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Where’s The Money Now? |
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By Nicholas Jalowski,
Managing Director, CTP, CMC |
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If you are one of the many companies that had a down year in 2009, and are now looking to borrow money, did you hit a roadblock when you requested it from your bank? And if your bank is not willing to make the loan, do you know what other options are out there? In this article, I’ll try to explain why the banks are hamstrung to increase lending, and offer some existing market alternatives to find the funding your company needs.
Let’s start with the banking industry. Commercial banks are highly regulated businesses; primarily because they are entrusted with deposits from the public.As such, they must justify the loans they make through careful underwriting, and periodically convince auditors that the loan can be repaid in full. If there is any indication that the loan may not be paid in full, the bank may be required to classify the loan and take a loan loss reserve. Banks do not like taking loan loss reserves as it hurts their bottom line performance.
Now here’s where it gets a little convoluted.Current regulations require that banks demonstrate that their borrowers have “historical” earnings that can comfortably amortize the loan in question. Otherwise, the dreaded classification and reserves are in play. So what if you’re a middle market converter and, like many,had a down or loss year before you request a new loan? Well, that’s a problem, because with a down or loss year, you may not have the historical earnings that the bank needs to demonstrate that the loan will be repaid.Thus, you get declined for credit.
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The banks are caught in a Catch 22.They are getting hammered by the public right now for not making loans. But if they make the loans to businesses that have suffered setbacks, they get hammered by the regulators to immediately classify the loan and increase reserves.Therefore, the safest route for the bank is to only lend to pristine, financially strong companies, or
not at all.And unfortunately, it is the small and middle market businesses that need the capital right now as they make their comebacks. |
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The statistics bear it out. In a recent Wall Street Journal article, the FDIC reported that “loan balances across all major loan categories fell during the second quarter, and total loan and lease balances fell 1.3 percent. Total
assets for the industry fell 1 percent to $13.2 trillion during the quarter.” |
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Four Loan Sources |
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Like nature however, the capital markets do not leave a void unfilled for long. So where is the money now? I’ll give you four general categories of funding that you can turn to as an alternative to a bank loan. But understand upfront that the cost of most of these alternatives will be higher than a bank loan. |
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The first stop on the pecking order of alternatives would be asset based lenders; sometimes called ABL companies. ABLs can be divisions or subsidiaries of commercial banks, or they can be independent finance companies. This category of lending has picked up dramatically in the recent past due to the fall off in bank lending, and because of the way they underwrite their loans. While the conservative ones will still factor in recent earnings, the key to the underwriting is not so much net income, but the turnover and value of the assets they are financing. |
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ABL loans are not repaid with earnings per se. Rather, they expect to be repaid with a turnover of the asset financed. For example, assume an asset based lender finances 75 percent of an eligible account receivable. The loan is repaid when the receivable is collected; regardless of whether the borrower made a profit on the deal or not. |
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The key to obtaining this type of financing is to have enough available collateral for an ABL lender to underwrite
the loan. What type of collateral do ABLs lend against? The most prevalent facilities are revolving
lines of credit with advances against accounts receivable and inventory. But some may also consider other
categories of assets including equipment, real estate and even intellectual properties. |
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| ’Banks are getting hammered by the public right now
for not making loans. But if they make the loans to
businesses that have suffered setbacks, they get hammered
by the regulators to immediately classify the
loan and increase reserves.’ |
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This type of lending is booming. According to an article in the abfjournal, a trade publication, “assetbased
lending picked up in the second quarter,closing out the period at $16.7 billion, a 43 percent increase
over Q1/10 issuance.” |
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Keep in mind that ABL lenders come in all flavors and niches. Some will not consider a loan below a certain
dollar threshold amount, some will not lend on inventory, some only lend in a certain geographical
territory.You will have to do some homework to find
the ABL lenders that fit your loan parameters. |
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The Commercial Finance Association, a trade group
made up of many asset based lenders, has a web site
that can help you in your search. After typing in
www.cfa.com, click on the “Find a Lender” tab above
and it will guide you through a search. |
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Loan/Lease Option |
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If you need equipment financing, the loan and leasing market has been coming back. Lenders such as
People’s Capital and Equipment Finance Corporation
are actively in the market seeking borrowers. But
again, the larger deals are probably going to require
good historical numbers. If you had some financial difficulty
and are looking for smaller funding amounts,
you may do better.This is due to the way the leasing
companies underwrite their leases. |
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Generally speaking, leasing companies have two
methods of underwriting their deals depending on the
amount of the request.They select a monetary threshold
to place you in one or the other category based on
their past experience. If your request is under the
threshold, they will review what I call your “willingness
to pay.”They usually check a bank reference and
three trade references, and if it looks like you pay your bills, they will grant the lease. |
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However, if your request is above the threshold, they
will review your “ability to pay.”That would mean an
analysis and review of your financial statements to see
if you have the earnings ability to live up to the deal.
