Wednesday, June 06, 2007

Read the Fine Print

Today's Small Business Column in the LA Times is probably a good example of small businesses that either don't read the fine print or don't understand the implications of the loan documents they are signing.

Here are four points from the article by LA Times staff writer E. Scott Reckard a small business might consider when evaluating business loans.
  1. The SBA is guarantor of last resort, not first, should a small business default on its SBA-backed loan obligation. The banks I deal with (and the laws may vary by state) tell me that the loan documents typically give them the option of pursuing the assets of the business or the personal assets of the the personal guarantor in any order they choose in the event of a default. Not sure about the order your lender has the right to pursue in the event of a default, read the fine print before you sign and ask if it's not clear to you!
  2. The security interest and lien that the borrower gives the lender may be a blanket lien on all current and future assets of the business as well as a lien on your home. This may tie your hands when you're attempting to obtain additional loans from different lenders down the road. Not sure about the restrictions, read the fine print before you sign and ask if it's not clear to you!
  3. The article attributes to Michael D. Ames, executive director of the Center for Entrepreneurship at Cal State Fullerton a comment that a company needs four or fives years of profitability to qualify for receivables financing (presumably factoring). I suspect (and hope) the staff writer misunderstood this one. To qualify for the lowest cost receivables financing from a bank, a company typically must have two to three years of profitability though in some cases, exceptions are made. A company doesn't have to even be profitable to qualify for factoring - which is why many non-profitable firms utilize it!
  4. The staffing company discussed in this article was put into default on their loan not for missing loan payments, but for the technical default of violating a non-payment related covenant. Loan covenants are a key consideration for a business accepting any form of financing. Know and understand those covenants and how they impact the operations of your business.
A couple of last comments from yours truly.

The staffing company discussed in this article made a key mistake that destroys many a small business. It allowed one customer to become too large a portion of its revenues. Bad things happen to companies that make that mistake - don't let it happen to you.

Factoring of accounts receivable is often a much better financing solution for many small companies when compared to bank financing. It's easier and quicker to obtain approval compared to bank financing, doesn't typically require covenants and the funding amount can increase with the growth of the borrower's revenues. Provided your customers are paying your invoices, it's self liquidating leading to a much lower likelihood that a small business can overextend itself by borrowing more than it can repay. Personal guarantees are not as stringent as those required in a bank financing and can sometimes be limited to acts of fraud. The staffing company in this article should have been using factoring.

Is factoring more expensive than bank debt? In terms of absolute cost, usually. But considering all the other factors, factoring is a financing solution to which businesses of all sizes should give serious consideration.

Need help finding the right lender or telling your story the right way? Read "Matchmaking for Business Loans" and give me a call!

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