Why “Big Banks” Are Turning Down Working Capital Lines of Credit at a Record Pace (Part 2)
The Wall Street Journal reported on November 22 that “New Loan Rules Are on Tap.” Small businesses who use Deposit Advance loans to even out their working capital shortfalls will now face restrictions as the Office of the Comptroller of the Currency will increase scrutiny on banks that make these types of loans. The WSJ further reported that the implementation of these guidelines will push borrowers to payday lenders, pawn shops and others outside the banking system. This regulation is a negative development for small business because most small businesses avail themselves of consumer debt programs that can be garnered by the owner for working capital. This development will unfortunately increase the cost of capital and further limit small businesses access to capital. With a bit of planning we can work around this legislation.
Going to a payday lender or pawnshop for financing should not be your first choice. There are many secondary lenders and factors in the market that are reputable and in most cases are more flexible than banks. These institutions are well capitalized, highly professional and would be very pleased to work with small businesses that have working capital needs and are growing.
An example is Capstone Business Funding, LLC (of which I am a Principal) provides Working Capital by purchasing your Accounts Receivables and unlike other companies in the same line of business, there are no long terms contracts. Capstone provides working capital at your request, only when you need it. Our clients grow rapidly once they learn how to effectively deploy the capital we provide.
One of our clients is an electrical contractor. Prior to working with us the company struggled to achieve sales of $5,000,000 per year. The company was notified last year that its $1,500,000 revolving line of credit would be termed out to a 60 month term loan. Just like we discussed in last week’s post, the bank was facing the option of classifying the loan or converting it to a term loan. Following the conversion of the credit facility into a term loan we established a factoring facility for our client.
For those who don’t know, factoring is a financial arrangement where a company (in this case, Capstone) purchases accounts receivable from another company. The purchaser advances funds and assumes the credit risk. Once the invoice is paid, the purchaser sends the balance collected less their fee to the company that sold the accounts receivable in the first place.
We negotiated a Limited Subordination Agreement with the client’s bank and began factoring their accounts receivable. During the first few months of the relationship, the client factored selected invoices and began to bid on projects they could not bid on before due to their line of credit limitations (which prevented the client from taking on new jobs prior to previous jobs being paid). Part of the bidding process requires disclosures regarding how companies will fund contracts if awarded. Normally, a contractor indicates his available credit on his bank line. However, by using Capstone, our clients can write “unlimited” because our credit approval process is based on the credit of the general contractor or the owner of the project, not solely our client.
What seems like a minor change in the way our clients conduct their business have significant positive results. From our prior example, Capstone knew the outcome would be positive but our client had no idea. In summary:
- Our client’s business changed from job to job (due to cash flow limitations) to a significant backlog of work.
- Multiple contracts were awarded at good margins and suppliers were paid in advance of terms creating payment discount opportunities and increasing profit margins on already profitable jobs.
- Sales went through the roof. Typically, Capstone’s clients grow on average by 15% to 20% per year. This client went from $5,000,000 in sales per year to $13,000,000 in sales per year.
- Remember that pesky term loan for $1,500,000? The loan balance as of the end of the 3rd quarter was below of $750,000. The bank was (and still is) happy to have us involved and began referring other clients to us who had similar problems.
- Fortunately for us, this is the norm for our clients rather than the exception.
What is your back up plan if your bank decides to term out your credit line or you are denied a working capital line of credit? Lay off some of your valuable staff? Turn away good and profitable business? You can turn a negative event into an opportunity to grow your company with Capstone Business Funding, LLC.