Asset-based lending can be more expensive than a bank loan or line of credit, but for some it may be the best choice, providing flexibility and cash flow when others won’t. That can be especially helpful to a startup with solid customers but a short operating history. Bankers have tightened their purse strings and are likely to keep them tight. A recent Federal Reserve survey of senior loan officers found 75 percent have made lending standards for commercial and industrial tougher than the average for the past decade, and one in four said standards wouldn’t return to typical levels before 2011.
With credit hard to come by, some business owners are turning away from banks. Instead of traditional credit lines, they’re financing operations by tapping the value of their business assets — invoices, equipment and even inventory — as collateral.
Asset-based lending can be more expensive than a bank loan or line of credit, but for some it may be the best choice, providing flexibility and cash flow when others won’t. That can be especially helpful to a startup with solid customers but a short operating history.
Bankers have tightened their purse strings and are likely to keep them tight. A recent Federal Reserve survey of senior loan officers found 75 percent have made lending standards for commercial and industrial tougher than the average for the past decade, and one in four said standards wouldn’t return to typical levels before 2011.
While the downturn has depressed all kinds of business activity, including demand for credit, asset-based lending in the U.S. rose 8.3 percent in 2008 to nearly $600 billion in loans outstanding, according to data compiled for the Commercial Finance Association. “Even in a tough economy where providers of credit are really tightening up lending, our guys are still out there,” says Brian Cove, chief operating officer of the New York City association.
“There’s always a market opportunity for alternative financing during a downturn,” says Jason Hartmann, a senior vice president with River City Bank in Sacramento.
In tough economic times, he says, banks are less likely to bend their lending standards to help a company that doesn’t meet every requirement. “Given the operating results of some companies in the region, it’s just not feasible to lend to them” under strict standards, even if they have customers and need the cash to fill orders or pay suppliers. “If it’s for working capital, that’s when you see your asset-based lenders and factors step in,” says Hartmann, who has referred some customers to asset-based lenders when banks couldn’t help them.
Banks play a big role in asset-based lending; affiliates of Bank of America and Wells Fargo are among the biggest members of CFA. The financing arms of equipment makers such as Caterpillar and General Motors are also major players in the market, though many cautious customers are delaying equipment purchases during the downturn. But the lineup of asset-based lenders also includes factors, who lend cash against the value of customer invoices, and other financiers that look at virtually all assets of a business as a potential source of collateral.
“The key for an asset-based lender is the collateral and its availability,” Cove says. Most asset-based lenders keep a close eye on that collateral, with some even making regular visits to the client’s warehouse to spot-check inventory.
While a bank working within a strict regulatory framework may decide a young or challenged business is too risky for a loan, an asset-based lender can look beyond the cash flow of the business. It could consider not only whether a business is creditworthy but if its customers are creditworthy as well.
“There’s always a market opportunity for alternative financing during a downturn.” Jason Hartmann, senior vice president, River City Bank
“Cash flow is the lifeblood of your business … and the majority of it circles back through your company,” says Tim Frazier, who owns the Placerville factoring business Liquid Capital of Sacramento. Lack of credit can choke a business, especially one that is still growing, and the credit landscape has dried up in the past two years.
“We’ve gone from one extreme to maybe the other,” Frazier says. “A couple of years ago, if you could walk into a bank under your own power and sign your name, they would throw money at you. Everyone was living in their own personal piggy bank.” With home equity — a major source of small business capital — down and credit constricted, Frazier has started seeing more interest in factoring.
In its most basic form, factoring loans money against an invoice. Say a business has an invoice for $10,000. The customer may not pay it for 45 days, but the business has to pay its supplier in 30 days, and pay its employees every two weeks. With factoring, the business can turn over a creditworthy invoice to a factor and immediately receive, say, 75 to 80 percent of the face value. What was an account receivable becomes money in the bank. When the customer pays the invoice, the factor releases the rest, less a percentage based on how long payment took and sometimes a fee.
Terms vary depending on the lender and the situation. Frazier, an affiliate of Toronto-based Liquid Capital, has a financial stake in each loan he makes and says he typically charges a few percent for an invoice paid in 30 days, and more if payment takes longer. A large, repeat customer might qualify for a better rate. “It’s very similar to what a merchant pays a credit card company” in processing fees, he says.
