During periods of tight business credit, lenders are more likely to call a note payable on demand or even find borrowers in default for minor technicalities. Business borrowers should have a backup plan ready in the event a bank pulls your line of credit.
Business loans differ from consumer loans in many ways. Banks and other commercial lenders often have covenants requiring a business to meet certain performance and liquidity benchmarks. They also typically have financial reporting requirements. If you fail to meet one of these loan agreement requirements, your lender may find you in default of the loan. If that happens, the lender can require you to immediately pay the full outstanding balance due. Many credit-line loans also have on-demand provisions that allow the lender to reduce the maximum amount available with no notice or simply make the balance payable immediately. While these provisions may seem harsh, they are widely used in lending agreements throughout the United States.
If your bank calls in your loan or credit line, the first thing you should do is take a deep breath and imagine you are on the other side of the banker’s desk. Lenders know that most borrowers can’t simply write a check and pay their line of credit; otherwise they wouldn’t need one. Bankers have two things on their mind: to get your loan paid off and to keep your loan off of the bank’s past-due list. That said, lenders are not likely to foreclose on the collateral unless you exhibit extraordinary signs that your business is rapidly liquidating the collateral or otherwise compromising your ability to repay. Most lenders will work with you to find a way to pay off the loan.
One common technique lenders use when they terminate a business line of credit is to set up some or all of the outstanding balance on a term note and allow you to pay the note off over one to three years. This may not be a good option for you if your business still needs a line of credit, because unless the line of credit is unsecured, you won’t be able to pledge the same collateral to another lender.
If your business sells to other businesses and carries accounts receivable on its books, the easiest and quickest way to replace the lost line of credit is to set up a financing arrangement with a factoring company. Factoring companies are commercial finance firms that finance your accounts receivable for a fee. Rates and terms vary significantly among factoring companies, but if you shop right, this financing method can be affordable, especially when measured against the cost of lost sales opportunities.
If you choose to use a factoring company, do your homework. Make sure you read companies’ legal agreements before you agree to do business with them. Understand all the fees associated with factoring. Better factoring companies have easy-to-read agreements with few additional costs. Many companies actually find using a factoring company for their working capital is easier, albeit more expensive, than a bank line of credit.
If you or your business has equity in real estate, you may be able to refinance the property and get cash out. Many states prohibit borrowers from using home equity for business purposes, so check with your state first. Businesses with real estate equity can also use a combination of two loan arrangements: a factoring line of credit with accounts receivable as collateral, and a real estate equity refinance for permanent working capital. This dual loan arrangement allows for safety cash to be injected into the business and a working capital line of credit to be used for the future.
Businesses should also consider approaching a community-based lender that works under the Federal Community Development Loan Fund program. These lenders are chartered to help create and keep jobs. Though they usually have loan limits of $200,000 to $300,000, they are often a good place to turn to if your business needs funds and a larger commercial bank is not an option.
Sam Thacker is a partner in Austin, Texas-based Business Finance Solutions.