We are in a period of time where asset based loans have grown in significance due to the more conservative approach currently being taken by banks and institutional lenders.

In most cases, Asset Based lending is significantly more expensive than bank or institutional lending, reflecting the higher level of risk inherent in the business being financed. With greater cash flow comes lower cost forms of asset based lending as well, but for the purposes of this discussion, I’m referring to asset based lending that falls in the 18% to 24% per annum type rate range.

Any business owner will tell you that you can’t function long term on those types of rates and for the most part, they are absolutely correct.

The higher priced, and more traditional form of asset based lending is meant to be short term in nature, dealing with either distress or growth.

In a distress situation where the business is failing, gone through a down turn in the market, or has been unceremoniously dumped by its institutional lender for some reason, an asset based financing facility buys time to either turn things around, wind down, or sell off in a manner that does not destroy value or equity in the process.

For situations of growth, if the growth rate is too high, especially for newer businesses or smaller scale businesses, banks and institutional lenders will shy away from business financing these situations due to risk of the business not being able to properly scale growth and crashing and burning at some point along the way to a better top and bottom line. Once higher levels of sales are maintained over a period of time, then lower cost forms of money will be more than happy to step in and take over the business. They just don’t have the stomach for the potential wild ride that may occur during a growth spurt.

Neither a growth or distress situation can be sustained for any length of time which is why the asset based financing can be a very good fit, even at significantly higher rates of interest than what can be secured through an institutional lender.

In situations where the business is asset intensive and needs a high level of financing leverage over the long term, an asset based financing solution can still work, but its going to have to be a lower cost version which tends to require a minimum facility size of $5,000,000 and strong cash flows and margins to support a lower cost of funds.

Click Here To Speak To Business Financing Specialist Brent Finlay About Your Asset Based Loan Requirements

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Unless you’re a fairly large company with substantial profitability and assets, its unlikely that an asset based lending solution is going to be a long term or even a medium term funding solution.

The reasoning is fairly simple. The cost of most asset based lending will either not be affordable long term or will substantially eat away at your profits.

The focus of an asset based lender is to finance assets that either they can control directly or that they can easily set up a clear liquidation pathway to get their money back from the liquidation of the assets.

This specialized form of lending charges a premium for the lenders ability to provide funding in situations where conventional or traditional lenders will not be interested. By becoming focused on a slice of the asset lending market, the lending competition can be very minimal in many locales, creating an opportunity for pricing that reflect the underlying risk to the lender.

If you ask an asset based lender why their pricing may be substantially higher than a conventional financing source, the lender will regularly offer back that you’re renting equity due to the fact that the business does not have sufficient retained earnings from profitable operations or paid in capital to secure cheaper forms of money.

While some may feel this is a bit of a cheeky answer to the question, there is a lot of truth and merit in it as well.

First of all, the next option for financing if an asset based loan is secured will likely be an equity investor or equity injection from the current owners. Any investor will require a return on capital at or above what an asset based lender will be charging.

Second, by acquiring capital in the form of a loan, it can be acquired without diluting ownership and paid back according to an agreed upon repayment schedule.

Which leads us back to bridge financing. Outside of institutional asset based lenders that are priced off of the prime rate, the next best pricing options will need to get comfortable with how they are going to get paid back in one or two years or they won’t fund the deal.

Why? Because they know the cash flow will not be able to handle the higher cost of financing for an extended period of time and that without some realistic transition plan to cheaper money in the future, they will likely pass on the financing opportunity. This will then lead to even more expensive asset based loans that are more closely aligned with liquidation and price their financing accordingly, knowing full well that may of the borrowers will fail to turn the business around or find an exit strategy that will repay the debt.

That’s why its important to only enter into an asset based deal if you can clearly see the other side of the bridge or the probability of getting something in place is pretty high.

Otherwise you’ll on a bridge to nowhere fast when the cash flow can no longer service the debt.

Click Here To Speak To Business Financing Specialist Brent Finlay

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Too often business owners and managers get overly focused on their ideal form of financing versus what’s available to them in the time they have.

A good example is the current situation in 2010 where many businesses are starting to see a return to more normal business patterns as we get to the back side (hopefully) of the current recession, but they lack the working capital resources to take advantage of available opportunity.

But because last year was challenging, they not only have weak financial statements to work from but also potentially strained working capital and credit due to needing to cover cash flow short falls over the last 12 months.

And even though they may have never experienced an off year before, they still may not be able to secure incremental working capital from their bank or move to another bank to gain access to a different source of capital.

