This is a guest blog post by Ben Gage, COO of Diversified Business Resources, Inc.
The number one reason most small businesses fail is due to a lack of adequate operating capital; and an independently-owned franchise is like any other small business. Whether money is needed for an emergency expense, everyday payroll, taxes or to take advantage of a growth opportunity, if funding is not available the business will suffer.
Because of the current difficulties all business owners face getting bank financing, this guide will help owners of franchises to understand and make use of Asset-Based Lending programs to get the funding they need.
The Problems with Bank Financing
Getting a business loan from a bank can be a very discouraging and uncertain process. Completing the application takes forever, it can be expensive and the documents the borrower is required to provide will fill a large suitcase. The slightest negative event on the credit history of the borrower will prevent the loan from being approved.
No bank loan will ever be issued unless the borrower provides something of value (collateral) that has a fair market value that is equal to or greater than the loan amount.
There is never a guarantee the loan will be granted and if it is, there will be restrictions on how the loan proceeds can be used.
Additionally, for the five reasons listed below, less than 30% of all bank loan applications submitted by a franchise owner will be approved.
Five Reasons Banks Do Not Loan to Small Businesses
Since the banking system meltdown of 2008, there are five main reasons banks will not make loans to small businesses.
Reason #1 – Too Big to Fail
The great recession of 2008 actually threatened the survival of all U.S. banks. To keep the international banking system working, bankers and politicians coined the phrase “too big to fail” as a way to justify the greatest financial bailout in history.
As billions in newly-printed money flowed into the vaults of the world’s largest banks, smaller banks were left to fend for themselves. This immediately gave big banks a huge competitive advantage that continues many years after the financial system meltdown.
Reason #2 – New Banking Regulations
To deal with the sub-prime mortgage loan abuses that triggered the great recession of 2008, treasury regulators around the world have imposed a complicated program of strict new banking regulations for what loans can be issued and the credit rating requirements for all borrowers.
Additionally, banks are required to maintain higher reserves and comply with very burdensome record-keeping and reporting requirements. Only the biggest banks can comply with these new lending requirements.
Reason #3 – Negative Credit Events
From 2008 to 2013, over seventy-five percent of all small business owners in the United States experienced at least one negative financial event that significantly lowered their business and/or personal credit ratings. These negative events include late payments, credit card charge-offs, loan delinquencies, home short sales, and foreclosures and bankruptcies.
Because big banks do not want to give loans to small businesses, they use these negative events to reject over 80% of all loan applications they get from small business owners.
Reason #4 – Lower Interest Rates
As a direct result of the economic downturn and with the goal of rebuilding the U.S. economy, the Federal Reserve has kept a very tight lid on interest rates. Big banks can make more money loaning to each other than to small companies.
Because of this consistent policy of low interest rates and with only so much money available to lend, there is no incentive for big banks to make loans to small and medium-sized businesses.
While current loans to small business have decreased by 30%, loans to big businesses continue at the same rate as before the recession. The crash of the British currency after their exit from the European Union assures that interest rates will stay low for some time to come.
Reason #5 – The Risk/Reward Ratio
Big banks currently make more money on loans to each other and their big business clients than on loans to small companies. Although small companies make up the majority of businesses in the United States and account for most new jobs, loans to small businesses have a greater risk and offer a lower financial reward than a loan to a big business.
Until this risk/reward ratio changes, small business owners will continue to find it very difficult to get a bank loan.
Alternatives to Bank Financing
Seasoned entrepreneurs know that bank loans are not the only source of business capital. Franchise owners have several other ways to obtain the operating capital required for their business.
To offset the lack of start-up and expansion funding available after the 2008 banking meltdown, several large franchisors now offer different types of financing programs for purchase of a new franchise or the expansion of an existing franchise network.
Be sure to read these loan documents very carefully to understand the franchisor’s enhanced rights of business control and foreclosure upon a payment default.
Friends and family members will often provide a going business with a short-term loan. Make certain all loans from friends or family are documented by a professionally-created written agreement and pay particular attention to the increased relationship risk that comes with this type of loan.
Sale of Equity
Sale of an ownership interest in a franchise business can also be a source of business capital. A key concern with this type of funding is how bringing a new partner into the business might affect the division of profits, business management, and decision-making.
Merchant Cash Advance
Merchant Cash Advance (MCA) companies will advance a business owner a lump-sum amount in exchange for a very large fee and the right to make daily deductions from the business bank account. Repayment terms range from 3 to 12 months and there is no discount for early payment.
