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Commercial Break

When banks can't give you the funds you need, look to commercial finance companies for help.

By the mid-1990s, Princeton Laundry had fallen on hard times. Despite a healthy client roster-it catered to New York City hotels-the rising costs of operating in Manhattan had taken a toll. A steep mortgage and mounting maintenance expenses for its commercial co-op space made it exceedingly difficult to sustain the operation. To make matters worse, the commercial laundry, owned by the Garlasco family for three generations, was behind on its taxes.

"Our accountant kept telling us, 'Your business is profitable, but where you're located [is] driving you out of business,'" recalls Kevin Garlasco, 40, the company's treasurer and managing partner. Heeding the warning, the family moved the company in a dramatic new direction-a 20-minute drive north to the Bronx, where community leaders were dangling business incentives for economic growth. There, the Garlascos built a new production facility that opened in 1997.

Leaving Manhattan was only a temporary solution, though. Even after Kevin, his father, Larry, and brothers John and Michael mortgaged their homes for funding, the family still needed a large infusion of working capital to stabilize the company. Unfortunately, traditional creditors were wary of recent financial hiccups, though the business had been around since 1918. "We tried going to banks," says Kevin, "and it was always the same thing: They wouldn't give us a loan because we were in a tight situation and a little behind in paying our taxes. We were falling into a hole."

The answer to their financial woes was a commercial finance company, Business Alliance Capital, in Princeton, New Jersey. Business Alliance provided a $600,000 revolving line of credit secured by accounts receivable. "We laid everything out on the table with them, and it wasn't a pretty situation at that time," Kevin remembers. "It's gotten drastically better. We were able to clear up our taxes, and now we're running our business much more efficiently." Indeed, the family firm has grown approximately 30 percent to annual sales of $7 million since the 1998 funding intervention, which also included about $500,000 in equipment financing.

A Different Breed

While Business Alliance Capital obviously saw growth potential, it didn't place blind faith in the struggling business. Finance companies are simply a different breed of lender than more mainstream creditors, such as banks. Nonbank lenders like Business Alliance Capital advance funds based on a percentage of a firm's assets- usually 25 to 60 percent for inventory and 75 to 85 percent for accounts receivable-and when that firm's receivables are paid, the cash is turned over to the lender to pay down the loan. Because the loans are secured by assets, finance companies can lend to businesses with irregular cash flow, even losses-the very borrowers banks try to avoid. Banks are principally cash-flow lenders, leaving many highly leveraged companies and those with sporadic growth outside their financing domain.

Although there was a time when only troubled companies resorted to asset-based funding, it's an increasingly common financing strategy for businesses with fluctuating capital needs. "It's what we call the David and Goliath effect," explains Mike Parrish, regional manager for The Commercial Finance Group in Atlanta. "You have a guy who's a hammer manufacturer providing product to The Home Depot or Lowe's, but the problem is that neither Lowe's nor The Home Depot is going to pay them in the 35 days that a traditional company like that would get paid."

Part of the appeal of asset-based lenders is their willingness to give space to borrowers going through a rough patch. Banks routinely impose financial covenants on borrowers to monitor operating perform-ance, dictating such things as minimum-working-capital balances and debt-to-equity ratios. Depending on the extent of the covenants, a business may be just one financial misstep away from losing critical funding. Finance companies, in contrast, rarely use the kinds of restrictive covenants that accompany cash-flow loans, instead touting themselves as a stable financing source even if a company's circumstances take a negative turn. Ted Kompa, president and CEO of Business Alliance Capital, says, "The company, from a standpoint of calling a loan for financial performance, would have to be in pretty dire straits for a properly secured finance company to want to take action."

The Cost of Convenience

The simplicity, however, comes at a price. While competition has helped drive down the cost of asset-based credit, small loans may run 15 to 28 percent. Both risk- and collateral-monitoring requirements figure heavily in the total asset-based funding cost. For instance, a business that generates a large volume of small invoices typically pays a monthly collateral-monitoring fee ranging from one-quarter to one-half percent. On top of those fees, prepayment penalties are standard to deter borrowers from refinancing with a bank if creditworthiness improves.

It's quite common for businesses to get a bank loan once their financial situation progresses. Princeton Laundry isn't one of them, however, despite now having more secure financial footing. Kevin Garlasco says the higher costs are a small price to pay for peace of mind during periods of market volatility, such as the months following the 9/11 terrorist attacks, which dealt a severe blow to the commercial laundry's core constituency: New York City hotels. "Sales did slow down, but we got through it. If I were with a bank," he says, "they probably would have been breathing down my neck."

Along with higher fees, finance companies have more arduous reporting requirements. Lenders may require daily reports on sales and collections to establish how much funding a business can draw against assets; in determining borrowing capacity, lenders subtract ineligible assets, such as past-due receivables. On a positive note, the rigorous reporting forces owners to examine key aspects of their operations. "They may see receivables getting old, but maybe they haven't looked to see why," says business advisor Debra Pauli, president of Corporate Financial Solutions in Atlanta. "This lending program forces entrepreneurs to understand intimate details of their businesses. A business is asset management from cash flow, and that's what this lending program is all about."

The lesson isn't lost on Kevin Garlasco, who knows he has to actively manage receivables to keep the funds flowing. "Anything over 90 days, that money is not available to borrow," he says. "So I really have to keep control of my customers and keep them paying."

MEET YOUR MATCH
While asset-based lenders are abundant, loan size ultimately determines an entrepreneur's range of financing options.

For modest financing deals, borrowers may have to look harder for an asset-based lender that focuses on smaller transactions. "Many specialize in [loans] under $1 million, but they're not national in scope," says Ted Kompa, president and CEO of Business Alliance Capital in Princeton, New Jersey. "You have to look at each individual region to see who is active in that area." He recommends contacting the Commercial Finance Association, a New York City-based trade group for asset-based lenders, for a list of finance companies in your area. You can search for lenders by geographic region and loan size at the association's Web site, www.cfa.com.

Before signing on with any finance company, though, carefully investigate its track record. "Do some due diligence on that lender. Ask for references, and talk to current customers to get a feel for what that customer [thought] they were getting when they went in versus what they actually have now," advises Debra Pauli, president of Corporate Financial Solutions in Atlanta. "You have to remember that this is a competitive marketplace. Interview a lot of lenders in your market."

 


Crystal Detamore-Rodman is a Charlottesville, Virginia, writer who covers the small-business finance market.

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This article was originally published in the August 2004 print edition of Entrepreneur with the headline: Commercial Break.

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