Lawrence Gardner, Owner, Lawrence Gardner Associates
Lawrence Gardner, Owner, Lawrence Gardner Associates

The 32-year-old business owner had returned from a successful, highly paid job in Washington, D.C., to help his father’s turnaround of an ailing, financially distressed distribution company importing parts from China, heavily dependent on supplier open account terms, and an expensive and capped factoring agreement.

Resorting to checkbook management to measure available liquidity, or the SWAG (swinging, wild-assguess) method, his father had managed to spend 110% of earnings that forced extended supplier payments well beyond terms and on the verge of shutting down the company’s lifeline of high-value truck parts from overseas to service its Fortune 500 customers and avoid disrupting their assembly line operations. The factor also tacked on a cost premium for foreign receivables insurance for eligibility.

Turnaround Efforts

While the son did not have a formal background in turnaround experience or fluency in financial statements, he immediately found himself traveling to the company’s discontented foreign vendors with a plan to bring vendors current within trade terms over a period of time. This won support of key overseas vendors to continue shipping open account as a result of complete transparency in addressing the company’s financial situation and turnaround remedies in progress.

Two years later, after implementing cost-cutting measures, improving margins and designing sophisticated, proprietary software for customers tracking on-time delivery, the father — suffering from ill-health — agreed to be bought out on the basis of a non-interest bearing note payable with principal repaid more than five years. The impact was to push leverage beyond what commercial bank lenders would characterize as healthy, based on a limited track record of a return to sustained profitability and lack of demonstrated reliable debt serviceability, in spite of offered subordination of the father’s note payable, adequate collateral coverage, pristine receivables, high-turning inventories, and detailed inventory listings and reporting. Again commercial bank lenders rejected the working capital credit request as being “too risk averse.” The common refrain offered to the owner’s presentation was: “Come back to us when the balance sheet shows ‘significant’ improvement.” But the rejection never defined the lenders’ metrics of financial stability.

Fast forward two years: The still-young-but-now-in-charge owner-entrepreneur — renting a 100,000-square-feet warehouse facility in Riverview, MI — was presented with the opportunity of purchasing the warehouse at a distressed price, caused by a bank foreclosure. Through a newly formed limited liability company to purchase the real estate, and a relationship with a commercial bank offering to provide a $1.4 million, 25-year SBA 7(a) term loan financing with 10% owner-provided equity, the monthly P + I payments would become less than rent triple-net, thereby increasing cash-flow. The bad news: On a combined financial statement basis, the effective leverage was pushing 7:1; again considered intolerable for commercial bank lending purposes, even though rough constructed pro forma projections showed adequate debt serviceability for a working capital line of credit, trade payables now brought within terms, and all taxes current.

Need for Inventory-Based Financing

Again the company was caught between the crosshairs of doubling its revenues, being profitable in 2012, 2013 and 8 months YTD 2014, a cap on the factoring facility coupled with expensive interest expense cutting into the bottom line, and now a real need for supplementary inventory-based financing. Armed with a PowerPoint, the entrepreneur met with bankers to explain the company’s unique market niche of receiving 17% export tax credits from the Chinese government, as long as Chinese vendors were promptly paid following 90-day open account terms (and allowing for 45-50 days ocean transport for receipt of goods in Michigan). This tax credit made the company highly cost-competitive.

Commercial bank lenders were impressed with the company’s progress and return to profitability. They were also aware that Meritor, an expanding customer relationship, awarded the company its 2014 Supplier of the Year designation for quality, on-time deliverability and direct supplier access to the company’s sophisticated software for accessing anticipated goods arrival, clearing customs, quantities and pricing. But this time around, the same commercial bank lenders noted that the Dodd-Frank Banking Act had created skepticism towards the company’s updated EBITDA projections and management’s ability to service debt. They also felt the company was too highly leveraged for commercial bank lenders to feel comfortable, and opted out in the hopes of avoiding intense future scrutiny from banking regulators.

