Education Library · Foundations · Article 8
A contractor needs $40,000 to cover payroll and materials while a large job waits 45 days to pay. There’s no bank line in place, so he takes an advance that funds the next day, with a payment pulled from the business account every business day. The job pays, but the daily payment keeps coming out, and a few weeks later cash is short again. A second funder offers another advance. By the time he applies for a bank term loan to clean it all up, the bank is looking at two daily debits on his statements, two liens on his receivables and a stack of recent applications, and it declines.
Each of those decisions made sense the day it was made. Together they changed what the business could qualify for next. That is what debt sequencing means: the order in which a business takes on debt affects which doors stay open afterward.
Every approval changes the next application
When a lender reviews a business, it looks at the debt that’s already there. Existing payments come out of the same cash flow the new lender is counting on to get repaid. Liens already filed tell the new lender where it would stand in line if things went wrong. Recent applications and newly opened accounts show up too.
Inquiries are part of this. On the personal side, FICO says hard inquiries stay on a credit report for up to two years and affect FICO scores for one year. One inquiry doesn’t move much. A cluster of them in a short stretch, along with several new accounts, can look to an underwriter like a business searching for cash, which is often exactly what’s happening.
An approval also changes the picture. A new $1,500 monthly payment is $1,500 less cash flow the next lender can count on. That’s fine when the debt pays for something that earns more than it costs. It becomes a problem when the payment itself starts creating the next shortfall.
How stacked short-term debt blocks bank and SBA options
Merchant cash advances and many short-term business loans collect daily or weekly, and those payments show up on every bank statement a future lender reviews. Many of these funders also file a UCC lien on the business’s receivables or other assets, and many agreements include clauses restricting the business from taking other financing against the same assets. Taking a second or third advance on top of the first is called stacking.
A bank or SBA lender usually wants a clear collateral position and enough cash flow to cover its payment comfortably. A stack of daily debits and prior liens makes both hard to see. An auto repair shop doing around $1 million a year had four advances at one point and was declined for a refinance. As our team recalled it on a later call, the lender didn’t want to go behind the advances that already held the first lien positions.
Another owner had about $307,000 between two advances and two short-term loans. One bank told him it would consider refinancing if the balance were under $250,000. He described another decline this way: “they’re like, we don’t like your cashflow. And it’s like, but if you refinanced everything, my cashflow would be amazing.” He was probably right about the math. The lender, though, was underwriting the business as it stood, payments included, and not the business as it would look after the refinance.
Refinancing current business debt is an allowed use of SBA 7(a) loans, and some lenders do refinance advances into term loans. The lender still has to be satisfied that the business can repay, and the deeper the stack, the fewer lenders that will look at it.
The cheapest money is usually the hardest to get
Bank lines of credit and SBA loans tend to carry the lowest rates and the longest terms. They also ask the most of the business: tax returns, financial statements that tie out, solid personal credit from the owners, and often collateral. Underwriting takes weeks, sometimes longer. For SBA 7(a) loans, the business also has to show it can’t get the credit it wants on reasonable terms from a conventional lender.
Fast money works the other way. It can approve on a few months of bank deposits and fund in a day or two, and the cost reflects that.
The timing problem follows from those two facts. When a slow month or a late-paying customer hits, the only money that can arrive in time is the fast, expensive kind. The low-cost options have to be applied for and approved while the business looks strong, before it needs them. A line of credit set up during a good year and left mostly unused is very different from one applied for while payroll is three days out.
Match the term of the debt to what it pays for
A truck that will work for seven years can reasonably be paid off over five. Putting it on a 12-month loan, or an advance, makes the payment far larger than the truck’s contribution in any given month. On the other end, a 45-day gap between doing a job and getting paid for it is a short-term need, and paying interest on it for five years doesn’t fit either.
The SBA builds this idea into its own rules. A 7(a) loan is generally limited to 10 years or less, unless it finances real estate or equipment with a useful life longer than that, and real estate loans can run up to 25 years.
Mismatches are how many stacks start. Equipment or a buildout gets paid for with short-term money, the payment squeezes monthly cash, and the squeeze gets covered with another short-term advance.
What to look at before the next debt
Before signing, it helps to see how a new obligation will look to the next lender:
- How often the payment comes out, and how it compares to a slow month’s cash flow, not a good one
- Whether the lender files a lien, and on what: one piece of equipment, receivables or all business assets
- Whether the agreement restricts other financing, and what it costs to pay off early or refinance
- Where the account reports, if at all
- How many applications have gone out in the last few months
Contract terms, lien language and anything with tax consequences are questions for your attorney or CPA.
This article is educational and isn’t legal, tax, accounting or lending advice. Program rules, lender terms and credit bureau practices change, so verify current terms before acting.
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