Breaking The Bank
It's February 1992. You've raised more than $350,000 to get your manufacturing business off the ground, and the launch is such a success that by May, all your cash is tied up in receivables--and you need more money to keep growing. Where do you turn for help?
That's the question 33-year-old Ken Seiff asked himself when his company, Pivot Rules Inc., faced the scenario described above. "I needed to open letters of credit for future [clothing] lines, but I couldn't afford them," recalls the New York City sportswear manufacturer, who needed to pay his Hong Kong-based suppliers.
Seiff's accountant suggested he contact Heller Financial Inc. This Chicago-based international commercial finance company offers equipment financing and leasing, factoring, working capital loans, collateral-based and cash-flow financing, small-business lending, and specialized equity investments. The factoring division specializes in the garment and textiles industries--a good match for Seiff.
"Banks aren't terribly interested in the apparel industry, and from what I know of them, they're also not very interested in start-ups," says Seiff, explaining why he chose Heller. "We also had a relatively limited collateral base, which would have made it even less enticing for a bank."
Heller, on the other hand, was an aggressive lender willing to purchase and collect Pivot Rules' accounts receivable. What attracted Seiff to Heller--even more than the fact that it met his immediate needs--was the potential he saw to establish a long-term relationship.
Seiff's decision to go with a nonbank lender for financing is one being made by a growing number of small-business owners. In fact, according to the SBA, two of the top three lenders for the SBA's 7(a) program for fiscal year 1996 (based on number of loans approved) were nonbank lending institutions. The Money Store Inc. was the top lender, AT&T Small Business Lending Corp. was third. Seiff's lender, Heller Financial Inc., came in 11th.
There's no doubt commercial finance companies are steadily encroaching on the small-business lending territory previously dominated by banks. Finance Companies and Small Business Borrowers, a study conducted for the SBA Office of Advocacy by Dr. George W. Haynes of Montana State University in Bozeman, found that from 1980 to 1992, nonbank financing companies increased their business lending from slightly less than $86 billion to almost $300 billion. Finance companies are also the second-largest supplier of business credit (13 percent) behind banks (54 percent).
"In general, finance companies want to see strong assets to back up a loan and will monitor those assets much more carefully. For that reason, they can loan more against the assets. So chances are a smaller business might get a larger loan from a finance company [than from a bank]," says Bill Sihler, a finance professor at the Darden Graduate School of Business Administration at the University of Virginia in Charlottesville. However, says Sihler, this money will cost more. Consequently, a business must decide which is more important: the amount of money or how much it will cost to borrow it.
A Different Breed
Nonbank lenders come in all shapes and sizes. They are factors, commercial finance companies, credit unions, credit card companies and even life insurance firms. Heller, for example, in addition to traditional asset-based lending, also provided Seiff with overadvances (when you're given more money than your assets are worth) and letters of credit for exporting, and even allowed the company to deposit the proceeds of an initial public offering.
"I was concerned that at a bank, I would just be a number," says Seiff. "At Heller, they provided me with a team I could call any time. I knew that would be important to us if we were going to grow quickly."
Morristown, New Jersey-based AT&T Capital Corp. has evolved from a telephone equipment leasing company into the third-largest SBA lender in the country. "Our risk management is different from a bank. We offer greater flexibility and more understanding of asset-based financing," says Robert Neagle, a senior vice president with AT&T Capital's Business Finance Group.
AT&T's loan volume makes the company better able to assess risk, contends Neagle. "We do so many loans, we can capture and evaluate the data on performance by industry and geography," he says. "Consequently, a loan that seems risky to another lender may not be so to us."
Because AT&T is a preferred SBA lender, Neagle says it can also process loans more quickly. Its loans for equipment, construction and real estate financing range from $50,000 to $2 million; working capital loans generally start at $2 million.
The Money Store Inc. has been lending to small businesses since 1979. In 1996, it had a total loan portfolio of $2.3 billion.
"Since 1983, The Money Store has been the nation's largest SBA lender," says Paul Leliakov, president of the company's commercial lending division.
What makes The Money Store different from banks, says Leliakov, is the commercial lending division's exclusive focus on small-business loans. "In a bank, you may not receive the same level of expertise," he says. "Also, some of the financing products we offer may not be available at a bank." The Money Store offers full implementation of the SBA program. For example, it offers franchise loans, whereas some banks do not.
The Money Store's network of field staff operates 60 offices in 49 states. And, like Heller and AT&T Capital, The Money Store is looking to establish a relationship with borrowers that transcends a single transaction. They want to work with business owners on an ongoing basis to respond to their changing financial needs.
But Wait, There's More
In addition to the mega players, the commercial finance industry is populated by hundreds of smaller firms, such as Manchester Commercial Finance LLC. This 2-year-old Minneapolis company serves businesses in the upper Midwest that need up to a $1 million line of credit. Its average loan is $500,000.
"We are an asset-based lender and typically do transactions a bank won't do," says Manchester president Stephen Bakke. "These could be companies with fast or erratic growth, those with unusual seasonal fluctuations, or those that have unprofitable years or are highly leveraged. They could also be firms that require a financing decision faster than a bank can make it."
Manchester focuses on collateral lending and monitors its loans closely, says Bakke. It often requires weekly or even daily reports from its small-business borrowers. The company is not so concerned about the current profitability of a borrower--but it definitely considers future growth potential. In exchange for this credit rating latitude, borrowers pay higher interest rates.
In addition to asset-based lending, some finance companies purchase accounts receivable or invoices in conjunction with offering financial services like collections. Custom Data Services Capital (CDSC) in Baldwin, New York, for example, provides its small retail and service company customers with private-label credit cards and accounts receivable funding. "If it's a retail store, for example, we provide [the store] with a credit card it gives to its customers. This allows us to track receivables," says CDSC president Leonard Leff.
