How to Use Asset-Based Loans to Take Advantage of Arising Opportunities
By Chris Morin, EVP / Bay Area Regional Director of Commercial Banking, Scott Valley Bank
Starting a business or managing a business during a rapid growth stage can be challenging. The business lives or dies based on the business ownerís access to capital or the ability to obtain proper financing. Many banks today, small and large, offer traditional business lines of credit that are based on a businessís collateral and the strength of the balance sheet and income statement. Then there are many non-bank finance companies that offer more structured asset-based financing solutions. The primary assets considered are accounts receivable, inventory, and equipment. Depending on the specific situation, this can be an acceptable solution, especially if your business has strong assets and a contingent of credit-worthy customers.
Banks offer asset-based formula lines of credit to companies that have historically profitable operations, but which may exhibit higher leverage, weaker working capital and personal guarantees, while maintaining good accounts receivable and inventory.
An example of a business with such an arising opportunity might be a manufacturer that is looking to bring on a large client, but does not have the cash to purchase the inventory needed to fulfill the clientís order. An extensive review of the existing accounts would examine account quality, identify concentration(s), past-dues, dilution (account credits), and any other ineligibles. Once determined, the bank can then structure a line facility that advances a certain percentage, say 60% to 80%, of those eligible accounts. Finished goods inventory (if on hand) can also be included into the review and structure, and an advance of 15% to 50% against eligible inventory could be provided. The line is then closely monitored, usually every 30 days, to make sure the line balance stays proportionate with the assets being leveraged. The client remains responsible for billing and collecting accounts and properly applying regular line pay downs. This can be a short-term financing solution to meet a short-term need. The scenario would change if the same manufacturer presented the same opportunity, but they had lost money the last few fiscal years. This is where a non-bank solution may be ideal.
Non-bank financing companies can offer solutions to businesses, but not so much on the same criteria as a bank. They place much more emphasis on the specific collateral being pledged by the business. Therefore, the non-bankís accounts receivable financing (and potentially inventory financing) can be similar to bank structured financing, but adds an increased element of review, monitoring, and collection of accounts. The businessís customers may be contacted or notified of the arrangement, asset reporting is more frequent, and the collection of payment is usually controlled via lockbox. Whatís the upside? More financing may be received and obtained quickly with less business credit quality and there are usually no financial reporting requirements and loan covenants.
Another non-bank solution is factoring accounts receivable. This is an arrangement in which a business can actually sell its accounts receivables as opposed to pledging them. The factor gives a business a certain percentage, say 70% to 90% of the accounts, and depends on the strength of the payer. The business can be selective about which accounts it sells. The finance company in this scenario assumes all of the credit risk and the business gets quick cash.
The economy in the last few years has forced many businesses from many industries to review the structures just discussed. There is far less negative connotation attached to these options today and many more companies are willing to provide this financing. Using asset-based financing can get your company started or to the next level. If you are starting a business or have a growth opportunity, reach out to a qualified source such as your banker, CPA, or a finance professional to identify proper solutions that will meet your businessís needs and help you get it moving, or keep it moving.