The challenge: Traditional bank lenders generally don’t like to finance businesses during periods of variable cash flow or unpredictable collateral, for example, periods of very high business growth or otherwise low operating performance.
The solution: Non-bank (alternative) lenders that specialize in asset-based lending or those that provide short-term bridging loans can often look beyond the turbulence of a transition period to meet a business’s financing needs until that the company can return to a traditional loan relationship.
Key considerations for borrowers:
- Cash is king: Focus on alternative loan cash availability and debt service, not interest rate
- Do the rewards outweigh the cost of capital?: If the benefit of taking on the new business is greater than the cost of capital, the high interest rates may be worth it.
- Plan your outing: Develop a clear plan from the outset to return to a bank from an alternative source of capital
Bank lenders don’t like to lend money to businesses when cash flow and/or collateral are constantly changing, for example:
- Example A: A business is experiencing strong growth that causes a significant inventory buildup that requires additional working capital financing or creates a period with uncertain future cash flows and perhaps inadequate warranty coverage depending on the cash conversion cycle; Prayed
- Example B– A business is experiencing a difficult operating period due to, for example, an operational restructuring, sales force realignment, or major project scoping error, creating negative cash flows or earnings
In circumstances such as these, a bank lender may reduce available funds (eg, increase the reserve on a loan basis or create specific collateral), request additional collateral, or simply ask the business to find another lender.
Non-bank lenders are often willing to look beyond the turbulence of a transition period to understand and structure themselves around the real risks in order to feel comfortable providing the necessary capital.
Alternative lenders are structured to lend in periods of uncertainty; They generally have greater flexibility to tailor their loans to:
- Provide additional growth capital during periods of rapid expansion, without penalizing a company for investing as traditional lenders do.
- Financing a business in the early stages of a proven change, much earlier than when a traditional lender would lend
Alternative lenders also provide more flexible terms (cash debt service, amortization, loan maturity, covenants) and cash availability than traditional lenders, and therefore charge higher interest rates.
Key considerations when borrowing from a non-bank (alternative) lender:
Businesses turn to non-bank or alternative lenders when traditional lenders don’t provide the necessary capital or bank terms are too restrictive. Here are several key considerations when evaluating an alternative loan:
- Cash is most important, so focus on required cash debt service (principal and interest), No the interest rate on the loan
- Often the total debt service on an alternative loan at a higher interest rate will be less than the total debt service on a traditional bank loan because the principal payments are much lower.
- If the benefit of taking on the new business outweighs the cost of the loan, the high interest rates can be worth every penny.
- Have a realistic plan to return to a traditional lender before taking out a bridging loan
- Make sure the loan provides a cash cushion if the transition takes longer or costs more than expected
- Ask yourself: Does the lender understand my business and appreciate me as a customer? The answer must always be yes. If not, find a lender that does.