The Credit Union Option
If you don't want to turn to a finance company, credit unions are also excellent sources of small-business capital.
"We're a niche player in the market," says Daniel A. Mica, president of the Credit Union National Association. "We represent 12,000 credit unions, and only about 15 percent offer commercial loans."
Although most people associate credit unions with mortgage, car and personal loans, these institutions are also small-business lenders. In fact, many credit unions were organized to help select groups of entrepreneurs.
Take Alternative Federal Credit Union in Ithaca, New York, for example. It was established in 1979 by the Alternative Fund, a group of community business owners, and members must be connected to this organization. According to manager Bill Myers, much of the credit union's small-business financing is micro-lending, with an average loan size of $12,000. Its lending is also often coupled with free technical assistance.
"Our loan officers are trained to look at financial statements and listen to [business owners] to see if it's a loan that can help a business," says Myers. "They devise a solution and, in effect, become a business partner."
In contrast, Citizen Equity Federal Credit Union (CEFCU) in Peoria, Illinois, takes a more traditional approach to business lending in the nine-county region it serves. In addition to offering secured loans, it provides letters of credit, offers revolving lines of credit and is an SBA lender.
While CEFCU's loan requirements don't differ from a bank's, their local ownership and decision-making ability give them a better understanding of the community and its economics, maintains Gil A. Johnson, CEFCU business loan manager.
Even more important, Johnson says credit unions can more easily and quickly respond to the needs of their constituents. CEFCU is a perfect example. The institution began lending to small businesses in 1994 because of requests from members.
Don't Stop There
Although finance companies and credit unions are obvious sources of small-business capital, there are other places to look. Have you considered your life insurance policy or credit card company lately?
"You can take a loan against your life insurance policy if it's a permanent policy," says Virginia Bueno of the American Council of Life Insurance. Insurance companies will lend up to the cash value of the policy minus interest.
Permanent policies have a cash value feature, and the best part about these "loans" is that they don't have to be paid back. They're also easy to obtain, can be used for any purpose and have competitive interest rates.
But there's a downside, cautions Bueno: "If you tap into the cash value of your policy, it's going to affect your death benefits. It lowers the benefit [paid to your heirs] by the proceeds of your loan."
If you're an American Express Small Business Services card holder, you may be eligible for a pre-approved, unsecured line of credit of up to $50,000 from the company. It's accessible by check and can be used for any purpose. Entrepreneurs may contact American Express to apply for the credit line. The company also offers equipment leasing up to $25,000 for card holders and noncard holders alike, as well as auto leasing financing up to $40,000 for card holders only.
Another good source of financing to consider is your suppliers. "If they can get credit and you can't, they may be willing to give you credit because of the profit they're making on the products sold to you," says Sihler. He adds that there is typically a cost for this credit, and the supplier could use the equipment you are purchasing as collateral.
Home Court Advantage
Although many business advisors don't recommend it, some entrepreneurs look closer to home for financing by taking a second mortgage on their house.
Mortgages are, of course, mainstays of many banks. But according to G. Richard Bright, senior vice president of home equity lending for Countrywide Home Loans in Calabasas, California, many mortgage companies will also make these typically 15-year home equity loans.
Second mortgages are best for people who want to borrow all the money they need at one time and secure fixed, equal payments. A home equity line of credit, on the other hand, is a revolving credit agreement with a fixed credit line in which the borrower can write checks up to that limit, says Bright. Interest rates are higher, but this option offers more flexibility. While plenty of companies offer second mortgages, few offer the home equity line of credit.
The advantages of these two options are that the interest is tax-deductible and tends to be lower than an unsecured loan or credit card, says Bright. Conversely, you must recognize that these loans could put your home at risk.
It's all well and good to know how each of these sources work, but deciding which one is best for you means understanding the pros and cons of each.
According to Sihler, finance companies might be good for entrepreneurs seeking loans of $250,000 or less with quality assets, particularly seasonal ones. Additionally, firms that are producing pre-sold inventory for financially reliable clients like the government or a Fortune 500 company may also want to explore this route.
Borrowing against life insurance could be a smart move because some older policies have interest rates as low as 5 percent, says Sihler. But be aware there might be some negative tax implications. For example, the interest paid on this loan may not be deductible as a business expense.
Whatever source of lending you choose, it's still important to do your homework. You need to determine whether the lender knows enough about your business to weather the ups and downs with you. Will the relationship be here today and gone tomorrow, or can the resource meet your firm's future financing needs? Finally, examine whether the loan will help or hinder you in the short and long term.
Once you know the answer to these questions, your choice should be clear.
AT&T Capital Corp., 44 Whippany Rd., Morristown, NJ 07962, (800) 221-7252
Alternative Federal Credit Union, 301 W. State St., Ithaca, NY 14850, (607) 273-4666
American Express Small Business Services, (800) SUCCESS, http://www.americanexpress.com/smallbusiness
Citizen Equity Federal Credit Union (CEFCU), P.O. Box 1715, Peoria, IL 61656, (309) 633-7000
Countrywide Home Loans, (800) 570-9888
Credit Union National Association, (202) 218-7748
Custom Data Services Capital, (800) 338-7353, http://www.cdscapital.com
Heller Financial Inc., 500 W. Monroe St., Chicago, IL 60661, (312) 441-7000
Manchester Commercial Finance LLC, IDS Center, 80 S. Eighth St., #3640, Minneapolis, MN 55402
The Money Store Inc., 3301 C St., #110-M, Sacramento, CA 95816, (916) 446-5000
Pivot Rules Inc., 42 W. 39th St., 9th Fl., New York, NY 10018, (212) 944-8000
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