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Short
term operations money may be secured against first, any
unencumbered physical assets of the business; second,
additional funds from shareholders or personal guarantees
from principals. On occasion, inventories can be used as
temporary security for operations loans. Bridge financing
is normally secured by assignment of all the receivables
and personal guarantees. On the balance sheet the accounts
receivable, inventory and supplies stocks show up in the
current assets section, while the counterpart loan
information is displayed in the current liabilities
section.
Lenders normally charge a higher base rate of interest for
operating loans reflecting this relatively weaker security
position. The amount of the operating line of credit, will
be determined from the projected cash flow information in
the business plan. Lenders favour businesses that exhibit
strong management, steady growth potential and reliable
projected cash flow (demonstrating the business' ability
to pay the monthly interest payments on this line of
credit from its projected revenues in a written business
plan).
Operating Term
Loans
Operating Term Loans for working capital are
used to enable a retail, service or manufacturing business
to purchase raw materials, retail or parts inventories,
process or promote these and pay monthly expenses
including principal and interest on outstanding term
loans, wages and salaries, rentals, leases, utilities,
etc.
If a
business was able to sell all its inventory (stock) at
full margin and collect the cash for it immediately,
realizing its profit before it had to pay suppliers for
that stock and before it had to pay its monthly expenses,
that business might require no particular working capital
loans. However, most are not cash businesses and don't
enjoy that luxury. They face build-ups of day-to-day and
monthly expenses such as stock parables, wages, rentals,
leases, etc., often in advance of collecting the cash
sales revenues to pay the trade suppliers, the labour
commitments and the regular overhead expenses. Operating
Term Loans (Working Capital) are commonly offered by
credit unions and non-commercial lenders who are unwilling
or unable to offer operating (revolving) lines of credit
to their customers. This term loan is made like any other
term loan, and is fully secured against unencumbered
assets, personal guarantees and co-signers.
Revolving
Lines of Credit
A line of credit is a long term commitment by a
commercial lender to honour the day to day cheques of a
business up to a maximum figure agreed to in consultation
with the business. The lender retains a number of signed
drafts (notes held for discount) from the business on hand
to use as required to place funds as needed into the
account. The business was made responsible for depositing
all sales revenues on a regular basis into the account to
"buy down" the outstanding loan balance whenever there
were the funds available to do so.
This
up and down, fluctuating nature of the loan amount
(account balance) is why it has come to be called a
"revolving line of credit." There is no scheduled
repayment of principal because there is no set principal
amount of the loan. The interest rate normally floats at
2%-3% above the prime rate and is applied to the largest
amount of loan outstanding in that account during the
course of any month. There are no other account service
fees.
Traditionally, revolving lines of credit are the preferred
borrowing formats of most commercial businesses and
manufacturers. The normal sources of these loans are
commercial lenders, the chartered banks, and more
recently, some credit unions. Most commercial businesses
require differing amounts of cash each month to meet their
actual operating commitments for that month; they want to
pay only interest justified by the actual usage of
borrowed cash (without penalties); and pay nothing at all
when revenues are entirely sufficient to pay the month's
expenses. This requires a special kind of loan that can
provide long-range flexibility (allowing the principal of
the loan to vary from month to month); that can
temporarily cancel the loan without penalty in a month
where borrowing is not required; and that can provide an
almost automatic approval from the lender for each new
loan amount (to a maximum overdraft). While some of this
might be achieved by a Bank Overdraft Scheme, the more
commonly accepted way is to use a revolving line of
credit.
More Short Term
Instruments
Modern Overdraft Scenario
More recently the banks have fine-tuned this
program to what could be called a planned overdraft scheme
. The bank will approve a business for a certain overdraft
amount. They no longer work with a series of pre-signed
drafts. The actual interest rate has been dropped to a
point to two points above the prime rate and a system of
service charges for the overdrafts has been substituted to
make up the difference.
Interim Loans
Interim loans are a type of bridge financing
intended to "bridge the gap" between the time a specific
receivable is received in cash and the time the company's
parables become due. The assignment of the receivables is
the primary security for the loan. This is quite common
where a government agency purchase has been made. The
lender knows the customer will pay, but also that the cash
may take some time to collect. When a government financial
assistance program makes an award, reimbursable only after
the moneys have been spent or the project is in place,
bridge financing is an appropriate format.
Assignment of Book Debts (Receivables)
The receivables are assigned to the lender to
secure the operating line of credit. These are still
collected by the business, but in the event of business
default, the lender can assume collection of these
directly. The assignment is supported by the monthly
submission of the list of receivables.
