New Challenges (and Solutions) for Managing Working Capital By Nic Perkin
These days businesses reliant on bank financing may be faced with some major challenges when trying to refinance outstanding debt, finance working capital needs and pursue growth opportunities. This article looks at why some businesses are finding bank financing unattainable, and even undesirable, and why many are turning to alternative financing options.
While the darkest days of the financial crisis seem to be behind us, political and economic uncertainty remains. Nonetheless, businesses that spent the downturn focused on streamlining processes, cutting payroll, tightening expenses and outsourcing non-critical business functions realize they can no longer afford to remain in a “wait and see” position. The reality is that many companies need to move forward or risk losing business and becoming competitively disadvantaged.
Unfortunately, businesses reliant on bank financing may be faced with some major challenges when trying to refinance outstanding debt, finance working capital needs and pursue growth opportunities. This article looks at why some businesses are finding bank financing unattainable, and even undesirable, and why many are turning to alternative financing options.
Financial Reform Continues to Impact Underwriting
Financial reform legislation, such as Dodd-Frank and Basel III, has placed strict capital requirements on banks and increased scrutiny over credit decisions. Most large companies that rely on bank financing have typically had an easy time accessing credit. For small- and medium- size businesses that tend to rely heavily on bank credit, tighter credit requirements have become a huge hurdle. In fact, according to an opinion poll released earlier this year by the Small Business Authority, Main Street Alliance and the American Sustainable Business Council, 90% of small business owners nationwide agree the availability of credit for small businesses is a problem, and 61% agree it’s harder to get a loan now than it was four years ago.
Lack of Lending Capacity Tightens Purse Strings
According to a refinancing study by Standard & Poor’s, an estimated $2.9 trillion in U.S. corporate debt is scheduled to come due from the second quarter of 2011 through the end of 2015. As a result, banks have begun dealing with a wave of corporate refinancing. Experts believe that with demand for debt capital outstripping bank-lending capacity, an increase in competition for those funds will certainly lead to a rise in interest rates.
Larger, higher-rated corporations, that typically have more refinancing options available to them, may not feel the squeeze. Small and middle-market companies, however, particularly those with weaker credit quality may find they have fewer traditional options for refinancing their debt in the coming years. Community banks still consider small business lending their main focus, but rates are typically higher and lending thresholds lower. Larger banks are less inclined these days to make smaller loans unless the business hands over most or all of its banking business. Even companies with an existing bank relationship in the form of a loan or line of credit are coming up short when requesting a refinance or credit line increase.
Recession has Created a Smaller Pool of Banks
From 2008 until the end of 2011, the FDIC closed 414 banks. As of June 15, 2012, another 31 banks have been added to the list. Continued loan defaults and stricter regulations put many more banks — mostly community banks and middle-market lenders — in danger of failing. Considering the current financial climate, it is no surprise that a growing company may be alarmed that the financing it has in place today may not be available tomorrow.
Bank Lending Has Become More Costly
Many business owners and finance executives regard bank financing as a cheap and simple way to fund a business. Unfortunately, many banks, wanting to boost their own liquidity, have focused on raising interest rates, increasing and adding fees and cutting credit limits. In fact, some banks are reported to be downsizing their small business customer portfolios by demanding that certain borrowers pay off their credit line balances or agree to a new repayment plan with a higher interest rate than the original credit line had.
Processing fees, documentation fees, third-party fees and government fees and taxes are typical of most loans and lines of credit. Even loans guaranteed by the Small Business Association (SBA) charge a guaranty fee of 2 % to 3.5% of the loan value. Additionally, some loans require a company to put up a down payment and pay sales tax on the loan in advance, which can be a significant upfront cost. Businesses can incur hidden charges, penalties for missing a payment, or for paying early, whether to alleviate their debt or to refinance. These extraneous fees make traditional financing costs more than merely “principal plus interest.”
