First of all, there can be many definitions of asset based loans.
For this discussion, we are referring to asset based loans in the context of a working capital facility that leverages the equity in accounts receivable at a minimum, but can also provide leverage on inventory, equipment, and even real estate.
The standard asset based loan or ABL type arrangement requires the borrower to open a joint account with the lender and that all funds paid to the business be deposited in this joint account.
The lender will, as they say, sweep the account every day and apply funds coming in to the balance outstanding on the loan. The borrower will request funds from the lender on a daily or weekly basis, depending on the requirements, to pay bills as they come due.
This is a highly simplified overview of how an asset based financing facility actually works from an operational stand point… each lender and financing scenario will have its own unique aspects.
There are two basic scenarios (with lots of variation within each one) where asset based loans can be considered to finance business operations.
The two scenarios include situations of growth and situations of financial distress…basically opposite ends of the lending spectrum.
In both cases, what is common is that the business requires high asset leverage to generate the cash needed to operate the business.
Under both these scenarios, conventional lending parameters may not provide sufficient leverage, causing the business to fail outright, or not be able to take advantage of growth opportunities immediately available to the business.
Most asset based loan facilities are born out of the inability of a conventional financing arrangement through a bank or institutional lender to provide the level of financing the business requires.
In highly stable companies with very strong balance sheets and cash flow, the ABL solution can be provided in house through the conventional lenders own asset based lending group. These institutional asset based lenders provide the higher leverage required at slightly higher rates than what their conventional business division would lend money out at. The large bank asset based lending programs are also only going to be available for growth and market development scenarios.
When a business cannot qualify for what we’ll call low cost institutional asset based loans, they turn to boutique lenders that provide ABL services at similar leverage, but at higher rates.
If a business is in distress, the asset based lender will provide higher leverage on assets and very tight cash management to give the business the best chance to turn things around or wind down the operations without destroying equity. Either way, this tends to be a short term solution until the business can once again qualify for a lower cost source of capital.
In situations of growth, the higher cost, traditional asset based lender will once again provide higher leverage at higher rates and serve as the senior lender until the business can qualify for a lower cost form of financing within a manageable range of leverage.
Unless a business is being funded by a low cost form of institutional ABL, the time period of business financing via an asset based loan is typically two or three years as the high cost of financing cannot be sustained over a long period of time in most cases.
Therefore, most traditional asset based loan providers are a form of bridge lender that does not expect to be financing the business into the long term.
Once again, there are many variations to these asset based loan programs, each with their own unique fit in the market place.
To better understand what type of asset based loan facility might be appropriate for your situation, you might consider utilizing the services of a business financing specialist that can help you navigate the landscape.
When a business starts to have cash flow issues, one of the first things that start to fall behind is government remittances for income tax, payroll deductions, and sales taxes.
The argument from the business owner is that there is no money available to pay these bills and still cover off wages and essential operating costs, so the government will have to wait.
And while this may very well be the case, the long term survival of the business is going to depend on having this be a short term scenario.
If it can’t be made short term, then a growing or consistent level of government arrears is likely going to start a death spiral for the business.
This is largely because you start the process of death by a thousand cuts.
Lets discuss further what can potentially transpire.
First, your existing primary business lenders will typically have a covenant that you are up to date with your government remittances. If you fall behind, at best they will charge you a higher interest rate until the remittances are brought up to date. At worst, they will demand repayment and kill your cash flow if you are utilizing any type of bank or institutional operating facility.
Second, if you want to try and restructure your existing debt, even if you have the cash flow and equity to attract more business financing capital, no lender is likely going to advance any new funds to you unless the government arrears are brought up to date. If there isn’t enough incremental capital available to do this, then restructuring will not be possible. Even if there is a way to restructure to get everything in order, it will likely involve moving to another lender, potentially a higher cost lender that works with company’s in a certain amount of financial distress, where the costs of transfer to the lender can be considerable, further putting you behind the eight ball.
Third, at some point the government will take action against you. Many times you can negotiate a repayment plan to catch things up, but if this goes sideways, then in many jurisdictions the government agency you owe the money to will step in and seize your bank account, register garnishee orders with your customers, and put you in cash flow management hell.
If you can keep the government stuff paid up to date, you improve your chances to maintain existing credit and improve your chances to secure incremental debt or equity financing.
When you’re behind with these accounts, your options are limited and in most cases non existent.
Having a plan to stay out of government arrears, or putting a plan in place to pay them up as quickly as possible is going to be important to long term survival of the business.
