If your business has recently experienced challenges, or is relatively new, you might not have access to capital through traditionally structured loans. Many banks simply can’t offer credit under these riskier circumstances.
So how can you get the money that you need to grow your business and move things forward?
“Asset-based loans provide companies with financing solutions that they otherwise may not be able to obtain through traditional financing,” says Lee Shodiss, senior vice president and manager at Bridge Capital Finance Group. “Generally, this is a more flexible financial product, with fewer restrictions and fewer covenants than a traditional banking product.”
Smart Business spoke with Shodiss about how an asset-based loan can help your business succeed.
What kinds of business can benefit from asset-based lending?
Generally, these loans are a great fit for startups, companies that are looking for high-growth opportunities, companies that are doing mergers and acquisitions and those that may have had an inconsistent financial performance as a result of the economy and that are now beginning to recover.
Either they don’t have the historical profitability and sustainability that banks offering traditional lines are looking for, or they may not have any equity because they are brand new startups. It could also be the case that the business and its owner are not able to meet restrictive covenants that are typical of a general commercial loan and therefore don’t qualify for a traditional loan.
How can an asset-based loan offer a company flexibility?
With asset-based lending, the bank is more focused on the actual collateral than it is on ownership’s personal net worth, the company’s net worth, its profitability, or its ability to maintain restrictive covenants. The bank is more interested in the source of the collateral and the ability of the collateral to be collected. As a result, it does more due diligence on the collateral and less on the principals and the profitability of the business.
Collateral is the primary source of repayment on the loan, so the bank will focus more on that one source and secure that one source more clearly than it would in a traditional loan in order to mitigate the risk.
Is this type of loan more costly than a traditional loan?
Yes. As part of the bank having less reliance on the net worth of the guarantor, equity and four or five covenants related to the loan, the pricing is higher. But it’s a moving scale to risk. Just because a company wants to do an asset-based transaction doesn’t mean the pricing is always three times what it is with traditional banking. There is a sliding scale related to various risk profiles that is used to determine the proper pricing.
But as a company improves its performance and its profitability, it can migrate toward a more traditional structure, with the cost being modified accordingly. If the level of risk changes, the price structure can be modified. So if you’re not quite qualified for a traditional loan, but after a year things have changed, you can migrate to a more traditional structure.
How do you start the process of getting an asset-based loan?
Your banker should be asking you a lot of questions about the industry you’re in, what size line you need, the terms of how you are paid and what collateral there is to fund the loan. The banker should also be asking about accounts receivable, inventory, purchase orders and other areas of your business to help you identify and fine tune your real needs.
In the first meeting, you should be ready to discuss where you have been financially and to talk about your company and what your needs are. If both sides determine there may be a fit and the business wants the bank to move forward and provide a proposal, then you’ll need to provide the company’s financial statements, accounts receivable agings, financial forecasts, capitalization tables and other documentation to the bank.
How can a business identify the right bank for its needs?
Businesses need to make sure they understand who their lending partner is and get to know them, because that relationship is going to be critical. Make sure that your lending relationship provides flexibility and isn’t going to restrict you down the line.
There are a lot of lenders that can provide you with one product, but the problem becomes, as your business morphs and grows, you have to go out and find another banking relationship. And that is challenging.
Your bank should get to know you, and be comfortable with you, because if it’s not comfortable with management, the deal will not be done, no matter what the collateral is. Conversely, you should be comfortable with your bank and view your banker as a partner in your business. Your banker should visit your company, try to understand your business, see how products are made or services are rendered, and get comfortable with your company and with management.
If you can find a partner that can help you through all the stages of your business, it’s a much easier process. Find a bank that can come in early in the life cycle of your business and help you grow, a bank that can take you from startup to going public and beyond.
Lee Shodiss is senior vice president and manager at Bridge Capital Finance Group. Reach him at Lee.Shodiss@bridgebank.com or (408) 556-6502.