SHORT TERM FINANCING INCLUDING EQUIPMENT FINANCING Chapter 11

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SHORT TERM FINANCING INCLUDING EQUIPMENT
FINANCINGChapter 11
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SHORT TERM FINANCING

• This is a discussion of borrowing from banks and
  finance companies using assets as collateral.
• First we will discuss banks and the various types
  of working capital loans they make.
• Next we will discuss the types of working capital
  loans made by commercial finance companies.
• Finally, we will discuss the differences between
  finance companies and banks.
• As a prelude to this discussion, we will discuss
  the legal forms used to secure an interest in
  assets.

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SHORT TERM FINANCING

• The UNIFORM COMMECIAL CODE is one of the most
  important commercial laws that a country could
  have. With assurances that they can seize
  collateral, a lender is much more interested in
  making a loan.
• Developing Countries (such as China) could really
  use this.

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SHORT TERM FINANCING

• UCC Forms
• UCC 1 - Financing Statement whos borrowing from
  whom, using what as collateral.
• UCC 2 - Security Agreement a listing of the
  collateral forms designed for Vehicles, A/R, or
  Inventory. Lenders vary from very strict to quite
  lenient depends on financial strength of
  borrower.
• UCC 3 - Inquiry form used to see if someone has
  a Financing Statement on an asset.

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SHORT TERM FINANCE FROM BANKS

• Bank Relations
• Choosing the right/appropriate Bank
• Retail Banks
• Wholesale-Oriented Banks
• Combination Banks
• Correct Office
• Selection of the Banker/Loan Officer(s)
• Building of Rapport
• Enthusiasm
• If you treat like an enemy they will be!
• Find Hot Buttons
• Never go Off the Record

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SHORT TERM FINANCE FROM BANKS Types of Loans

• SIGNATURE LOANS
• Shows banks confidence in Company.
• Must be repaid at least yearly.

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SHORT TERM FINANCE FROM BANKS Types of Loans

• ACCOUNTS RECEIVABLE PLEDGING
• Usually require good financial statements.
• Loan 30-90 of eligible receivables.
• Not over 90 days old (or, with some lenders, 90
  overdue)
• Maybe no service company receivables no
  Government.
• No concentration factor no diffusion factor.
• Returns and allowances really scare lenders and
  will lower percentage loaned - maybe a lot.
• Typical cost is prime to 2-4 points over prime.
• Plans vary by bank may have to be rather good
  risk.
• Most popular form of bank financing.

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SHORT TERM FINANCE FROM BANKS Types of Loans

• INVENTORY PLEDGING
• Generally disliked by banks they prefer A/R
  financing.
• Up to 50 of raw materials or finished goods 0
  on WIP
• Marketability is the key if there is a market,
  more attractive. Fashion goods, like fabric, not
  acceptable.
• For finished goods, if guarantees by Co.
  receiving financing are important this can lower
  or make inventory ineligible.
• If banks loan on receivables, they may take
  inventories to keep others from taking it.
• Costs about the same as Accounts Receivable
  financing.

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EQUIPMENT LOANS

• Banks and finance companies will lend about
  80-100 of Quick Sale value. Market value
  mostly irrelevant to lender.
• Appraisal companies give two kinds of appraisals
  Market value and Quick sale
• But there are two kinds of Quick sale values
• Orderly Resale - value if put up for sale over,
  say, 6 months.
• Knock Down Value - what would it bring if put up
  for auction?
• Three kinds of appraisers
• Appraisal Companies, e. g., American Appraisal
• Auction Companies, (Liquidators), e.g., Tauber
  Aaron
• Machinery dealers - least reliable.

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EQUIPMENT LOANS - APPRAISERS

• CHECK WITH PROSPECTIVE LENDERS BEFORE YOU HIRE AN
  APPRAISER BECAUSE THE LENDER MAY NOT ACCEPT THE
  APPRAISAL.
• SINCE AN APPRAISAL CAN COST 5-10,000 or more,
  THIS COULD BE MONEY WASTED.
• USUALLY, AN ORDERLY RESALE APPRAISAL WILL
  RESULT IN A HIGHER Quick saleVALUE THAN AN
  AUCTION APPRAISAL.