But what is likely versus what they are focused on can be two completely different things.

This is where having a basic understanding of how business financing works can be so critical to your business.   In times when a dog won’t hunt, its better to not go hunting, or take a different approach.

Lately I’ve been getting a rash of very predictable phone calls for this time of year from business owners frantically getting nowhere trying to secure additional funding with a weakened financial profile.

Is it possible to secure incremental financing or refinancing at prime plus rates in a weakened financial position while we’re still within in this more conservative recessionary lending period?

Yes it is.

Is it probable.

No it’s not.

There’s the famous Albert Einstein quote that the definition of insanity is doing the same time over and over again and expecting different results, which could have been written about business owners not understanding how to go about securing business financing at any given point in time.

Taking it even one step further, even if it were possible to secure your ideal financing in less than optimal lending circumstances, can this be accomplished in the time you have?

What good will it do to get the optimal commercial financing in place if you’ve missed the boat on solid business that could have helped you get back on track or at least generate some positive cash flow during the last 6 months of unrealistic money shopping?

When there is no financing contingency in place, and additional cash is required sooner or later to take advantage of opportunities or keep the balance sheet from further deterioration, the best capital to go after is capital that can be secured in the time required.

Once you get into this mindset, its not about getting the best potential deal, its about minimizing the costs associated with the most probable deals.   And the most probable deals are likely going to be asset based with higher costs.  They will also be bridge loans in that you’re not going to want to pay higher financing rates any longer than you have to.

Once you get focused on financing options that work with your capital needs and time requirements, the exercise becomes picking an option that you’re going to be able to afford even if the best case scenario is breaking even.

Remember, this is a short term fix because you believe better days are ahead.

But if business owners refuse to adjust their financing expectations for any point in time, they may not only descend into madness, but insolvency as well.

Click Here To Speak With Me Directly About Your Business Financing Requirements.

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There are a whole number of ways you can get into special loans, the most common is when you’re offside with one or more of your loan covenants.  But even if you’re onside with everything, the bank doesn’t have to have a reason as these loans are typically made on the condition that repayment can be demanded at any time.

So, regardless of how you got there, the bank has stamped special loans on your forehead and are either trying to squeeze the cash out of you drop by drop, or have set some sort of deadline (typically between 30 and 90 days) for repayment to occur before they start realizing on security.

So what are you’re options?

If you’re truly not offside or only marginally offside on your covenants, you could potentially go to a competitive bank that is currently interested in your business profile and industry.

The first challenge with that approach is that other banks are going to think there is something more seriously wrong to warrant the special loans tag, so they may not give your request any serious attention.

The second challenge is that even if they are interested, they may not be able to move fast enough to assess your application and get financing in place before your bank starts trying to realize on security.

A bank refinancing request for several million dollars can take 60 to 90 days, or more to complete, depending on the assessment process required and the conditions that need to be met.

So, when pressed for time, and requiring a higher probability of success, many businesses turn to asset based lenders.

For service companies that may only have accounts receivable to offer up as security, factoring becomes the only viable option in terms of speed and predictability.   But to even make this work, there will need to be enough margin to cover the higher cost of financing.  While a bank line of credit can be right around prime, factoring will run at 1.5% to 2.5% per month.

For businesses that have physical assets, there are more options to consider.

With real estate, it still may be possible to get an institutional lender to provide financing at similar rates to the ones being paid out, provided that there is a recent appraisal and environmental audit completed.

If time is of the essence, then private real estate financing may be arranged at 65% loan to value and interest rates around 10%.  There typically is only one year terms on this type of money, so you’re basically signing up for a one year bridge loan before refinancing will be required again.

Equipment refinancing will likely be based on a percentage of forced liquidation value with rates in the lower to mid teens.

If  the business has a high investment in accounts receivable, inventory, and equipment, then a working capital form of asset based loan can be arranged utilizing all short term assets as security at rates from 18% per year to 30% per year.

And for any asset based solution, there are likely going to be lender fees to pay as well, making the exercise more costly.

If you spend too much time trying to secure a cheaper financing solution for refinancing, you could run out of time and potentially be out of business.

Bottom line, you want to avoid the special loans tag at all costs.  A fast refinancing, if possible, is going to be expensive, and destroy a lot of value in the process.

Yes, every one wants the lowest cost financing, but lower cost financing is not only low risk, but very fickle as well, especially during economic down turns.  And everything is set up so the plug can be pulled at any time.

Click Here To speak to me directly about business financing

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