Accessing Capital When Traditional Credit is Constrained

By Mike Semanco, President, Hennessey Capital

What is a borrower to do?  Although the traditional credit market is showing signs of life, businesses are still facing a challenging credit market.  Hard asset (equipment and real estate) collateral values have dropped dramatically so refinancing of loans requires more cash in each deal.  Younger companies still require a track record, typically 2 years, to qualify for traditional lending.  Because of constrained credit conditions, companies have to think outside the traditional box to finance their business. 

 

In our business, we have seen companies negotiate preferred payment terms with their customers.  Down payments, progress payments and shortened A/R terms are being pursued as viable alternatives.  Companies who have normally written off the notion of factoring receivables are now using it as a standalone financing product or using it in addition to current bank lines to fund incremental growth.  ABL lines of credit are now more mainstream since most ABL lenders are focused on collateral and not solely on cash flow. 

 

In addition to working capital alternatives, companies are looking at micro loan programs and seed funds to help with growth financing.  These loans are usually under $50,000 but can make a difference to a young, growing business.  State funded programs are constrained with lack of cash but could also be a source for creative financing.  PO Financing for distribution businesses remain a good source of capital but project financing for manufacturing companies is non-existent in the traditional market. 

 

Young companies are traditionally undercapitalized.  In a tightened credit market, this creates more stress when new opportunities become available.  Communication is always the key.  Ask your banker if options exist outside their world.  Do be afraid to ask customers what may be available.  If customers like your product or service, they may be open to concessions.  Ask your professional advisors to make introductions to funding sources.  They should be aware of various options and point you in new directions. 

 

Credit is available.  You may just need to look outside the traditional box to find it.

Your Bank Issued a Demand Letter: Now What?

 

 By Jeff Wright, Senior Vice President, Hennessey Capital

                       

The principal owner of the company is usually surprised and upset when receiving a demand letter from the bank requesting that he/she pay the loan in full in 10 days. Chances are that when a bank issues a demand letter, the owner has defaulted on the loan under the terms and conditions documented in the Loan and Security Agreement. Failure to make timely payments and violation of financial covenants are common reasons that trigger the issuance of a demand letter. Do not panic and assume the company must go out of business and close its doors. This is the traditional first step banks take to collect on a  loan.

 

Do not ignore the letter! The bank will take steps to protect its interest, which might be contrary to what you deem are the company’s best interest. Contact the loan officer and schedule a meeting to discuss what the bank’s intentions are with the loan relationship. There may be an opportunity to restructure the loan under new terms and conditions. If the bank presses to be paid off in full, it is unlikely you can obtain alternative financing on such short notice. This takes time and may require negotiating a Forbearance Agreement.

 

Under a Forbearance Agreement, the bank agrees to forbear from taking any actions to collect the loan for a period of time, usually one to six months, provided you meet defined hurdles in operating performance, reducing the bank’s loan exposure, improving its collateral position, and/or providing evidence that alternative financing is being sought. The agreement will also ask you to acknowledge the default, confirm the balance owed, reaffirm your  guaranty, and waive any claims you  may have against the bank.  You can also expect the bank to increase your  interest rate, charge additional fees, ask for additional collateral, and/or reduce advance rates. It does, however, buy you time to find another lender.

 

Prior to meeting the bank, review your documents, preferably with your attorney, to determine what rights you have. Many bank documents allow a “cure period,” which allows you time to mend the default. Also have the attorney or advisor with you when you meet with the bank. Many business owners do not understand this process and it is critical to have a trusted advisor there to represent you and protect your interests. Be prepared to provide the lender with financial and collateral information that supports your plan to pay off the bank in a timely manner, with proof the company is viable and that the bank’s loan exposure will improve in the interim.

 

Bring a current financial statement, receivable and payable agings, inventory numbers, and operating and cash flow projections, supported by open purchase orders and backlog reports that support projected revenues and overhead cuts made to improve cash flow. Understand what your cash needs are over the short term. Cash is king at this point. Having access to capital is key to the company’s survival. Use your trusted advisors, i.e. attorney or consultant, to help in preparing your plan and in negotiations. They also have resources that can assist you in finding alternative financing if that becomes necessary.

