May 8, 2020 – Joseph Heim recently served as a guest author for Business First of Buffalo. Here, Joe takes a look financing options for business owners in a post Covid-19 economy.
Guide to financing options for SMEs during Covid-19
Even before the onset of the Covid-19 pandemic, small and medium-size enterprises (SMEs) and their CPAs began to see signs of a weakening global economy. In the retail sector, we saw businesses that were heavily reliant on brick and mortar continue to struggle with the high cost of rent and less foot traffic in stores.
The uncertainty of trade tariffs and their potential impact resulted in many businesses purchasing inventory in advance of the probable rising costs of their products. As a result, prices increased in many industry sectors, including food, textiles, clothing and consumer goods.
This is a very stressful and complex time for business owners. Now, they are focused on how to transition their business through this economic cycle, potentially restructure their balance sheets and adjust their business models to compete in this challenged economy. A critical component of this assessment will be the access to working capital, the lifeblood of all operations. Many businesses have taken quick action to secure either an Economic Injury Disaster Loan (EIDL) or a Paycheck Protection Program loan, both administered by the Small Business Administration (SBA). In May, we expect the U.S Treasury’s Main Street Lending Program to provide additional working capital solutions.
Looking beyond the matrix of government supported loan programs and the shifting dynamics of the Covid-19 economy, it may be difficult for business owners to evaluate which financing solutions to utilize moving forward. At the same time, banks will be evaluating their loan portfolios, increasing loan loss provisions and exiting marginal loan arrangements. Some businesses will lose their banking relationships.
Unsecured vs. secured financing
There are a variety of funding solutions for companies to evaluate. To sustain and grow their operations through all business cycles, a business will require a working capital line of credit either on an unsecured basis or secured by forms of collateral. An unsecured loan carries a higher degree of risk for both the bank and the borrower. The lack of collateral raises reliance on the borrower’s cash flow from income and liquidity as well as on the guarantor. In addition, it is typical for unsecured revolving lines of credit to have certain requirements and loan covenants.
The primary advantage of a secured line of credit is that the business can gain access to a higher line of credit at a lower interest rate because of the security of the assets pledged as collateral. In many instances, asset-based lending, a form of secured financing, will support a company through both tranquil and volatile economic conditions.
Asset-based lending (ABL) finances, both seasonal and permanent working capital in the form of revolving credit lines, collateralized by accounts receivable and inventory, and are subject to a periodic borrowing base. ABL financing is available from banks as well as non-banks, such as independent commercial finance companies. With this type of financing, lenders closely control credit availability and collateral. Asset-based lenders typically use a borrowing-base formula (derived by multiplying the value of eligible collateral by an advance rate or discount factor), and may control cash receipts.
Because greater emphasis is on collateral (than in cash flow lending), ABL is structured so that collateral will be available if the loan must be liquidated. Asset-based loans offer a lower degree of risk for lenders and are more likely to gain approval for borrowers, making them a good solution for most lending needs. ABL is an attractive lending option to borrowers who lose their banking relationships.
Businesses and their advisors should follow a process in identifying specific asset-based lenders and evaluating the proposed structure and terms of an asset-based working capital line of credit. It’s not uncommon for the proposed loan amount, availability, advance rates and interest rates to be different among the various asset-based lenders. Business owners should work with their advisors in assessing their business financing needs and assisting with the transition into the new financing arrangement.
To read the rest of this article on the Business first of Buffalo website, please click here.
About the Author
Joseph A. Heim CFE, CPA
Joseph Heim has over 25 years' experience investigating matters involving white-collar crime, fraud and corruption. He provides forensic accounting, litigation support and expert witness services to businesses, attorneys and commercial finance lenders. He is the Partner in charge of Dopkins Asset Based Lending Consulting Services.