Read the Fine Print in Your Business’ Debt Obligations
Retail giant Toys R Us recently filed for bankruptcy, and according to reports, it did so for the same reason that many individuals do: The company took on too much debt. If you think that big companies are immune to the pitfalls of loans and debt, think otherwise. And if debt is enough to crush national brands like Toys R Us, imagine what it could do to your small business.
Toys R Us Goes Under
After falling on hard times in the early 2000s, Toys R Us was purchased by a number of private equity firms, including Bain Capital. Those firms obtain numerous loans for the companies they purchase, which may be enough to reinvigorate them, but also may be more debt than those companies can handle. But at the time loans were easy to come by and business gave little thought to how they would be paid back.
Then the economy tanked, and the company was left having to continually refinance the debt to keep it affordable.
You may have noticed that while companies like Wal-Mart and Best Buy made the move to online sales and internet presences, Toys R Us never really did. That’s largely because the money that would be needed to modernize with the times was instead used to service debt. By the time it filed for bankruptcy the company was spending four hundred million dollars a year to pay debt.
Chapter 11 Reorganization
As you probably know from experience Chapter 11 bankruptcy isn’t a death knell for companies, but rather a chance to reorganize by cutting expenses, restructuring contracts, and being monitored by creditors and bankruptcy courts.
Toys R Us is seeking to renovate its stores to keep up with the times, but whether the bankruptcy court will allow that is another issue.
Business owners should take a lesson from Toys R Us, and be very wary of the debt that they take to try to “save” a failing company. Usury laws will often provide little protection as in many states, usury loans don’t apply to business loans, or else they may have much higher interest allowances than consumer loans do.
Another practice common in today’s market is receivables funding, or merchant financing. This kind of loan is disguised as not actually being a loan. Rather, a lender “purchases” the future sales of a business. So, for example, the lender may pay $10,000 for $20,000 worth of the merchant’s (debtor’s) receivables.
The good news is that the merchant only has to pay back the receivables from sales when and if they occur, and thus, there is no consistent monthly payment. The negative, of course, is that however you look at it, the interest rate is huge and possibly shielded from usury laws since it may not technically be “interest.”
Surely not all debt is bad and it can be used to make improvements to your business. Just make sure you understand the fine print of any loan that you take out, so that you aren’t stripping your business of the ability to grow.
Make sure your business is safe when signing important agreements and documents. Contact Tampa asset protection and business attorney David Toback to review your contracts and business documents.