Voluntary Arrangements) are typically used in United Kingdom and Wales, but recently have become applicable in other countries as well. These agreements are an alternative to the business refinancing, as CVAs are also part of debt reduction methods. The benefits for a business debt company, when choosing a Company Voluntary Arrangement are:
- The creditor might agree to significantly lower interests or even freeze all additional fees towards the commercial debtor;
- The creditor might agree to forgive part of the full debt amount, and sometimes this portion can reach 30% less of the total debt liability;
- The aforementioned points lead to improvement and increase of positive cash flow
- New agreement is signed between the two parties, where the new monthly fees are filed in compliance with debtor’s financial condition; business debt
Used literature & external links