Why loan workout options matter
When a small business faces a sudden drop in revenue, rising costs, or an unexpected crisis, the first impulse may be to consider bankruptcy. But in many cases a negotiated loan workout preserves the business, saves time and legal fees, and produces a better recovery outcome for both borrower and lender. In my 15 years advising small businesses, well-structured workouts have often been the difference between survival and liquidation.
Lenders favor workouts when a recovery plan looks feasible: they typically recover more than they would from a forced liquidation and avoid the time and expense of foreclosure or bankruptcy. For owners, workouts can buy breathing room to stabilize operations, preserve customer relationships, and protect jobs.
Authoritative resources
- Small Business Administration (SBA) guidance on loan servicing and assistance: https://www.sba.gov/
- Consumer Financial Protection Bureau (CFPB) resources on working with lenders: https://www.consumerfinance.gov/
- IRS guidance on canceled debt and tax consequences: https://www.irs.gov/taxtopics/tc431
Common loan workout options (what they are and when they help)
-
Loan modification: A permanent change to loan terms—lower interest rate, longer term, or reduced monthly payment. Use when the borrower’s core business is viable but needs a sustainable payment profile. See our related guidance on loan modifications for businesses: “Loan Modification for Small Businesses After Revenue Shock” (https://finhelp.io/glossary/loan-modification-for-small-businesses-after-revenue-shock/).
-
Forbearance agreement: A temporary pause or reduction in payments. Best for short-term crises (seasonal dips, temporary closures) where cash flow will recover. For more context, see “Forbearance Agreement” (https://finhelp.io/glossary/forbearance-agreement/).
-
Debt restructuring / reamortization: Rewriting the debt schedule—consolidating multiple loans into one payment, reamortizing principal over a longer term, or changing payment priority among creditors.
-
Covenant waivers: Temporary or permanent changes to loan covenants (financial ratios, EBITDA covenants, collateral requirements) that would otherwise trigger default.
-
Debt-for-equity or partial equity conversion: In more severe cases, lenders accept an ownership stake in exchange for reducing unpaid debt. This reduces cash burden but dilutes existing owners.
-
Payment plans and partial repayment: Short- to mid‑term schedules that spread arrears over an agreed period; sometimes combined with a small fee or interest on the deferred balance.
-
Loan forgiveness or write‑down: Rare for commercial lenders except under specific programs; more common for government disaster programs or where lender expects little recovery otherwise.
How lenders decide: what they look for
Lenders weigh the borrower’s prospects and security. Key factors include:
- Recent and historical cash flow and profitability
- Updated financials and realistic cash‑flow projections
- Collateral value and lien priority
- Owner commitment and willingness to inject liquidity or cut costs
- The borrower’s business plan for recovery
Most lenders run a viability test: if the borrower can reasonably meet revised payments and the lender recovers more over time than by enforcing the loan, a workout is likely.
Documents and evidence you should bring
Prepare these before your first negotiation:
- Last 2–3 years of tax returns and business financial statements (P&L, balance sheet)
- Current interim financial statements and bank statements
- Rolling 13‑week or 12‑month cash‑flow forecast showing recovery scenarios
- A clear written plan explaining steps you’ll take to return to normal operations
- A list of all creditors, balances, interest rates, and maturity dates
In my practice, lenders are far more receptive when owners arrive with a realistic forecast and specific cost cuts already implemented.
A practical, step‑by‑step negotiation checklist
- Inventory debt and priorities: separate secured vs. unsecured loans and note upcoming maturities.
- Contact the lender early: call your loan officer and follow up in writing—don’t wait for a late notice.
- Present a concise package: financials, forecast, recovery plan, and a clear ask (e.g., 6‑month forbearance + 36‑month reamortization).
- Discuss options in order of preference: short-term forbearance if recovery is likely; modification if hardship is medium-term; equity conversion only as last resort.
- Negotiate terms carefully: clarify fees, interest accrual on deferred amounts, reporting requirements, and the consequences of defaulting on the workout.
- Get the agreement in writing and review it with counsel: ensure terms are precise about timing, reporting, credit reporting, and release of liens if applicable.
- Monitor compliance: deliver required financial reports and stay on top of cash flow to meet the new terms.
Pros and cons: what to expect
Pros:
- More affordable than bankruptcy in many cases
- Faster and less public than court proceedings
- May preserve credit lines and supplier relationships
Cons:
- Workouts often extend the life of the debt and can increase total interest paid
- Some workouts are reported to business credit and may affect future borrowing
- Equity conversion dilutes ownership
Credit reporting and tax implications
Credit: Workouts can be reported to commercial credit bureaus. Some programs appear as ‘modified’ rather than ‘in default,’ but a prior delinquency may remain on file. Ask the lender how they will report the action.
Tax: When debt is forgiven or substantially modified, the IRS may treat canceled debt as taxable income unless an exclusion applies (insolvency, bankruptcy, qualified principal residence indebtedness has specific rules). See IRS Topic No. 431 for details: https://www.irs.gov/taxtopics/tc431. Consult your tax advisor before agreeing to any debt forgiveness.
Real‑world, anonymized examples (patterns that work)
-
A neighborhood cafe with a months‑long revenue drop negotiated a six‑month payment deferral followed by a 48‑month reamortization. The temporary relief allowed the owner to rehire staff and rebuild sales.
-
A seasonal landscaping business used a forbearance arrangement during two slow quarters and then repaid deferred amounts over the following year once peak revenues returned.
-
A small tech firm exchanged a portion of its convertible note for additional equity when revenue prospects made cash repayment unlikely. The lender accepted potential upside in return for immediate debt relief.
These examples reflect typical outcomes I’ve negotiated and are presented to show what lenders will often agree to when a credible recovery plan exists.
Common mistakes to avoid
- Waiting too long to contact the lender. Early, transparent communication wins goodwill.
- Accepting oral promises—always get changes in writing.
- Failing to model worst‑case scenarios: prepare conservative cash flows so you don’t overpromise.
- Ignoring the tax consequences of forgiveness.
When to bring in professionals
- If you face multiple secured creditors or complex intercreditor issues, hire a commercial attorney.
- If cash‑flow modeling or tax consequences are unclear, work with a CPA or experienced financial advisor.
- For SBA‑backed loans, contact SBA resources and consider specialized counsel—SBA loans have particular servicing rules.
Resources and next steps
- SBA: guidance for small businesses and lender assistance: https://www.sba.gov/
- CFPB: consumer protections and negotiating tips when dealing with lenders: https://www.consumerfinance.gov/
- IRS Topic No. 431: canceled debts: https://www.irs.gov/taxtopics/tc431
- FinHelp articles: see our deeper pieces on loan workouts and related terms:
- Loan Modification for Small Businesses After Revenue Shock: https://finhelp.io/glossary/loan-modification-for-small-businesses-after-revenue-shock/
- Forbearance Agreement (definition and use cases): https://finhelp.io/glossary/forbearance-agreement/
- Refinance vs Loan Modification: https://finhelp.io/glossary/refinancing-vs-loan-modification-comparing-outcomes-for-borrowers/
Professional disclaimer
This article is educational and does not substitute for personalized legal, tax, or financial advice. In my practice I work directly with small business owners to tailor workout approaches—your situation may require different steps. Consult a qualified attorney, CPA, or financial advisor before signing any workout agreement.
If you’d like a checklist or template letter to request a workout from your lender, FinHelp offers downloadable templates in our resources section.