While there can be several different definitions to what constitutes someone calling themselves a business financing specialist, I’m going to give you my own spin based on my own opinion of the role.
To start with, a business financing specialist must be someone that is well versed in both finance and accounting with some direct experience working in a business.
The reason for these specific requirements is that the key to being able to assist a business owner or manager with their business financing needs is to first be able to understand exactly what is going on in the business and what their financing and credit profiles look like.
By having a solid background in business and finance, a business financing specialist can then determine what types of financing strategies will work and what types won’t work.
The second key requirement that a business financing specialist needs to possess is access to sources of debt and/or equity financing that providing business financing to the market that the business finance specialist serves. In addition to having direct access, the specialist must also be able to understand the lending/funding requirements of each and every source of business financing they work with and he or she must also stay up with their funding interests and criteria on an ongoing basis.
A business financing specialist is middle man (or woman), trying to connect borrower to lender, owner to investor, and so on. Without both sides of the equation, no amount of brilliant understanding of customer needs is going to do any good. The exercise here is to locate and secure capital that meets the requirements of the client.
If the business financing specialist or financing consultant cannot meet the client’s expectations, then he or she needs to work with the client to better define a financiable scenario or decline the engagement. Pushing a rope up hill is not an options. Either you have a workable engagement or you don’t.
The next characteristic of a business financing consultant is the ability to properly assemble information into a format and presentation that proactively addresses the targeted lender or investors key questions, concerns, and criteria. This is partially art and science which is developed over years of practice. The ability to tell the story properly separates the good consultants from the not so good.
The final main characteristic I will speak about is the ability to get a deal approved AND funded.
There is no consolation prize for getting close. Many times a financing deal will be 95% complete and fall apart at the last minute or level of sign off or both material and obscure reasons.
The ability to stay ahead of everyone else in the funding process, communicate on relevant and clear information on a timely basis, and problem solve issues as they arise are all keys to having business financing success.
The business financing or commercial financing process is not easy, and has even gotten harder since the start of 2008 when we have been pushed into a financial market place not seen since the second world war.
As a result, the need for business financing specialist is more prevalent now then ever.
It costs money to utilize this type of expertise, but that is no different than with other professionals including accountants, lawyers, insurance brokers, and so on.
The questions business owners and managers have to ask themselves are 1) do I know enough about the business financing process to do it myself; and 2) do I have the time to invest in the process or is my time better spent on core business activities?
One of the first things I hear business owners say about equipment leasing is that they are going to be able to write their payments off and get a tax break from doing so.
While this may be true, its not always going to work like that for a number of different reasons.
First of all, only an operating lease that is properly structured can allow you to write off all lease payments as an operating expense.
An operating lease has a number of different rules, which can vary by tax jurisdiction, but for the most part, require the lease obligation to have at least 10% of the original asset value be outstanding at the end of the lease along with the lessee having an option at most to acquire the asset at the end of the lease.
This is in contrast to a capital lease where the lessee is obligated to purchase the asset from the leasing company at the end of the lease term for a predetermined nominal amount in most cases.
If a lease qualifies as an operating lease, the payments can be classified as an operating expense and a write off against earned income in most tax jurisdictions (check with your own accountant or tax adviser).
But what does that really gain you?
If you have a capital lease, you basically fall under the same guidelines as owned equipment, which can be financed by some combination of cash and third party debt.
With a capital lease, you depreciate the asset and write off the cost of financing, if there is any, just like you do with an equipment loan.
Therefore, an operating lease does not give you a greater write off so to speak, but it can potentially allow you to write off the allowable tax expenditures faster.
For instance, one of the situations where an operating lease can have a nice fit is in the financing of grain bins.
A grain bin is going to be depreciated over 10 to 20 years as it has a long potential useful life. So the capital cost of the asset is going to be applied against earnings over a long period of time, minimizing the tax write down that is available in any one year.
But if the grain bin (or granary if you want to be really accurate) is financed via operating lease with say a three year term, 90% of the capital cost and 100% of the business financing cost can be written off in three years instead of ten or more years.
The other key element for getting an immediate tax advantage from an operating lease is you have to be taxable with a higher marginal tax rate being more beneficial than a lower tax rate.
Bottom line, there can be tax advantages to equipment leasing, but you better go see your accountant first and crunch the numbers as there is automatic benefit to leasing and the lease payments are not automatic write offs either.
