No one likes to think about their business failing, but it’s a very real possibility. If your small business does go under, what happens to the loan you took out to get it started? The answer, unfortunately, is not always simple. It depends on the type of loan you took out and the terms of your agreement. In this article, we’ll explore what happens to small business loans if business fails. We’ll also provide some tips on how to protect yourself financially in case your business doesn’t make it.
What Happens to the Principal?
There are a few different things that can happen to the principal of a small business loan if the business fails. The first is that the lender may be able to recover some or all of the money through collateral. If the business has any collateral, such as property or equipment, the lender may be able to sell this to recoup their losses.
Another possibility is that the principal may be forgiven if the borrower agrees to it. This is often the case with government-backed loans, such as those from the Small Business Administration (SBA). In these cases, the borrower may be required to repay a portion of the loan, but the rest may be forgiven.
Finally, it’s also possible that the entire loan may need to be repaid if there are no other options available. This is typically only the case with unsecured loans, however, as secured loans usually have some form of collateral that can be used to recoup losses. If a business default on an unsecured loan, they will likely have difficulty obtaining future financing.
What Happens to the Interest?
If your small business loan is through a traditional lender, such as a bank, then the terms of your loan will likely include a clause that requires you to pay back all outstanding interest if your business fails. This is because when you take out a loan, the lender takes on the risk of lending you money and expects to be paid back in full, with interest.
Some lenders may be willing to work with you if your business fails and you are unable to pay back the full amount of your loan, but this is not always the case. It is important to understand the terms of your loan agreement before taking out a loan so that you are aware of what could happen if your business does not succeed.
What if the Business is Sold?
When a small business loan is used to purchase a business, the lender will typically require the borrower to personally guarantee the loan. This means that if the business is sold, the borrower is still responsible for repaying the loan in full. If the business is sold for less than the outstanding loan balance, the borrower will be responsible for making up the difference.
Personal Guarantees
A personal guarantee is a legal agreement between a borrower and a lender that makes the borrower personally responsible for repaying the loan if the business fails. This means that the lender can come after the borrower’s personal assets, such as their home or savings, to repay the loan.
Personal guarantees are often required by lenders when lending to small businesses, as they can be seen as higher risk than larger businesses. However, personal guarantees can put a lot of financial pressure on small business owners and should only be entered into if the owner is confident they will be able to repay the loan.
If you are considering taking out a loan for your small business, make sure you understand all of the terms and conditions, including any personal guarantees that may be required.
Conclusion
If a small business loan is not repaid, the lender will likely pursue collection action. This could include sending the account to a collections agency or even suing the borrower. If the borrower is unable to repay the loan, the lender may end up with a loss.