 

During the forbearance period, the bank will be monitoring the company’s performance and will take more aggressive action if they believe their loan loss exposure has increased. This will be evident if there is a default in the Forbearance Agreement or troublesome information is obtained through their due diligence. Be honest and up front with the bank and don’t be afraid to communicate bad news. Hiding information from the bank can result in broken trust and the bank’s unwillingness to cooperate in the future. They may take action to have a third party involved to protect their interest.

 

As a last resort, consider filing for bankruptcy protection. Bankruptcy will allow you time to reorganize the company with less debt. Unsecured creditors and some secured creditors debt can be negotiated at a discount and paid over time. Do so only after considering the consequences. Will you have the support of key vendors and customers going forward? Who will fund operations while you are in bankruptcy? Can you retain key employees to assist in the turnaround? Will there be sufficient cash flow to continue as a going concern and pay bankruptcy costs? 

 

This process can be emotionally draining and costly, but is necessary if the company is to survive. The ultimate goals are for the company’s operating performance to  turnaround and have the bank retain you as a client.

 

Payroll Funding: Avoiding the Cash Crunch

By Joe Romeo, Senior Business Development Representative, Hennessey Capital

Are you pulling your hair out each time Payroll Check Date approaches?   Maybe a review of your working capital resources is in order.

Many companies face a recurring cash crunch when it’s time to pay their most valuable assets, their employees. Next to the fixed costs associated with buying inventory, building products or creating deliverable services, making payroll is often one of the biggest consumers of cash.

 

Typical scenario:  Your business is going pretty well resulting in a good amount of A/R, but your customers continue to defer payment to or beyond terms.   These are some of your best customers so you are caught in the delicate trap of “collections versus managing the customer relationship.”

 

There is a sound and simple solution for this scenario – working capital financing.   Services like factoring can give you access to immediate cash to provide gap financing and reducing the stress around meeting payroll.

 

Factoring advances of up to 85% of your A/R immediately, when you invoice your customers giving you the working capital you need to run your business and make payroll.  As a bonus, factoring is completely discretionary - you utilize it when you need it.

 

While we are on the subject of payroll, there are some other things you should consider.

 

Paying your employees and satisfying your payroll tax requirements are an essential part of running a successful business.  Many organizations outsource this service.  Outsourcing will save time and expense by not having to perform this work in-house, allowing the business owner to focus on running the business and managing the bottom line. 

 

You can also combine a factoring facility with Hennessey Capital Payroll Solutions – a single point to handle all your human capital management needs.

 

Steering clear of the many pitfalls associated with the regulations involved with payroll is often difficult.  Outsourcing this function to a third party can be an effective remedy. Solutions can include general payroll administration as well as reporting and depositing your taxes with the proper State/Federal authorities. 

 

This involves:

• Accurately calculating and submitting payroll taxes to the state and federal agencies.
• Selecting the proper options available to pay employees and submit payroll.
• Making sure data that is stored or transmitted electronically is secure.
• Ensuring your data is protected from unexpected circumstance such as a fire, hurricane, snow storm, flood or power outage, etc. Optimal disaster recovery plans continuously back up all client data in different locations, so that even in the event of an unforeseen circumstance (weather-related delays, power outages, etc.) all clients’, employees’ and any corporate sensitive information is protected and secure.

As your business grows, you will likely need to hire more employees and add staff to manage those employees. As a company’s employee size increases, more attention needs to be given to Human Capital Management issues. 

PO Financing- the ideal financing tool for the right situation

By Mike Semanco, President, Hennessey Capital

For many entrepreneurs, landing that large purchase order is just what the doctor ordered.  You worked hard to win the client, outlasted the competition and are in a position to build on your success.   The team celebrates until someone asks, “Do we have the cash to purchase the large amount of supplies needed to deliver the project?” 

Growth can be a major drain on a company’s cash and a major reason why we stress the importance of cash forecasting. 

Although purchase orders are covered in the Uniform Commercial Code as an asset of a business, it is not an asset that is easily financed, unlike accounts receivable, inventory, equipment or real estate.