One lender expressing moderate interest suggested the company return after having in its possession CPA FY 2015/2014 financial statements (i.e. April 2016) and three-year historical year-end statements to sufficiently evidence sustained profitability and an improved balance sheet. At the same time, the company aggressively opened a 60,000-square-feet rented facility in Monterrey, MX to service existing customers’ increasing POs, support its newest customer (Volvo) and to take advantage of Mexico’s 13% tax incentive export credit to the U.S. and elsewhere. The company could no longer rely on factored receivables to accommodate and sustain its growth. Its existing lender, having financed the SBA 7(a) term loan, said the bank’s ABL unit had a minimum threshold of $5 million in outstandings to be considered, and the bank’s small business group was not set up for receivables and inventory monitoring, despite being an existing customer of the bank.

An Asset Based Lender Delivers

The company’s owner sought out our consulting firm. We worked with the company’s management, and quickly received three ABL proposal letters, subject only to a due diligence field audit. Negotiating the best, competitive financing terms and conditions, the company found a home with an asset-based lender and closed within 30 days from signing the proposal letter, paying the upfront due diligence fee and utilizing in-house loan docs. The lender brought a highly experienced team to the table, including the senior underwriter (versus the latter hearing information second-hand from the BDO), to better familiarize the lender with the company’s unique market niche and competitive edge, need for inventory financing, understanding the assumptions behind the accelerated growth numbers and management depth.

Being less concerned with high leverage than with addressing adequate collateral coverage, basis of debt service, timely financial reporting information and clean quarterly audits, the asset-based lender took a risk on the company. As a financing safety valve accommodation for purposes of adequate borrowing formula availability, the lender creatively approved a sublimit for financing U.S. dollar-denominated Mexican receivables, without insisting on being backed by credit receivables insurance coverage. (These previously had been deemed ineligible by commercial bank lenders, even though several of commercial banks had sophisticated international divisions to understand cross-border risk transactions.)

An Exit Strategy

To facilitate exiting from the company’s factoring arrangement, Gardner encouraged the company to:

  • Move beyond CPA tax basis statements (non-accrual accounting basis and for understating the company’s true profitability) to CPA-compiled, comparative FY 2013/2012 with full footnote disclosure to add comprehension to the company’s key supplier base and preferential payment terms
  • Address the newly established Mexican operation, but at the same time put a cap on further upstreaming of funds to this affiliated entity and institute a plan for repayment, as the Mexican affiliate became cash-flow positive
  • Create an internal reporting breakdown of inventories to include “in-transit” and break out the same for reconstructed CPA-compiled 2013/2012 financial statement, and include full footnote disclosure, moving the company towards CPA -reviewed 2014 financial statements in accordance with GAAP to facilitate a further increase in the line of credit based on the company’s most optimistic pro forma growth
  • Provide a newly constructed inventory report breakdown to the lender of inventories on-hand and in-transit, backed by identified corresponding specific customers’ POs and releases and avoiding possible lender concern of speculative inventory purchases
  • Construct a detailed cash budget based on different customer allowed payment terms, preferential supplier terms, coupled with anticipated formula-based borrowings
  • Create best-case/worst-case scenarios, and project customer diversity and interest rate-sensitivity analysis, anticipating the Fed to increases rates during the later half of 2015. (As a result, the asset-based lender agreed to a 100 basis point interest rate reduction after six months following disbursement if the company achieved 80% of projected six months conservative scenario EBITDA performance after disbursement. By exiting out of factoring, the company is projected to reduce annualized interest costs by $75,000.)

Interest Rate Reduction

Lastly, the asset-based lender agreed in writing to review the effective APR at the annual renewal period for a significant interest rate reduction providing the company:

1. Remains in financial loan covenant compliance

2. Exhibits clean quarterly field audits

3. Remains within borrowing formula

Again, the perceived difference in dealing with an experienced ABL, risk-opportunistic lender, understanding the business structure and getting behind the numbers versus “one-size-fits-all.”


The outcome was a timely win-win for the borrower and the lender. In particular, the lender got its arms around the credit, didn’t overpromise what it was prepared to deliver from a time and term standpoint and didn’t hide behind the Dodd-Frank Banking Act, which was truly meant to correct egregious commercial banking lender practices leading to the 2008 banking crisis. It creatively complemented the company’s explosive growth via a disciplined, structured financing, resulting in the borrower not being constrained by a myriad of financial loan covenants that may have impeded profitable earnings growth.