Business growth comes in many forms. Winning new customers to grow your customer base. Selling more products to your existing customers. Purchasing a new company to expand your capabilities. And if you are near or at production capacity, you need to increase capacity to deliver this growth. In most industries, manufacturing, transportation, and construction, for example, capacity growth typically means adding equipment or personnel. This could be production equipment, warehouse equipment, IT infrastructure, or labor. And expansion takes capital. But not all capital should be financed the same way, and not all capital funding sources are created equal.
For many businesses, the local bank is the first source to consult with for funding. Most businesses have checking and/or savings accounts with a local bank and many have a personal bank representative with whom they work. Bank financing can be an option but depending on the type of loan, its size or the status of the business or business owner’s credit, it’s not always available and if it is available takes a long time to get approved.
For example, many banks have entered and exited the equipment finance space, so depending on the state of the market or industry, the local bank may not be willing to finance equipment, or if so, at terms that may not be practical. In some cases, they might be willing but lack the specific industry expertise required to close a transaction quickly.
Line of credit
A line of credit (LOC) provides a credit limit against which a firm can borrow as needed. The borrower can access funds from the LOC at any time provided they do not exceed the maximum credit limit set in the agreement and meet any other requirements such as collateral coverage and making timely payments. LOCs can either be secured by collateral or unsecured. Unsecured LOCs typically carry higher interest rates than secured LOCs, and most LOCs carry variable interest rates.
Advantages to LOCs include ongoing access to capital and the ability to use the funds for a variety of reasons (inventory or raw material purchases, payroll, equipment, etc.) While LOCs offer a great deal of flexibility, they may not be available to all businesses, especially start-up companies. Additionally, some LOCs place limitations on taking on additional debt, or restrictions on owner withdrawals or other uses of capital. In some cases, annual updates of financial statements are required, thus increasing the burden on bookkeeping and paperwork.
real estate loan
If the asset being purchased is land or a building, a commercial real estate loan might make sense. A commercial real estate loan, in some respects, resembles a residential mortgage, though for a business property. Some lending entities place restrictions on the types of property they will finance, and some require the property to be owner-occupied. In many cases, the business entity needs to be structured as a limited liability entity rather than a sole proprietorship. Credit scrutinization can be intense and typically includes looking at business and personal credit history. These loans also typically require environmental diligence on the real estate and other closing conditions which can add substantial time and expense to the process.
Loan term length can be considerably longer than many other financing options which can make commercial real estate loans attractive, but most loans of this type require substantial down payments, sometime as high as 25-30% of the value of the property.
If the capital being purchased is production or manufacturing equipment an equipment financing might be a good option. Equipment loans are offered by a variety of institutions – banks, equipment manufacturers (also known as captive finance entities), and independent finance companies. Loan structure is fairly straight-forward but terms and conditions will vary depending on the lender and the equipment being purchased. Commercial equipment loans can typically be used to purchase new or used equipment.
With an equipment loan, the financing institution maintains a security interest in the collateral until the loan is paid in full. At that time, the lien is released and the purchaser has clear title to the equipment.
refinancing existing assets for working capital
Some companies have existing assets – plant, property, equipment – that they own outright or are possibly financed, but that have equity built up. These assets can be used as collateral for new loans, thus creating working capital for use by the business.
If the asset is completely paid for, the lender assesses the value of the property and then provides a portion of that amount, typically up to 80% of the value, as a cash out, or a working capital loan. The company uses the equipment as collateral on that loan, as in a standard equipment loan. If the asset is only partially paid for, but has value above the currently financed amount, the lender will pay off the existing loan, and provide the additional funds as cash out to the borrower. The cash out can then be used at the borrower’s discretion for other business purposes.
Oftentimes multiple pieces of equipment or assets can be refinanced together in one transaction, thus reducing the number of outstanding loans and simplifying debt servicing.
Invoice financing, also known as factoring or accounts receivable financing, involves selling your uncollected invoices to a factoring company, who in turn provides you with cash up-front, and then collects on those invoices directly from your customers. As the company grows, so does the financing line, as the financing is based on the growing, billable business. As a result, your ability to access capital grows with your business.
Invoice financing is not a loan and approval for a factoring line is not solely dependent upon the business’s credit. Rather it’s also based on the credit of the business’s customers. This can be helpful for start-up companies with limited credit history.
selecting the right option
Choosing the right financing option for a business can be complex, but talking with a financing expert, someone that has industry experience, or experience with the type of capital being bought is a great place to start. An assessment of short-term and long-term needs will be helpful in determining which loan type, structure and financing entity is best suited for the company and their expansion needs.
This article was written by Chris Richardson from Manufacturers Capital and originally appeared in Fabricating and Metalworking Magazine in September 2019.