Purchase order financing is offered by very few finance companies and is usually best suited for distributors.  Manufacturers and service providers are not ideal candidates for PO financing due to the concern of performance risk.  PO Financing for distributors allows for the securing of goods by way of letter of credit (promise to pay once certain stipulations are met), so that the distributor can increase its buying power with suppliers.   In the case of a distributor, they are not responsible for manufacturing the product so performance risk lies with the supplier.  PO financing will be structured so that the supplier will not receive payment unless they produce the proper product as defined in the PO, which eliminates the issue of performance risk and thus satisfies the PO funding source.

PO financing carries more risk to a lender than traditional A/R financing thus the cost is more than traditional A/R financing.  Due to the increased cost, companies must make sure they have sufficient margin in the order.  PO financing is typically used in conjunction with an A/R line of credit or factoring facility so that once the product is received by the end user, invoices can be financed and the cash can be used to repay the PO funding source.  This opens up the PO finance facility to be used for new orders. 

Purchase order financing is not ideal for every business but in the case of a distribution model where product needs to be purchased and sold to large entities or retailers, it could be a great tool to secure the cash needed for new growth.

Creating a Credit Policy that Helps You Get Paid

By Candace Pavliscak, Chief Credit Officer & Senior Vice President, Hennessey Capital

Everyone thinks of the banking/finance industry when they hear the term “credit policy” particularly with the prevalent coverage in the media as of late. I have even seen “lending policy” and “credit policy’ used synonymously in some articles but I believe what they each represent is very different. While it is true that all financial institutions have a credit policy that drives their lending practices (some better than others as we have seen), every business should have some form of credit policy.

Why should your company have a credit policy? Think about it, as a goods or service provider you are extending credit to every customer that doesn’t pay you cash on the spot for your work. You should have some idea of how much credit you are willing to extend and to whom. The basics of a credit policy can be summarized as follows:

Know your customer. How well do you truly know your clients? What reputation do they have around town or among industry peers? What are their typical payment habits? Is there an end user beyond your customer that will affect payment to you? If so, how strong is that company? It is a recommended practice to request credit references and utilize public data to analyze your customers before you begin a relationship.

Know yourself. You need to be able to determine how much risk you are willing to take? This boils down to how much are you willing to lose. As we see with personal investors, some are willing to take big risks for the possibility of larger returns and others prefer smaller returns and limited risk. Find the balance that suits your business. Remember though that no one collects 100% from all its customers 100% of the time. Also be aware of how many “good sales” you have to generate to make up for the one “bad sale.”

Have a process and make sure it is communicated to all employees. This principle encompasses everything from your sales process (do your sales people understand your risk tolerance?, will they get the reference information you want?) to your invoicing process (what can you bill for?, when can you bill it?, where do you send the bill? and what approval is needed for your customer to pay the bill?) and finally to your collections process (do you have the right AP contacts for your customer?, are you making timely follow up inquiries?, and do you have any leverage if payment issues arise?)

Having clear expectations with your customer and your employees helps to set the tone and build relationships for your company to succeed.

Creating a sound credit policy is critical to avoiding confusion with customers and keeping your company’s financial house in order. For additional resources/samples of effective credit policies, see Inc’s Finance Guide: How to Create a Smart Credit Policy

So your customer needs a rush order?

There are a variety of red flags that can signal a potential problem with payment and/or collections from your customer. Beware: repeated rush order requests is one of those red flags. A sudden need for a “rush order” from your client might signal cash flow issues on their end. This might indicate that your customer has not planned accordingly for work flow. It could also mean they are short on cash and need to expedite delivery of a good or service, to speed up their payment and resolve a cash bind. If an unexpected “rush order” request is made, don’t be afraid to ask questions of your customer, including why the rush order is needed. You may also want to ask “What happened during the production cycle to cause this sudden need?” “Do you anticipate additional rush orders in the future and why?” The answers to these questions may signal there are troubles ahead. Keep in mind a one-time request doesn’t necessarily indicate a problem, but if you receive repeated requests from the same customer, you might want to think twice.