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SHORT TERM FINANCE - FINANCE COMPANIES

• Finance companies are asset based lenders. They
  tend to be much more experienced than banks in
  making asset based loans. Also, they tend to be
  more difficult to live with than if you
  borrowed from a bank.
• Some finance companies are Cash Flow Lenders as
  they will lend on good cash flow but little
  assets. Usually bigger deals.

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SHORT TERM FINANCE - FINANCE COMPANIES

• ACCOUNTS RECEIVABLE PLEDGING
• Similar to banks, but they will scrutinize your
  customers more than banks will do they can
  hassle your customers.
• May tolerate concentration factor, more than
  banks.
• Today, cost starts at about prime to 4 points
  over prime may be 8-12 points over prime with a
  large cancellation clause.

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SHORT TERM FINANCE - FINANCE COMPANIES

• ACCOUNTS RECEIVABLE FACTORING
• Title changes hands. You actually sell title to
  factor.
• Factor must approve the customer before you make
  sale.
• This relieves company of maintaining credit
  dept.
• Very important in some industries, e.g., clothing
  mfgrs.
• May create Negative Demand Effect if used where
  not common. Customers may resent being hassled
• With and without recourse means who will stand
  bad debt. Without recourse will be very
  expensive.
• With and without notification do you tell the
  customer?

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SHORT TERM FINANCING - FINANCE COMPANIES

• A/R FACTORING cont.
• Can be quite expensive compared with A/R
  Pledging, but you dont have to have a strong
  Balance Sheet!
• Many manufacturers feel they can pass on cost
  to customer can charge up to about 5 per month.
• If your financial status declines, factor will
  drop percentage they lend, say, from 90 to 70.
  Some manufactories need advance from factor to
  buy the material and/or pay suppliers, so 70 may
  not be enough.

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SHORT TERM FINANCE - FINANCE COMPANIES

• INVENTORY PLEDGING
• Same borrowing percentages as banks but with much
  more insight into the inventory itself.
• More experience.
• Will likely check the inventory turnover if
  slow, may decline to lend on the inventory.
• Like banks, finance companies may take inventory
  even though they do not lend on it if they are
  doing receivables financing.

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SHORT TERM FINANCEFinance Companies vs. Banks

• Priorities
• Banks - Financial statements - with a lot of
  importance on the balance sheet and the cash
  flow, guarantees and then the collateral.
• Finance companies - About a tie with cash flow
  and collateral, then financial statements and,
  quite importantly, guarantees and/or personal
  assets.

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SHORT TERM FINANCEFinance Companies vs. Banks

• Finance companies will say that it is better to
  do business with them because if you get in
  trouble with them, they will work with you and
  banks will not. The reason they say this is
  because of the fact that they usually write their
  term loans using The Rule of 78. This is a
  formula which uses the sum-of-the-years-digits
  basis in determining the interest earned by
  finance company for each month of the year. Gets
  name from the fact that the sum of the digits 1
  through 12 is 78. Interest is 12/78ths in first
  month, 11/78ths in second month, etc.

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SHORT TERM FINANCE - RULE OF 78
Principal Payment
Monthly Payment s
Shows that a lot of early payments go to
interest. Interest on old loan can be
enormous if terminated early.
Time
Interest Payment
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GOVERNMENT SOURCES OF SHORT TERM FINANCE

• Small Business Administration
• Guarantees loans for working capital and terms
  loans for such things as equipment loans up to
  eight years on equipment, more on buildings.
• Borrower must be a For profit firm
• Loan must not be for speculation - no land
  purchase if for resale
• (Usually) Must be turned down by normal sources
• May not be for any newspaper, radio, etc. - first
  amendment problem. May be part of a package of
  loans, e.g., for the inventory part.
• Max. dollar guarantee varies over time
• Small Business Investment Companies (SBICs)

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GOVERNMENT SOURCES OF SHORT TERM FINANCE

• RURAL BUSINESS-COOPERATIVE SERVICE
• Somewhat similar to SBA but restricts loan
  guarantees to businesses in Rural areas - Towns
  of less than 50K and areas around them.
• Several programs including direct loans and
  guarantees.
• If buying a business in a rural area, may be
  excellent source of financing, especially if jobs
  can be created or saved.
• REGIONAL LOANS - SUBSIDIES - FOR BUILDING
  PURCHASES. Locally, counties are competing for
  businesses to move to their county.
• THE EXPORT-IMPORT BANK

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SHORT TERM FINANCING INCLUDING EQUIPMENT
FINANCING
END