Successful business owners rarely miss an opportunity to consummate a strategic acquisition or sign a marquee customer. But tighter banking regulations, economic uncertainty and a tough credit market have dampened the enthusiasm of high-spirited executives by making it difficult to secure a traditional commercial line of credit.
Even if your balance sheet has taken a hit due to the recession, you may still be able to acquire a working capital line to grow your business by borrowing against the value of your company’s accounts receivable or inventory.
“In today’s environment, an asset-based loan is often the best option, because bankers can underwrite around problematic profit and loss statements or balance sheets by focusing on the value of the collateral,” says Tony Spinogatti, first vice president and portfolio manager for Asset Based Lending at California Bank & Trust.
Smart Business spoke with Spinogatti about using an asset-based loan to meet your company’s needs for working capital.
When should executives consider an asset-based loan?
If your company’s P&L and balance sheet have been negatively impacted by the recession, a traditional commercial line of credit may not be a viable financing option. However, the company may qualify for an asset-based loan, which is secured and underwritten based on the value of the company’s accounts receivable and inventory. It’s not unusual for a small to mid-size company to maintain accounts receivable and inventory levels of $2 million to $10 million that can be used to secure a working capital line to finance working capital and/or expansion.
What are the advantages and disadvantages of an asset-based loan?
Asset-based loan structures can provide greater flexibility as the loan amount is based on prescribed collateral values or advance rates. For example, advance rates on accounts receivable, being closest to cash, typically average 80 to 85 percent. And, depending upon the various components of inventory the advance rate may be 30 to 50 percent of prescribed inventory’s value.
Interest rates for asset-based loans are slightly higher than the rates for traditional lines of credit. However, because the prime rate is currently 3.25 percent borrowing rates are at historical lows. While the reporting requirements for asset-based loans are fairly rigorous borrowers say the process offers some unexpected benefits. For example, borrowers who may be required to process invoice payments through a bank-controlled lock box benefit by collected funds being applied directly to the outstanding loan balance. Instead of reviewing changes in accounts receivable, inventory and loan amounts on a monthly or quarterly basis, management is reviewing those changes in real time. Executives also report a benefit from more accurate cash flow forecasting and some have even discovered a unique way to make a profit. Management can use the line of credit to negotiate payment discounts from vendors. Those payment discounts can add up over the course of a year, offsetting interest expense and to the bottom line.
Is it difficult to qualify for an asset-based loan?
The qualification process is similar to any commercial line of credit, but bankers primarily focus on the quality of the assets in addition to internal controls, financial reporting and the experience of the management team. If the line is secured by accounts receivable, the banker will consider advances based on the value of outstanding invoices less than 90 days past due from invoice date, the credit worthiness and payment ability of the underlying customers and whether employees follow a disciplined collection process. Finished goods and raw material typically have different advance rates and lenders will not normally advance against work in process, so keep that in mind if you’re thinking about securing a loan with inventory. The company’s balance sheet and the owner’s personal financial statements aren’t decisive, but be prepared to substantiate the value of the company and personal assets.
What should executives know about the application and underwriting process?
Plan on submitting financial statements for the last three fiscal years, an interim statement, most current accounts receivable aging and, if applicable, inventory report. If your company has lost money, you’ll need to submit a 12-month forecast as well as back-up documentation so the banker can understand and validate the forecast assumptions. For example, he or she will want to know where you plan to cut expenses if your forecast shows a significant reduction in SG&A, or he may ask to see copies of customer agreements if you’re projecting a hefty increase in revenue. Be ready to explain your logic and methodology but keep in mind that the communication process provides an opportunity to build a long-term relationship with your banker.
How can a business owner identify the right bank for its needs?
The national or ‘big’ banks tend to focus on large and very small companies and often overlook the needs of middle market companies. Community and regional banks specialize in loans of $1 million to $10 million and provide customers access to key decision makers within the bank. Of course, you’ll want to select a banker who understands the nuances of your industry as well as the local marketplace. You not only benefit from an asset-based loan structure, but from your banker’s experience, industry insight and solutions to your company’s financing needs.
Tony Spinogatti is the first vice president and portfolio manager for Asset Based Lending at California Bank & Trust. Reach him at Anthony.Spinogatti@calbt.com or (213) 593-2080.