As a business financing consultant my first response to the question of how to best shop around a commercial deal is not to.
There is a saying in the commercial financing world that shopping is death.
While this may be a bit melodramatic, there is a message carried with the expression that should be considered by all business owners and managers seeking business financing.
Unlike a personal credit or residential mortgage application that is evaluated on three to five readily available metrics, a business financing application can take a considerable amount of work to complete.
Each lender only has so much time and resources to invest in reviewing all the applications for financing they receive, so it only stands to reason that they are going to put their efforts into deals they think they can fund with borrowers that are committed to working with them.
The more a deal gets spread around, the more likely the lenders involved are going to become aware of this and when they do, there is a good chance they may automatically decline the deal and move on to the ones they feel they have a better chance at closing.
If you are shopping your own deal around, one of the tell tale tip offs to a lender that you are in full shopping mode is the inquiries on your credit report. Any type of application for business financing will require a credit check and when your credit gets putted and there are ten other lenders listed who have recently made inquiries, then its going to be pretty obvious to any given lender what you’re approach is and they will respond accordingly.
This may be a chance you are prepared to take, but keep in mind that the lender that declines you for shopping (even though they will never say that) could have been the best option available.
The other way shopping can go horribly wrong is through the use of financing brokers. Employing more than one broker plus submitting applications yourself will likely result in lenders receiving applications from more than one source. This again can instantly kill your options with a lender as they wonder how widely this is being shopped and how serious you are about their funding services.
As a business owner or manager, the most important thing for you to do is to manage your own deal. What that means is that you need to keep track of all the places your deal has been and if you have third party agents working for you, they need to tell you where they are planning to send the deal so that there are no instances where the same deal crosses paths.
The second part of managing your deal is not allowing a lender to pull your credit until the end of the application process. One of the ways to get them to move forward without pulling your credit at the outset is to provide a copy of your credit that you have procured yourself for your personal profile and the business profile. This won’t take away the lender’s need to pull your credit before anything is finalized, but it does allow them to make an assessment based on something reasonably current. By doing this, you are eliminating all the inquires to your credit that are dead giveaways to other lenders as to how broad this deal is being circulated.
The most important aspect of searching for business financing is to intimately understand your own financial and credit profile as well as the lending targets that are going to be interested in both at a particular point in time so you can hunt with a rifle instead of a shot gun.
The best way to do this is to work with a business financing specialist who can develop a detailed understanding of your profile and requirements and get you in touch with the most relevant lender or lenders right away so that you’re not wasting valuable time trying to cover the whole market with applications.
Its hard to look at the news these days and not hear or read about someone in a debt crisis, whether it be an individual, business, or country.
A debt crisis typically occurs when there is more money going out than going in and debt is used to fill the gap or hole in the cash flow.
Debt is acquired by leveraging assets on the balance sheet.
In order for any business to be able to access business financing debt and/or not get their existing debt called, they have to manage their balance sheet so that it meets the requirements of the lender.
In times of recession and down turn this can be extremely difficult, especially for new businesses.
But for existing businesses, governments, and countries, how many debt crisis scenarios could be avoided if better balance sheet management was being practiced?
By keeping the balance sheet in order (working capital ratio greater than 1, debt to equity ratio less than 5, all debt payments up to date, etc.) the business retains its ability to borrow money for times of growth and times of distress.
In good times, debt needs to be paid down, and in bad times debt may need to be required to keep the business going until the economic forces change back in favor of making profits.
But if a business is always living too close to the edge, good times or bad, there is no margin for error, and this is when a debt crisis occurs.
Proper planning and proactive management of the balance sheet will not guarantee that your business will never fail or reach a debt crisis moment.
But it will increase the probability that you will survive unexpected economic events by providing you with the means to finance yourself out of problems to a certain degree.
And if you do fall into this type of debt financing need, its going to be important to pay back the debt and build up your buffer for future needs.
While this may all seem totally elementary, building debt is an easy trap to fall into.
When things are going well in the economy, lenders will bend over backwards to give you access to more debt, even if it works against the fundamental balance sheet principals you should be managing.
And when there is a down turn, there is little forgiveness for those that are over extended as they are typically the first casualties.
The fundamentals are always the fundamentals.
Sometimes you have to say no to an opportunity if its going to overextend you too far for too long of a period of time.
Some times you have to retreat and try to minimize the damage when things are going against you versus throwing good money after bad.
By keeping your balance sheet in order, you will always have better options to consider than if you don’t.
