How to Pay Off Business Debt: 6 Orderings That Change the Total Cost

Sequence costs money. Two owners with identical debts and identical cash can finish a year in different positions because one paid in the order the creditors demanded and the other paid in the order the documents imposed, and the difference will not appear on any single statement.

What follows is an order, six places long, for a business that cannot pay everything this month. It is not the order a collector would propose. It assumes the company intends to keep operating and that the owner would prefer not to inherit the company's debts personally, two assumptions that shape nearly every choice below.

1. Money Withheld From Employees Is Paid Before Money Borrowed From Anyone

The federal income tax and the employee share of Social Security and Medicare withheld from paychecks never belonged to the business. The IRS calls these trust fund taxes because the employer holds the employees' money in trust until it makes the deposit, and 26 U.S.C. 6672 imposes a penalty equal to the unpaid amount on any person required to collect and pay it over who willfully fails to do so.

Two features move this debt to the top of the list. The penalty lands on individuals, a "responsible person" identified by duty and authority rather than title, and the IRS describes willfulness as intentional disregard or plain indifference, with no evil motive required; its own example of willfulness is paying other business expenses instead of the withheld taxes. And bankruptcy will not erase it for an individual: section 507(a)(8)(C) gives priority to taxes "required to be collected or withheld" for which the debtor is liable "in whatever capacity," and section 523(a)(1)(A) excepts those taxes from an individual's discharge.

The employer's own matching share is a tax of the business, not trust fund money, and it sits one step lower. States add their own versions. In New York, for example, the sales tax statute makes persons required to collect the tax personally liable for it.

An MCA funder can sue. It cannot make the owner's liability survive a personal discharge in the way the tax code does, which is the entire argument for this position.

2. Collateral the Business Cannot Replace Comes Second

A secured creditor does not always need a court. Under UCC 9-609, after default a secured party may take possession of the collateral, through judicial process or without it, so long as it proceeds without breach of the peace. The delivery van leaves the lot one night, and the next day's orders go unfilled.

The test is replacement, not size. A $2,000 monthly note on the only oven in a bakery ranks above a larger unsecured balance, because missing it threatens the revenue from which every other creditor is paid. A note on a second vehicle the business rarely uses may not rank at all.

3. Rank Debts by What an Extra Dollar Saves, and an MCA Dollar May Save Nothing

The instinct is to attack the most expensive debt first, and the merchant cash advance is usually the most expensive debt in the file. The instinct misreads how an advance is priced.

An interest-bearing loan charges for time. Pay principal early and the interest that would have accrued on it disappears. A hypothetical term loan carrying 14 percent simple interest saves roughly $2,800 for each year that an extra $20,000 of principal would otherwise have remained outstanding.

An advance is typically priced at signing. The purchased amount is fixed, and the fee is already inside it. Take a hypothetical advance with $45,000 left to collect at $450 per business day: that is 100 business days of debits. Send an extra $20,000 and the remaining $25,000 clears in about 56 business days instead of 100. The business still pays $45,000. The cost did not fall; only the calendar moved.

Six months into an advance, then, the expensive part has already been committed, and the only prepayment that lowers the total is one the contract rewards, through an early payoff discount or a negotiated reduction. Some agreements offer the first. An owner who learns which kind he signed only after the wire has gone out has learned it at full price.

Ask for the payoff figure in writing before sending anything extra. If the written payoff is identical to the remaining purchased amount, the extra dollar belongs, for cost purposes, to the loan that charges interest.

Whether a funder that prices by time in its marketing and by the fixed sum in its contract has described its product fairly is a question the contract does not invite.

4. A Guaranteed Debt Has Two Debtors, and One of Them Signed Your Name

Where the owner personally guaranteed a loan, a lease, or an advance, a default by the company becomes a claim against the owner's house, accounts, and future income. Paying those obligations ahead of unguaranteed ones protects the person who will have to rebuild if the business closes.

But the preference cuts in more than one direction. If the company later files for bankruptcy, section 547 lets the trustee recover certain payments made while insolvent within 90 days before filing, and within one year where the creditor was an insider, provided every other element is met. An owner who guaranteed a debt benefits when the company pays it. Whether that makes the owner the kind of creditor the one-year rule reaches is a question counsel should answer before the company begins paying guaranteed creditors ahead of the rest.

5. Avalanche and Snowball Answer a Question a Business Rarely Asks

Household debt advice offers two methods: pay the highest rate first (the avalanche) or the smallest balance first (the snowball). Both assume the monthly payment is roughly proportional to the balance. Business debt breaks that assumption.

Consider three hypothetical obligations. A card balance of $8,000 requires $240 a month. An equipment note of $30,000 requires $900 a month. An advance with $18,000 remaining collects $300 per business day, which across 21 business days is $6,300 a month. Retire the card and $240 of monthly cash returns, 3 percent of the dollars spent. Retire the note and $900 returns, also 3 percent. Retire the advance and $6,300 returns, 35 percent of the dollars spent.

For an operating company with thin cash, that release ratio is often the number that decides survival, and it can run opposite to section 3. The advance whose early payoff saves no cost is the one whose payoff frees the most cash. Both statements are true.

Which to honor depends on whether the business is short of profit or short of time.

6. Whatever Remains Is the Negotiating Pool

After taxes, essential collateral, guarantees, and the cash calculation have taken their places, the debts left over are unsecured, unguaranteed or already in default, and too large to pay on their original terms. Those are the candidates for negotiation.

They are also the debts that tend to be loudest.

Where Delancey Street Fits in the Order

Delancey Street works on the last category and on merchant cash advances wherever they fall in it. It negotiates with creditors. Because the company is not a law firm, a file that needs legal work goes to outside attorneys who hold their own licenses. The first review costs nothing and stays confidential. A business whose first problem is withheld payroll tax needs a tax professional before it needs Delancey Street, and one facing repossession of essential equipment may need a bankruptcy lawyer. The rest of the list can be sorted in an afternoon, with the agreements open on the desk and the bank statements beside them.