Asset Based Lending In Vogue

Some would say that 2010 is the year of the asset based lender, or at least that can be what it looks like for a lot of businesses trying to locate and secure financing.

Just to be clear, when I talk about asset based lending, this can cover off a lot of territory including such things as inventory financing, factoring, purchase order financing, equipment financing, private real estate mortgages, and asset based loan facilities that take some combination of receivables, inventory, equipment, and real estate as security.

As compared with corporate finance provided through traditional lenders like banks, the asset based loan providers are much more in tune with how to liquidate assets in order to get loan principal repaid if required.

In a typical, non recessionary market place, there are essentially three different categories of business financing provided by the capital markets to small and medium sized businesses.  The first tier would comprise the corporate financing and small business lending programs provided by banks and larger financial institutions.  The second tier is the business version of the sub prime market that is still institutionally driven, but with a focus on subordinate debt lending and higher risk corporate finance scenarios.  The third tier is asset based lending where lending risk and the related rates are higher than traditional banking rates.

In the current market, the corporate and small business lending is slowly coming back, but remains very cautious.  The sub prime lending tier is pretty much non existent, leaving the asset based lenders as the predominant lending option in many situations.

For the most part, asset based lending is used to finance growth, transition business ownership, and provide bridge funding for companies that have experienced a down turn in their financial performance and have hard asset equity to leverage to cash flow the business until financial results allow the business to return or acquire a lower cost corporate financing solution.

Major banks also have asset based divisions for medium sized businesses that are asset rich and require greater leverage than what traditional corporate financing can provide.  But for the most part, asset based lending is focused on higher risk  scenarios where some amount of operational uncertainty precludes traditional lenders from wanting to extend business capital.

In the current capital market, asset based lenders are seeing loan applications for lower risk scenarios than what they would typically be exposed to due to the lack of financing being provided by the other sources discussed above.

The result has been a considerable expansion of asset based loans particularly in the real estate market where private lenders continue to fill the void created by banks tightening up on their lending activities.

This is a hard transition for most business owners who feel that the economy is climbing out of the recession, but can’t get their bank or traditional lending sources to provide any new capital to their business operations.

For many, turning to a higher cost asset based lender is a hard pill to swallow as they feel their business should qualify for lower cost financing alternatives.  But in the current market, growth and even survival is going to cost more with respect to business capital for many small and medium sized businesses and the sooner business owners make the adjustment, the faster they will be able to get access to commercial financing.

This is not to say that asset based lending is the only solution or best solution, but the current reality is that these higher cost financing options may be the only option available in certain cases, making their consideration more critical to the business owner.

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Bridge Financing Basics

What Is Bridge Financing, And When Should You Consider Using it?

Bridge financing is simply a short term loan that helps facilitate the completion of a transaction.  The term bridge is used to illustrate that what you’re trying to finance has a clear and definite beginning point and ending point.

In many cases, bridge financing is sought to complete a transaction quickly so that more suitable longer term financing can be secured over a less compressed period of time.

In other cases, a bridge is strictly used for completing a transaction whereby when the entire transaction has successfully closed, proceeds from the transactions will be used to pay back the bridge.

Conventional debt financing programs like factoring, inventory financing, purchase order financing, private mortgages, and other forms of asset based lending are basically bridge loans in disguise.

The key characteristics of most bridge loans is that they are a more expensive form of debt financing, but that they can also be put into place rather quickly and are designed to manage the risks associated with an incomplete transaction.

In order to secure a bridge, the borrower typically has to have something of value to pledge that the bridge financier would be interested.  The most common form of security is real estate.  A Bridge secured by real estate can potentially be used for all sorts of purposes in that if the underlying transaction or activity being funded is not successful, the lender will just realize on the real estate security.

Other forms of assets can be used to secure a bridge.  In most cases, however, the lender will require possession and potentially legal control of the assets to protect their interests which is why real real estate tends to be the security of choice.

In terms of when to use a bridge, you need to go back to the earlier definition…the transaction or application of capital must have a clear beginning and ending.

If you can see clear to the other side of a transaction and all that stands in your way of a profit or ownership of a long term appreciating asset is capital, then a bridge should be considered.  As long as the return potential of the transaction is greater than the cost of the bridge,  a short term bridge loan may be a very shrewd financial decision.

The reasons why bridge loans aren’t considered more often is 1) individuals  view them as too expensive and 2) people think that lower cost financing should be easy to come by.

There is no question that bridge financing can be pricey.  This is opportunistic based lending that takes full advantage of the time pressures that cause deals to fall apart when traditional financing can’t be secured on a timely basis.