The invoice-by-invoice approach gives flexibility. Some businesses may have enough capital to handle most small orders, but use a factor for a few big invoices with customers who take a little longer to pay. It only works for companies that do business by invoice, which cuts out most retail and cash businesses. Frazier also says the model typically works well for staffing firms, contractors, transportation firms, manufacturers and distributors.
The textile and apparel industry accounted for about 59 percent of the $136 billion in U.S. factoring in 2008. Factors covered the gap while major retailers processed invoices from suppliers. Smaller factors were more likely to see invoices from transportation and business services companies. While factoring has grown every year since 2001, it grew only 0.5 percent from 2007 to 2008. Industry sources said that might reflect lower business demand and the tighter market’s effects on the factors’ own lines of credit. Last month CIT Group, the biggest U.S. factor, filed for reorganization under Chapter 11 bankruptcy protection.
Factoring is one of the oldest forms of accounts receivable financing, but there are many models. “We do it a little differently,” says Joe Drahos, a vice president of marketing in Folsom for Campbell-based Graystone Capital. “It’s more like a banking relationship than it is pure factoring.”
“Everyone was living in their own personal piggy bank.”
Tim Frazier, owner, Liquid Capital of Sacramento
Graystone is a direct lender. Founder and president Kevin O’Hare reviews each borrower’s application and writes the checks, offering lines of credit from $50,000 to more than $2 million, secured by accounts receivable. The amount available increases as customers pay their bills. Credit lines typically last 12 months with automatic renewal. Unlike some factoring arrangements, customers write checks to the company that issued the invoice, not Graystone, and finance fees are paid on the amount that’s actually borrowed, not the face value of the invoices used as collateral. Graystone advances up to 85 percent of the eligible accounts receivable, and charges an annual rate equal to the prime rate plus 3 to 4 percent, along with a monthly administration fee.
“For companies that have an opportunity to sell large orders but know that the customer may take awhile to pay … drawing against the accounts receivable would make a lot of sense,” Drahos says.
It made sense for Steve Abeln, managing partner of All Lines Supply, an installer and integrator of large-scale commercial security systems with customers including large state agencies and major employers in the Sacramento region. He bought the company in 2004 and about a year later, while trying to pare high fixed costs such as rent and debt service, he hit a cash flow crunch. That blip on the balance sheet and the fact that he had owned the business less than two years meant banks wouldn’t give him a line of credit, he says. “That two-years-in-business question, the banks look at that harder than I ever imagined.”
One of All Lines’ vendors was using Graystone, and Abeln got in touch. He’s been with Graystone for four years now and has expanded from his original accounts receivable credit line to others, including one the company uses to prepay purchase orders for better terms. “For me, the biggest benefit is peace of mind,” Abeln says. “We get our vendors paid, our payroll met, and I don’t have to worry about it. And because we can only borrow against a percentage of our accounts receivable, we can’t get over-leveraged.” Abeln says the company has more than $1 million in sales and now could get a bank credit line, but he’s sticking with Graystone because he likes the flexibility.
Without that flexibility, says Aubrey “Tex” Winn, his new concrete business would have a problem. Winn is chief operating officer of Enviro-Crete Inc., a North Highlands company launched about a year ago. It specializes in pervious concrete, which allows water to pass through and can help prevent drainage and erosion problems. Between the economy and the short history, banks didn’t want to take a chance on the company, Winn says.
Winn interviewed several factors before choosing Frazier and Liquid Capital. Now the majority of the company’s business is factored “because you can’t wait 60 days for the cash to pay your workers,” Winn says. “Without factoring, I feel in my heart, Enviro-Crete wouldn’t exist.”
But Winn used his head before his heart got involved, comparing several prospective factors. Less regulation for asset-based lenders makes for more flexibility, but also makes it important for a business to do its homework before signing up. Some states require a license. California does for some factors, but not all. Factors that are members of the International Factoring Association agree to be bound by its code of ethics, says Bert Goldberg, executive director of the Pismo Beach-based group, and IFA offers to help resolve complaints against its members.
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