And if you plan to stay in business for a long period of time, the ups and downs are going to be inevitable, so maintaining a strong borrowing basis is not really an option, its a requirement, unless you like walking a financial tight rope every once in awhile.
Even though we are living in a credit centric time where cash management is becoming more of an after thought, the power of cash or being in a cash position is and will always be considerable for those that know how to properly manage cash.
When I’m talking about cash, it can be actual cash in the bank or a revolving line of credit that has funds available against the approved limit.
In either cash, we are talking about the lowest cost form of money you have at your disposal and how you should be managing it.
When I speak of getting the most out of cash, its based on having a good working understanding of what the cash flow will look like over a period of time as well as cost/benefit relationships between receiving cash and making cash payments.
Everything thing in any business can be boiled down to two things … time and money. Everything you earn and spend will result in a cash transaction at some point in time. Everything you acquire or need to repay will have a specific payments required at a closing rate or scheduled payment date.
By understanding the expected inflows and outflows of your business in sufficient detail, you can determine how to best utilize cash to get more than face value.
For instance, paying suppliers within a discount period may provide a greater return on cash than buying an asset for cash that could have been partially or completely financed.
Collecting money sooner than later provides more cash in hand to apply in the business, but what types of cash or non cash incentives have to be provided to do so?
The first step in any form of serious and worthwhile cash flow management is to complete a cash flow forecast.
I recommend that any business forecast the future inflows and outflows of their business for at least 90 days, and turn it into a rolling forecast by updating it at least once a week, adding an additional week into the future and carrying forward and/or adjusting inflows and outflows that have not been resolved on schedule. Also, cash forecasting should be done in weekly time segments as monthly segments are too long an interval to match up inflows and outflows.
By going through this exercise at least once a week, you have a much better perspective of the cash that’s going to be available at any point in time as well as when cash may be short or in jeopardy of being short.
This can be extremely useful in situations of business distress and business growth.
In situations of distress, its going to be important to understand exactly when all commitments are going to be coming due, which ones can wait, which ones will require some servicing, and so on. Its going to be important to make sure that funds are available every pay period to pay salaries, otherwise everything will quickly grind to a halt.
In situations of growth, more capital may be required to fuel growth in the form of more inventory, more equipment, more working capital, more accounts receivable.
Properly utilizing cash to keep the balance sheet in order and leveraging cash to its fullest to secure cheaper forms of business financing can be instrumental in funding growth.
But getting greater mileage out of cash starts with weekly cash flow forecasting, months into the future.
The sooner you start to incorporate this type of discipline to your weekly routine, the sooner you will start seeing the benefits.
As a business financing consultant, my role in helping business owners and managers locate and secure business financing is to focus in on what is both 1) relevant and 2) attainable to them in the time they have to work with.
The cost of money is always going to be relevant to risk and supply for any business at any time.
Which basically means that the money (and its related cost) that can be available for what you want to do today can be very different to what may be available in the future or what was available in the past.
I bring this up because of the confusion that constantly gets created by different providers of capital, each living in their own little myopic world at times, explaining to business owners what cost of money they should or should not be paying.
One of the worst offenders of what I will call “cost of money confusion” are the major banks or “A” lenders who believe that if you can’t qualify for their low risk, low cost funding, that you shouldn’t be in business at all.
Worse yet is when they draw business owners or business managers in that are easily “on the bubble” at best in terms of qualifying for Big Bank financing, only to either provide a less than adequate financing facility or none at all.
This speaks to what is truly relevant to a business owner with a particular financing request. If you have lots of time, like 6 months or more, and want to take a flier at lower cost forms of money that you are likely not going to qualify for, then you may want to consider giving it a shot.
If you are under any type of time constraint where you’re trying to close a transaction, have an opportunity to expand sales, or need capital for some purpose where failure to do so by some time will either incur incremental operating costs, or cause you to have an opportunity cost incurred, then part of the criteria for considering different money suppliers is when is the cost of money less than or equal to the cost of the opportunity, transaction, or operating cost?
Because business financing can be difficult to secure most of the time, especially when you’re talking about larger amounts, sometimes the cheapest form of money is not the best target, even if you can qualify for it.
Relevance and availability is about zeroing in on best likely money supply source at a given moment for a given purpose.
Too often, business owners will spend months and sometimes years searching for the cheapest source of money because they have been brainwashed to believe its the only thing that’s relevant to them.
