The recession has made it more difficult than ever for small businesses to get bank financing. For fast-growth companies, the credit crunch we’re in is especially challenging. Yet there are still companies out there with high growth rates. Growth can be a double-edged sword, though: As more resources are expended to keep growing, growth can feed on itself. Some companies grow themselves right out of business.
There is hope, however, for companies in this predicament. It comes in the form of a creative financing alternative known as asset-based lending. ABL is ideal for companies that can’t qualify for traditional business loans due to fast growth or other extenuating (and often temporary) circumstances. Startup firms and those with heavy seasonal inventory needs are good examples, but any company with a solid foundation and a history of success that’s facing temporary financial challenges could benefit from ABL.
ABL generally comes in the form of (1) factoring services or (2) accounts receivable financing.
In a factoring service, companies sell their outstanding receivables to a commercial finance company — sometimes referred to as a “factor” — at a discount that’s typically between 2 percent and 5 percent. The amount of the discount depends on variables such as the credit risk of the debtor, any risk associated with the industry, the number of days the funds are in use and how much of the receivable is advanced up-front (80 percent is common).
There are two key benefits of factoring:
- Improved cash flow: Instead of waiting 30, 60, or even 90 days to receive payment, a business gets most of its accounts receivable at the time the invoice is generated. Getting receivables sooner can mean the difference between success and failure for companies operating on long cash-flow cycles.
- No more credit analysis, risk, or collections: The finance company performs credit checks on customers and analyzes credit reports to uncover bad risks and set appropriate credit limits, essentially becoming a business’s full-time credit manager. It also performs all the services of a full-fledged accounts receivable department, including folding, stuffing, mailing, and documenting invoices and payments in a ledgering system.
With accounts receivable financing, companies borrow against the value of their accounts receivable instead of selling them to a finance company outright. Their receivables, in effect, become collateral for the business loan, with the finance company advancing funds based on a calculation of the outstanding receivables. The best candidates for accounts receivable financing are companies that can demonstrate a history of strong financial planning, have solid financial reporting capabilities, and don’t have high customer concentrations (no more than 60 percent of sales to one customer, for example).
When searching for an ABL lender, talk to your bank first. However, since ABL is a specialized type of lending, many banks don’t do it in-house. Instead they refer their customers to commercial finance companies.
Be sure to check out any potential commercial finance company carefully. Find out how long they’ve been in business and how well capitalized they are. How many local businesses have used (or are using) them? Does the commercial finance company itself qualify for commercial banking services? With the credit crunch, some finance companies are now highly leveraged and may be in poor financial condition themselves, so do your homework. Professional experience and adequate capitalization are crucial.
A commercial finance company will become an integral part of your business team. Therefore, do your due diligence and think carefully about the relationship you’re entering into.
Tracy Eden is national marketing director for Commercial Finance Group in Atlanta. CFG provides factoring and accounts receivable financing to companies nationwide. Contact him at firstname.lastname@example.org or visit CFG to learn more.