Security for Working Capital Loans
The lender uses accounts receivable (the money
owed by customers) and inventory as the security
(collateral) for the loan. For accounts receivable lenders
may lend between 50% and 75% of the total outstanding
receivable, first deducting any invoices which have gone
over 90 days. On inventory, lenders may lend up to 50%
against cost based on supplier invoices. Any additional
cash required must come from your own resources or by
careful management and recirculation of the business'
profits and cash.
Personal Guarantees
The principal makes an agreement that if the
limited company is unable to repay the loan, he/she will
do so personally. If this guarantee is on top of other
security, attempt to negotiate a limited guarantee to
cover only the shortfall in the security. Recover the
personal guarantee as soon as the business has paid off
its obligation or can carry the debt on its own security.
A personal guarantee places all those things you and your
family hold dear at risk.
Postponement
If there are also loans from shareholders, the
lender may ask for an agreement that the company will not
repay the shareholders until the secured lenders have been
repaid in full.
Approaching
Short Term Debt Lenders
Mortgage Lenders
The institutional providers of first level
mortgage lending include the Insurance Companies, the
Banks, the Trust Companies and the Pension Funds. There
are also many short term loan financiers to be found in
the private sector. Many of these advertise their services
aggressively, especially where their offerings relate to
mortgage extensions on property in stable real estate
markets (such as the Lower Mainland market).
These
can be easily located through licensed and bonded
consultants known as mortgage brokers. These offerings
normally involve terms of one year or less with liberal
provisions for renewal. For these reasons these mortgages
often charge only interest, but have hefty penalties for
returned cheques and late payments.
A
first mortgage will earn the lender approximately 12%
interest, a second mortgage, 15%, and a third mortgage,
18% - 20%. Many of these will have, in turn, leveraged and
sourced two thirds of their funds for this mortgage from
an institutional or commercial lender, and accordingly
they will have to comply with various restrictions placed
on their investments by that lender.
Private mortgage financiers would normally be approached
after you have exhausted the commercial channels and been
rejected from dealing directly with them due to some
weakness in your equity or personal guarantee
abilities.
Approaching Mortgage Lenders:
There are many short term mortgage loan
financiers to be found in the private sector. Many of
these private mortgage financiers advertise their services
aggressively, especially where those offerings relate to
mortgage extensions on property in strong real estate
markets (such as the Lower Mainland market).
Commercial Banks and Credit Unions:
The Commercial Banks and Credit Unions are
normally prepared to offer financing based on accounts
receivable bridging and/or inventory purchases. Revolving
or operating lines of credit (and overdraft schemes) are
offered by the major commercial banks and some credit
unions.
Approaching Commercial Banks/Credit Unions:
Loan evaluation tends to be more rigorous and
sophisticated than mortgage loan evaluation. In summary,
this lender is evaluating the immediate abilities of the
management team, the collateral available to support the
loan and the short term commercial viability of the
situation, as portrayed in the projected cash flow
financial submissions. This cash flow projection will
normally be included in a detailed business plan (in a
bound presentation format) providing extensive information
on the management of the company or project; a detailed
history of the business, its current products, its
production methods, its operations, its position in the
marketplace; the purpose for which the loan is intended
(in intimate detail); any security available to be
pledged; and extensive financial information and
projections.
Trade Creditors, Factors and Commercial Finance
Companies:
Trade Creditors offer terms of 30 days before payment for
stock purchases is due. With newer, unproven operations,
C.O.D. (Cash On Delivery) is often required. Occasionally,
in a buyers' market, an important large dealer will be
offered 60 day payment terms. Often a 2% discount will be
offered to dealers who pay within 10 working days and a
penalty (e.g. 1.5% per month interest) will be imposed on
account balances unpaid after 30 days.
Factoring Companies may buy accounts receivable outright
without recourse and assume all the risks of collection.
These may advance funds against purchased receivables,
less a percentage.
Commercial Finance Companies often advance funds upon
assignment of receivables and warehouse shipping/receiving
receipts. They will also consider short term equipment
financing.
Approaching Trade Creditors, Factors and
Commercial Finance Companies:
Sales finance companies, in cooperation with the product
suppliers (vendors) commonly offer sales finance or
factoring programs and lease-back options on their
equipment. The onus is upon you to ask your vendor if
he/she has access to any such finance programs, or if the
vendor will finance the purchase directly, through a
factor or floor-planner scheme. Small office equipment may
often be purchased on a lease-to-buy arrangement.
Generally, these will expect a less detailed business
plan, but will be particularly interested in the parts
that relate to sales projections, stock movement and
replenishment and monthly cash flow information.
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