Banks are Requiring More of Businesses
For several years prior to the recent recession, credit was easy, and it was possible to obtain a line of credit or lease new equipment or space without having to personally guarantee the liability. Today, unless your business enjoys extraordinary financial strength, obtaining credit of almost any type for a business — whether you’re organized as a sole proprietorship, partnership or corporation — will require guarantees by the company owner(s). Banks are also piling on extensive and onerous requirements for businesses to “prove” their creditworthiness including restrictive covenants, audits and long-term contracts.
Banks aren’t alone. Loans from the SBA require a personal guarantee by any person with a 20% or larger equity stake in the business. And, many credit card companies are calling for personal guarantees on business cards.
Receivables Financing Proves to be a Successful Alternative
Because traditional financing is increasingly unavailable and more costly, many companies are utilizing online receivables financing as an alternative to support working capital needs. Using receivables in commercial finance transactions is not a new idea; they are widely used as a collateral component in business lines of credit, asset-based lending solutions and factoring deals.
What’s different about online receivables financing is that the transactions are structured as open, competitive auctions, and bid upon by a global network of accredited institutional buyers. This approach enables businesses to drive down their cost of capital and be assured they are receiving a competitive price. Another key innovation of the online receivables financing approach is the lack of a long-term contract, all-asset lien, covenants and personal guarantees.
In its early years, Vermont-based Catamount Glassware easily funded its growth through internal cash flow. The company manufactures specialty heat-resistant glassware and glass cookware, which it supplies to several Fortune 500 companies, including popular breweries and national retailers. In 1998, the company recapitalized the business through a SBA loan in order to expand operations. The process left Catamount president Alain Karyo with a firm distaste for the traditional financing process.
“[The bank] wanted to take absolutely everything as collateral, leaving us with zero flexibility,” remarked Karyo. As a result of that experience, the company has avoided debt financing, despite lenders interest and availability. “We probably could have grown at a more rapid rate, but I was never willing to take on the level of risk and the additional workload associated with disclosure to the lenders.” Still, Catamount has maintained its focus on quality products and has been fortunate to grow organically at a steady pace.
Karyo discovered The Receivables Exchange in 2009 and was quickly impressed by the flexibility and ease of use of the trading platform. Still, he was skeptical about selling receivables to fund growth. “I decided to give it a shot and after only a few auctions, I was amazed at how efficiently I could improve my cash flow. And, by selling the receivables of my best customers, it was a very cost-effective way to increase our liquidity,” said Karyo.
Mason-Grey, based in Georgia, provides highly specialized engineering services to improve industrial process plants, has also found receivables financing to be an ideal strategy for financing new growth opportunities.
“Having access to working capital is an ongoing concern for most companies, both large and small,” remarked Mason-Grey’s owner Joe Reini. “Today, banks want to see two years of solid financials before they will even consider approving a loan — a difficult hurdle for companies who are in a turnaround situation. With the use of The Receivables Exchange we have been able to accelerate our growth when we want — on our terms. Today, if a client needed us to grow by 30% overnight, we can. I can add the staff, make them billable and immediately turn those new hires into cash.”
Both Catamount Glassware and Mason-Grey are able to greatly increase liquidity by dramatically cutting their Days Sales Outstanding (DSO). Many companies are seeing similar results as they find success auctioning their accounts receivable.
Whether you’re in need of cash to fund day-to-day operations, or looking to further invest in and grow your company, bank financing may be your first choice for securing additional capital. Unfortunately, due to tighter lending requirements, stiffer regulations and reduced lending capacity, the financing you have in place today may not be available tomorrow. Many companies across a wide spectrum of industries have discovered online receivables financing to be a flexible, affordable way to gain access to the working capital they need, whatever the economic conditions.
Nic Perkin is co-founder and president of The Receivables Exchange, an online marketplace for accounts receivable financing. The Receivables Exchange allows businesses to access working capital flexibly and affordably, without the constraints of traditional financing.