MCA financing often becomes a debt trap where the business must borrow increasing amounts to repay the total amount due.
If funding is required for the purchase of equipment or a significant amount of fixtures, it may be possible to get an equipment lease from the seller or a third-party equipment leasing company. Although an equipment lease can preserve cash for other business purposes, make sure the cash flow of the business can reasonably support the monthly payments.
Sale of Assets
Sometimes a business will accumulate non-performing assets that have a tangible market value but are not necessary for the operation of the business. These could be outdated inventory; unused equipment, furniture, or fixtures; or any other balance sheet asset that could be turned into cash.
As detailed below, Asset-Based Lending is an alternative form of business financing any business that is generating accounts receivable can quickly qualify for and easily use whenever operating capital is required.
What is Asset-Based Lending?
In general terms, asset-based lending is a type of business finance where a purchase order loan, a line of credit, a short-term loan, accounts receivable factoring or other forms of funding are secured by specific business collateral (“the assets”). The most common forms of Asset-Based Lending can quickly convert the current accounts receivable of a business into cash.
How Does Asset-Based Lending Work?
Here is a step-by-step description of how accounts receivables can be used as the basis for an Asset-Based Lending program:
The accounts receivable for one or more customers of the borrowing client are assigned to the lender with payment for those invoices set up to either go into a lockbox bank account or directly to the lender.
When the client needs money for any business purpose, an invoice is submitted for purchase by the lender and the client receives a same-day advance that is generally 80% of the invoice face value. This process is generally known by the term “factoring.”
When the lender receives payment for the factored invoice, the 80% advance and the lender’s fees are deducted from the payment amount and the balance remaining from the 20% reserve is rebated back to the client. Fees for this service typically range from 2% to 3% of the factored invoice value for each 30 days the invoice remains unpaid.
Here’s a diagram showing how accounts receivable factoring works:
Typical Asset-Based Lending Programs
The following are the types of asset-based funding programs that are generally available to a franchisee:
Invoice factoring converts accounts receivable into immediate cash and provides same-day funding for any business purpose.
Purchase Order Financing
PO Financing provides the money needed to fulfill a purchase order. Up to 50% of the PO value can be used for materials, labor, vendor payments and shipping costs. Everything must be delivered within 90 days. All advances and fees are repaid by the factoring of the invoice when everything is delivered.
Business Lines of Credit
All businesses experience cash flow shortages. Whether because of fluctuating income and expense or an emergency or an unexpected opportunity, a Business Line of Credit can fill in the gaps. Fees are only charged for the time money is unpaid and our company (DBR) never charges a setup fee, line fee, audit fees or any of the other hidden fees charged by other finance companies.
Sometimes a lump sum of money is required to buy out a partner, pay a debt, negotiate a tax settlement or take advantage of a potentially profitable business opportunity. In these situations, a Short-Term Loan can provide the needed capital. With up to 12 months to repay, fees and payments are based on cash flow and factoring activity.
Letter of Credit Financing
Letters of Credit are often necessary for the production of product inventory. Our company will custom tailor a Letter of Credit financing program to the specific needs of each client and provide the financial guarantee required to get the inventory you need. Fees and payment terms are based on funding amounts and repayment timetables, and are designed to meet cash flow capabilities.
When Asset-Based Lending Might Be Best for Your Franchise Business
If you are experiencing any of the following situations in your franchise business, asset-based lending may be your best funding solution:
- Negative business or personal credit
- Inability to provide collateral as security
- Inability to get funding from other sources
- Immediate need for business capital
- Slow customer payment of invoices
- Need to fund a good business opportunity
Setting Up Asset-Based Lending is Quick and Easy
Because the credit of a client’s customer is the basis for the funding provided and all payments come directly to the company providing the funding, setting up an Asset-Based Lending account is simple and quick.
With our company, the requirements for set up of a new asset-based lending account are as follows:
- In business for at least 1 year and consistently generating accounts receivable.
- A signed application containing information about the business and owners.
- Copies of the invoices to factor and assignment of payments for those invoices.
- Full documentation of the transaction for PO Financing, Short-Term Loans and Letter of Credit Financing.
- With everything in place, DBR can provide same-day funding.
Running a franchise business is hard enough without having insufficient operating capital or being faced with the frustrating and uncertain process of applying for a bank loan. Because funding through an Asset-Based Lending program is easy, quick and virtually certain, all franchise owners should be familiar with this alternative form of business funding so they can use it to their benefit.
For more information please visit www.dbrfactors.com or contact Ben Gage by phone at (760) 738-1400 or by email at email@example.com.