Commentary & Analysis
Pouring Another "Cup O Joe": Lenders Talk About Lending (Part 2)
As everyone knows, the recession has made business financing hard to come by. In this two-part “Cup O Joe,” lenders to the printing industry report that loan products are available and discuss how printers can obtain them.
By Patrick Henry
Published: October 10, 2011
Editor’s note: each month, the partners at New Direction Partners join their colleagues at the financial management firm MargolisBecker in a “Cup O Joe”: a conference call with printers on a selected topic of interest. The call’s namesake is MargolisBecker founding partner Joe Becker, whose brainchild the monthly teleforum is.
Recently, with the participation of Mickey Urquhart senior vice president, People’s Capital and Leasing Corp.; Jeff Wright senior vice president – business development officer, Hennessey Capital; Tom Williams, partner, NDP; and Joe Becker, Cup O Joe examined options in financing and refinancing for printing companies. Addressed were the various types of lending products available to printers and the basic requirements of qualifying for them. An edited version of the discussion is presented here in two parts, continuing with commentary by Mr. Wright. (Mr. Urquhart’s presentation appears in Part 1.)
Hennessey Capital is an asset-based lender that helps printers by providing a workable line of credit secured by receivables and inventory. Our clients are small businesses that cannot obtain traditional bank financing. We typically finance manufacturers, distributors, and service companies with working capital needs under $3 million. Any small business that generates a business receivable is eligible for consideration. We also finance startup companies that don’t have the operating history traditional banks typically want to see or whose principals have poor credit scores.
Most of our clients are referred to us by banks, CPAs, attorneys, brokers, consultants, or other customers. Unlike banks, which focus on cash flow, profitability, and strong balance sheets, Hennessey Capital focuses on collateral value and strength of the borrower’s management team. We look primarily at the collectability of the receivables, since that is our primary source of repayment. We also look at the marketability of the inventory—rolls, sheets, drums, etc.—that could be sold off quickly in the event of liquidation.
How Strong Is the Collateral?
Each is reviewed as part of our due diligence, and advance rates are dictated by the strength of the collateral value. When we look at this package of information, the first question we ask is, “If we had to liquidate this collateral today, would we get repaid out of the loan?” We don’t want to have to rely on personal guarantees to recover our money.
We advance up to 85% of the value of eligible receivables and up to 50% on raw materials, finished goods, and inventory, but we can be flexible. We have gone as high as 90% on receivables and 60% on inventory, amortizing back to a level we feel comfortable with. If there is additional supporting collateral in real estate, equipment, or personal assets, we can be more aggressive in the advance rates.
There are some exclusions. We don’t include work in process (raw materials, finished goods, and inventory). Considered ineligible for lending are receivables over 90 days; and contra accounts in which there is both a receivable and a payable. A rule applied by most asset-based lenders states that if 25% of the borrower’s receivables are over 90 days, the balance less than 90 is also deemed ineligible. We will consider foreign receivables if we are provided with acceptable credit insurance. On the inventory side, work in process, packaging, and anything slow-moving or obsolete that hasn’t moved over the last year also is considered ineligible. We do not advance on fixed assets, equipment, or real estate, although we partner with others that do.
As a part of the due diligence, we initially will request a packet of financial information that includes three fiscal year-end financial statements and a current interim statement; current detail on receivable and payable aging; an inventory stock status report; projections; and an executive summary. The latter document includes the ownership of the company, its history, mission, sources and uses of funds, and personal financial statements for the owners. We also need to know what the borrower’s invoicing process is like: whether, for example, there are progress billing or bill-and-hold practices that we should consider in setting the advance rate.
We require personal guarantees from all of our clients. If the credit is strong and there is supporting collateral other than receivables or inventory, we may accept certain kinds of limited guarantees, But, as mentioned, we try not to relay on guarantees in order to get repaid.
Into the Lock Box, and Out Again
All of our accounts operate on a lock-box basis. The borrower notifies its account debtors to remit to a lock box that we control for the customer’s benefit. Collections go into the lock box, and we sweep it to pay down the borrower’s line of credit. Customers who want to borrow back submit a borrowing-based certificate: basically, a running receivable loan balance. Upon review, we advance the funds into the customer’s operating account to cover cash needs.
Timelines to close a deal usually are two to three weeks for factoring (i.e., receivables-based lending) and three to four weeks for asset-based loans. Although the type of financing that we offer typically is more expensive than bank financing, it does provide immediate availability of working capital. This lets the borrower take advantage of new opportunities to grow the business and cover its working capital needs when cash is tight.
Our asset-based pricing ranges from 10% to 15% on smaller deals. We also have a commercial finance line-of-credit product that is controlled like factoring, but at a higher cost to the borrower. Other costs to consider in asset-based borrowing are closing fees (1% to 2% of the facility amount); exit fees (1% to 2% of the facility amount if the loan is refinanced with another lender); and, as charged by some lenders, unused line fees based on the unused portion of the line of credit.
Our asset-based lending product is meant as a bridge. It is not a long-term loan relationship: it’s intended to get the borrower back to a traditional bank at better pricing. When sales are down and the owner needs a way to keep the business going until it can become profitable again, asset-based lending buys time and keeps open the possibility of bank financing in the future.
Objective: Get Them Back to the Banks
We have liquidated very few companies. Most of our clients stay with us from six to 18 months, get healthy again, and then move on. When that happens, we’re willing to waive the exit fee to any referring bank that they go back to for traditional financing at lower rates.
We can work with banks in situations where it has been determined that the customer is not quite ready for a bank loan but shows signs that it will be soon. We then can blend our rate with the bank’s to come up with something palatable to the borrower. Then, when the borrower is ready, the bank takes over, and we waive the exit fee. We’ve also stepped in when the customer has acquired a large contract but the bank doesn’t want to advance any more funds. Sometimes the bank will subordinate a debtor to us and keep the rest of the relationship, so that we are financing just one piece of the customer’s business.
Another advantage of asset-based lending is that borrowers do not give up control of ownership interest as they do with other sources of financing. But, asset-based lending is not for everyone. If the company’s margins are low—under 10%—chances are that the cost of borrowing will eat away at profitability. If this is the case, we will say so to the customer right up front.
Our asset-based lending product is a short-term solution. It can, for example, give the borrower a way to keep existing customers from defecting to the competition during a slump. It’s tough enough to get new business. Nobody wants to lose it to the competition because there isn’t a source of financing. When the top line needs to be fixed, asset-based lending can be the answer that keeps a tough job from becoming even tougher.