Which leads in to the second point.

Commercial financing for any type transaction that is not straight forward is almost never easy.  The process can take way more time that you think and even when you get a commitment to fund, there can be several conditions that need to be met before any funds are advanced.

The notion of easy to secure financing kills more deals that you can image.

And that’s why bridge financing should always be considered either as a back up plan or as a short term form of financing that gets the deal done and buys time for you to find a more suitable longer term business finance solution.

From a cost point of view, which would you rather have?   A smaller return or nothing?  Most people will say they will take a smaller return if they had too, but don’t spend any time getting a bridge financing contingency in place because their so focused on getting traditional financing locked in by the deadline.

So in many cases, they end up with nothing.

Personally, I wouldn’t use bridge financing if I didn’t have to either.  The trick is knowing when you need to bite the bullet and pay the piper, versus running out of time and driving your deal over a cliff.

Something to consider.

Business Loans Come In Many Forms

What Are The Different Types And Forms of Business Loans?

First of all, what is our working definition of a business loan.  For the purposes of this post, I will define it as a debt instrument with a stated rate of interest and defined period of repayment.

Any business loan is further defined by the purpose of its use, the security involved, and the timing of the related cash flow stream tagged for repayment of the principal and interest.

When the purpose is for working capital, business loans or debt instruments will come in forms that are short term in nature and are predominantly secured by short term assets like accounts receivable, inventory, and potentially equipment.

Working capital instruments for low leverage balance sheets and strong credit profiles will include lines of credit and term loans of 5 years of less.  Lines of credit will rise and fall with the cash requirements of the business, while term loans will have a fixed repayment term, drawing money out of cash flow for structured principal repayment.

For higher leveraged balance sheets and/or weaker credit, working capital can be provided through asset based business loans, inventory financing, accounts receivable factoring, and purchase order financing.

While all of the above are technically asset based loans, lets discuss each one separately.  The standard asset based loan provides working capital funds as a percentage of the liquidation value of accounts receivable, inventory, and equipment value, similar to a line of credit.  Unlike a line of credit, the leverage tends to be higher and is more closely managed by the lender through the lender collecting all the customer proceeds due to business and then continually adjusting the loan outstanding according to the current security value.  With a line of credit, there are balance sheet ratios that need to be maintained and reported on a monthly basis, but the cash is collected and managed by the business as long as the business owners and manager stay within the stated covenants.

Accounts receivable factoring is extended as a business loan on the strength of the customer that owes the receivable and provides the lender with rights against the receivable that’s outstanding.  There are many different forms of factoring and the rates can vary tremendously.

Inventory financing provides a business loan for the purchase of inventory and uses the inventory for security.  Some inventory financing models have the lender control the inventory in third party warehouses to protect their interest in the inventory while other inventory financing models will allow the inventory to remain on the business owner’s premise if the facilities and control systems can provide the lender with sufficient comfort.

Purchase order financing provides business loans based on an advance against the value of a customer purchase order.  The credit rating of the customer, the nature of the order, and the time period required to complete the transaction will determine the amount of purchase order financing.  For instance, most purchase orders are provided on the purchase of commodity goods that have an active market and can be readily liquidated by the lender to get their advanced funds back if required.  Inventory financing is also primarily provided on commodity type goods for the same reasons.  Both inventory financing and purchase order financing command higher rates of interest than traditional forms of working capital related business loans

Other forms of short term debt can be subordinate debt financing where a business loan is provided against assets that already have debt registered against them, but with sufficient security value available to secure additional capital in a second security position.  Because of the second position, the cost of these funds will be higher than the first position debt.

For intermediate term lending on the acquisition of assets with a useful life of 2 to 10 years, business loans come in the form of term loans or demand loans for equipment.  A demand loan can demand repayment at any time while a term loan cannot.  Equipment can also be financed through leasing which is different from a business loan in that the lease company retains the ownership of the assets acquired and/or provided as security while in the case of a business loan, the assets are owned by the business with security registered to the lender.

Longer term business loans for longer term life assets such as buildings and real estate are typically financed by commercial mortgage instruments.

There are still other forms of business loans such as convertible debentures and mezzanine financing that are more elaborate in nature and tend to be utilized when loan amounts are in the millions of dollars and more complex business enterprises are involved.

There are so many variations around all these forms of business loans, that each would require a separate discussion.

The point here is to remember that if the business has something of value than can be readily sold or liquidated in the market place for a predictable amount, then there is potentially a form of business loan available to that particular business.