What's It Worth?

Anatomy of a Loan

Here's how a typical asset-based loan made against a company's receivables might work.

Step 1. The company sells its product or service to customers. Unless it's a cash-based business or a business where customers pay for all their purchases by credit card, a receivable is created. The receivable, really a debt owed to the company, is usually repaid in 10, 15, 30 or 45 days.

Step 2. The lender makes a loan to the company based on the value of the receivables, typically advancing 80 percent of eligible receivables. The moment the funds are advanced, the company starts paying interest on the loan.

Step 3. Customers are instructed to send their payments directly to the finance company.

Step 4. The lender remits to the company the invoice payments, less the principal on loans it has already advanced, less interest.

Step three can make borrowers queasy--and for good reason. After all, in any business, cash flow equals life, and placing your lifeblood under the control of a third party can bring risks. For instance, suppose a borrower has a large outstanding balance that's continuously revolving. Further suppose that an entire group of the borrower's customers had sold products to a region of the world which experienced a financial meltdown. The lender, who monitors the assets very closely and begins to see the length of these customers' receivables expanding, may take a "reserve" to protect itself. Instead of remitting customer payments to the company, the lender holds some of them as a reserve against future loan losses. Suddenly, the company doesn't have funds it may have been counting on.

Requirements and Scenarios

Sterling's Gannon says that to successfully negotiate an asset-based deal, borrowers must come to the table with financial information that paints a positive picture and is detailed and accurate. Among the requirements he cites:

The business must have a reasonable net worth and long-term viability.

Financial statements must be reviewed by a certified public accountant whom the lender deems acceptable.

Borrowers must submit one year's worth of monthly projections.

The business's principals must guarantee the loan and support the guarantee with personal financial statements.

Keyman life insurance may be required.

Gannon says even if you qualify for an asset-based loan, it might not be the best way to go. "Asset-based loans are more expensive than bank lines of credit and often much more intrusive on the borrower," he warns.

For instance, he says, if you have a good guarantee, are profitable and need to borrow, say, $500,000 for 60 days twice a year, you should go to a commercial bank. "That's the cheapest, easiest way to go," Gannon says.

Similarly, if you have a good guarantee and need a line of credit to support inventory and receivables that can be paid back within one year, there's a good chance a bank will take a security interest in your inventory and receivables and offer a line of credit or a revolving line of credit. "This also will be cheaper than a traditional asset-based loan," says Gannon.

But, he says, "If your guarantee is not that strong, you're not that profitable, your business is undercapitalized, you need working capital, and there's no way you can pay off a line of credit for perhaps two or three years, you present a problem for most banks even if your business is a good one." In these instances, he says, a bank will often refer you to a finance company offering asset-based loans--this may be your only salvation.

Next Step

You can start your search for an asset-based lender at the Commercial Finance Association's Web site, http://www.cfa.com

Using the site's search engine, enter the amount and type of capital you're looking for. You'll be given contact information for commercial finance companies matching your criteria.

David R. Evanson's newest book about raising capital is called (Bloomberg Press). Call (800) 233-4830 for ordering information. Art Beroff, a principal of Beroff Associates in Howard Beach, New York, helps companies raise capital and go public.

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