If you can keep your request under the threshold, you
might have more success securing the money.How to
find out the number? Just ask. The business development
representative wants to put the dollars out and
should be glad to tell you. |
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Another Factor |
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What if your balance sheet is a disaster and you are
bleeding red ink? Can you still get financing? The
answer is yes.Factoring companies are a good solution
in this type of circumstance because they do not actually
lend you money. They purchase your accounts
receivable.As such, they do not care about your company’s
financial condition. Rather, they want to make
sure they are purchasing a valid receivable and that
the account will pay the billing when due. Usually, factors
will advance 75 percent up to 90 percent of an
eligible invoice amount. |
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Again, some factors seek larger deals with a guaranteed
amount of volume, while others make their market
in smaller size deals with no minimums. These
arrangements are usually charge a percentage of the
invoices and by how long the receivable is outstanding.
Expect typical starting fees of 2 percent to 4 percent
of the invoice for bills that are outstanding for 30
to 45 days. |
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Since they are technically not lenders, a factor can
move very quickly. Usually, they will do a search to
make sure there are no liens on the accounts receivable,
and then you execute an asset purchase agreement.
I have seen these types of deals close in as little
as three to four days. |
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This segment of the industry is growing, with more
and more new factor companies coming into the market.
The International Factoring Association recently
wrapped up its annual conference and reported that
“there are numerous new entrants to the factoring
industry in the United States and Canada, thereby
increasing the pool of capital available to businesses.”
This trade group’s web site, www.factoring.org,
offers a free search engine to find factors that might
be suitable for your situation. |
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The final category of lending that I find increasing in
the market is called “purchase order financing.”This is
for situations where a company has orders, but does
not have the funding to complete the order.The purchase
order lender will advance the funds for the
inventory and usually get paid by an account receivable
lender once the order is shipped. |
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For example, let’s say a POP display company has a large customer order that can be placed with a converter,
but the vendor requires COD payment, and the
ultimate customer pays in 60 days. If the display company
does not have the working capital, they may
have to forego the order. |
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As an alternative, a purchase order lender will take
on that opportunity, advance the funds to the converter
upon completion and shipment of the order, and
usually get repaid with an advance from the accounts
receivable lender. (Sometimes, the purchase order
lender will also act as the accounts receivable lender.) |
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Purchase order financing is also based on fees related
to the time the money is deployed, and it can be
quite expensive.There will have to be sufficient gross
profit in the order to make this financing alternative
sensible. However, if the only alternative is to pass on
the opportunity to fill the order and make some
money, a purchase order financing might be a good
option. |
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While these are trying times to obtain commercial
bank loans, the above funding categories are a few of
the options available to raise capital as the economy
improves. You can explore them on your own with
some of the sources that I mentioned, or you can hire
a financial intermediary who is constantly in the market
and knows what is available to get the job done.
The Turnaround Management Association can help
you find someone in that regard. If you go to its web
site at www.turnaround.org, and click on the membership
tab, you can run a search under “occupation” to find consultants that specialize in financing. |
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There is money out there waiting to finance business
opportunities. The hard part is finding the right
match. Hopefully, you now have some insight on the
various alternatives and where the money is now! |
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(Editor’s Note: Nicholas Jalowski is the founder and
Managing Director of Cambridge Financial Services.
In addition to his role in overseeing the management
of the firm, he is a practitioner specializing in
strategic consulting to firms in need of guidance in
turnaround management, corporate revitalization,
financing negotiations, loan restructuring and/or
workout management. He is a Certified Turnaround
Professional (CTP) and Certified Management
Consultant (CMC). In addition to his duties at
Cambridge, Jalowski is currently the President of the
Board of Directors of the New Jersey Turnaround
Management Association. He was formerly a corporate
banker with Bank of New York in New York City,
and Fidelity Union Bank in New Jersey. Jalowski can
be reached at jb@cambridgefinancialcorp.com or
at (732) 512-9200. |
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