Five years after the end of liberal credit policies and hyper lending came to a halt, small business owners still face rejection in the bank lending line. A slightly questionable balance sheet, a newer startup or even hypergrowth situation puts most small business squarely outside the “bankable box”. Fortunately, in that five years since the 2008 economic meltdown, an increasing number of alternative lenders have sprung up to fill in the credit gap. Commercial finance options, such as Factoring, Purchase Order Financing, Accounts Receivable Financing, DIP Financing and other Asset Based Lending products are available to provide small business owners with the working capital they need to reach their business goals.
It appears that 2013 will be the fifth year since “The Great Recession” began, when the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Federal Reserve Board lowered the boom on the past liberal credit policies which characterized most of the past decade including loans made to small business. To further scrutinize banks, the Congress and the Obama administration enacted Dodd-Frank and created another Federal agency, the Consumer Financial Protection Bureau. Beyond the relatively weak economy all this government investigation and enforcement outrage has caused a severe freeze on a lot of small business lending by banks in contrast to their hyper lending activity of five to ten years ago.
In short, given the overhead costs many banks have, combined with the intense compliance and regulatory examination of their loan portfolios — banks are hard-pressed to earn profits in lending to many small enterprises. Every week from where I sit at DS-Concept Factoring, Inc., I listen to complaints and frustration: How a business owner who considers their enterprise a responsible, decent credit risk has been subjected to a lot of “red tape” and minutiae by their banker. And most times after an extended application period — they are rejected for the loan!
For small business owners who have been faced with this failure that becomes a drag on their operation, there are several available commercial finance alternatives that many would be well-served to check out:
Costs for factoring between interest rates and processing fees are usually a little more than a bank loan. While the factor does have an interest in determining whether the company they are financing is credit-worthy, the factor is not as concerned as a banker. The factor is taking into account different issues about the viability and strength of the company. A major aspect is how the factor is in effect financing an invoice receivable generated by the company.
Beyond credit considerations about the company, is the company going to be able to successfully, profitably fulfill the material or service order? And, is the end procurement entity, which is responsible for the receivable, a good credit risk? This is often most effective when small or mid-sized companies are selling to a major company with ample financial resources.
There is recourse factoring, which means the factor can collect from the company if the end procurement entity fails to properly pay on the receivable. Non-recourse factoring means the factor accepts the full liability and cannot go back to the company they are factoring, if the end procurement entity fails to pay. All interest rates and fees are generally negotiable and vary in different circumstances. Many factors will have a minimum on receivables they will consider like: $50,000.
This is somewhat similar to the way a mortgage works. Again, the asset-based lender is less interested in the credit strength of the company they are financing. What counts here are the available assets a business owner holds, which can be collateralized either through the company or personal equity. Once a valuation and field examination is developed, there are some general commercial finance guidelines on how much money the asset-based lender will lend, say 70 percent of the valuation. The asset-based lender has to be able to take possession of the assets and liquidate them for cash, if in the event the company being financed cannot pay according to the terms of the loan. Many asset-based lenders will want a minimum transaction of $100,000.
This is often an option if the company cannot get financing from a bank, a factor or an asset-based lender (or maybe they are at their credit limit with these other sources). In the case of purchase order financing, the firm has relatively little interest in their credit scores. (Some companies may have even been bankrupt or just on the edge!) Purchase order financing is usually the most expensive option here because the firm is putting its money at risk, when generally no one else will step forward.
The firm is financing the purchase order generated by the company, nothing more (in comparison to the flexibility a business often has with a bank, a factor, or an asset-based lender). There are many conditions and restrictions on use of this firm’s money. Generally these firms have experience and knowledge which is very helpful for a company to consummate a deal. By not using purchase order finance, this company may have lost their opportunity to earn a profit. Minimum purchase orders considered are often $50,000.
Import/Export trade credit
This approach is a combination of banking, factoring, asset-based lending and purchase order financing. It becomes especially important because most of the other financing firms will not accept a client when a significant receivable must be collected in another nation. Import/export trade credit is somewhat cheaper than purchase order financing, and can be effective for manufacturers, distributors, jobbers, suppliers and vendors. Some criteria about the credit strength of the company being funded are required, but somewhat less than a bank would need. Import/export trade credit is based upon the collateral valuation of the “finished goods or materials” being transacted, and the firm’s ability to collect on the receivable from the procurement entity. Generally, firms seek a $100,000 minimum here.
Beyond a small business owner learning more about these four financing formats, there’s benefit to establish relationships with several of the firms in the commercial finance sector who provide these services. It may even make sense to “test drive” a transaction or financing experience through one of these firms as part of being prepared for any financing challenge that may arise.
There are two recognized peer industry organizations, the Commercial Finance Association (www.cfa.com), and the International Factoring Association (www.factoring.org). At no charge both offer names of members who transact business throughout the United States, or the globe. The members of these associations are generally in compliance with industry standards and ethics.