In the mean time, while they are looking and searching, they are likely forgoing some opportunity that could have been making them money…potentially far in excess of any incremental cost of capital they may have had to incur to get business financing in place sooner.
Don’t get me wrong…I’m all for super cheap money.
But…and its a big but…the circumstances and timing have to be right to go after it.
If you can’t operate on anything other than the cheapest forms of money available, then so be it. That will be a limiting factor going forward for sure.
The most cost effective source of money that exists at any given point of time, is the money you can secure (with terms and conditions that you are prepared to accept) and get funded in the time you have to work with… where the cost of capital is going to be less than or equal to the incremental economic return you expect to generate from investing more money in your business.
The notion that you should only consider money sources that fall into a certain snack bracket when it comes to cost is whimsical.
A good business man understands this and utilizes sources of capital that allow him to take advantage of opportunities and make a profit.
Sometimes, the net margin will be more and sometimes it will be less.
But without incremental capital, the margin is zero, regardless of the cost of money.
It has been an interesting summer to say the least in the world of business financing.
In a typical summer, things start to slow down by the beginning of August, with not much of anything going on in the last two weeks as everyone takes their last shot to get in some summer vacation.
This is not a typical year with a large amount of activity going on during July and August, much of which was unplanned due to the impact the U.S. credit down grade has had on the financial markets.
The primary form of capital to small and medium sized businesses is through the debt financing markets, which can come in a number of different shapes and sizes.
Every debt lender has to borrower the money they put out from somewhere and their own balance sheets must hold certain debt/equity ratios in order for the funds to keep flowing.
Sometimes the source of supply can go a few levels deep, with each successive source of debt financing having to manage their own balance sheet.
When the market took a nose dive, capital and equity went up in smoke, forcing some business financing sources to the sidelines, unable to produce a balance sheet that would allow their supply of funds to continue.
The result is that businesses that appeared to have a business financing facility lined up were left scrambling to find someone with money that they could move their business to.
In many cases, this is going to be more opportunistic lenders, pricing to the supply and demand of the market.
But shorter term money that is more expensive may be better than no money at all.
The same is true and more profound with equity investors and private placement houses who saw their capital get reduced significantly in a matter of days. And even if their are sources of equity that remain fairly unscathed to this point, they are still likely taking a more cautious approach to writing cheques on new deals.
The end result has been a very busy July and August with very little chance of a slow down of any sort as business owners and managers frantically look for new dance partners to fund their requirements.
And despite the low overall levels of interest, these types of sudden short term corrections can become more expensive in order to correct the new supply and demand dynamics.
If you’re looking to locate and secure commercial financing for your business, regardless of the form of financing, then you may want to consider how important starting off in the right direction can be.
First of all, when I say different forms of financing, sometimes there can be a variety of different ways to leverage your assets and cash flow to get the business financing you’re looking for. The different forms of financing will also vary in how they are applied by any particular lender, so the combinations of potential solutions can be considerable at times.
On the flip side, the potential combination of solutions can also be a real smoke screen in that many of what you might consider to be potential options are not options at all due to the way you’re financing request and business financing profile align with a particular lender’s requirements at any given point in time.
Enormous amounts of time can be wasted chasing the wrong solution, and in many cases a suboptimal solution is selected because of time constraints or due to the business owner or business manager’s lack of understanding with respect to what was available to them in the market place.
So the first step towards commercial financing success starts with an accurate assessment of your business financing requirements and your financing and credit profile.
Each lender will have lending/funding criteria that you’re going to have to meet to get approved and funded.
If you’re financing and credit profiles do not meet these requirements for specific lenders, then they need to be quickly eliminated from the selection process of sources of commercial financing to pursue.
Therefore, it becomes critical to business financing success that you understand where you financing request fits into the market before you start applying to commercial lending sources.
But this initial assessment process can be hard to self assess if you aren’t actively involved in the market and aren’t grounded in what the current lending/funding requirements are for a given lender or lending category.
To avoid making the whole process a hit a miss approach, you would do well to consider the services of a business financing specialist who can perform the key initial assessment with you to best determine the financing target you need to be focusing in on.
This can not only save you months of time, but also allow you to successfully locate and secure financing in the time period you have to work with. Too often additional costs are incurred or transactions are lost due to the inability to get commercial financing in place when required.
If you are in need of commercial financing for your business, regardless of the application or the assets and cash flow you have to leverage, I suggest you give me a call so I can quickly assess your situation and provide relevant commercial financing options for your consideration.