I’m writing this as I sit on a beach in Cabo San Lucas looking out over the ocean. Only a finance guy would find this scene a metaphor for the current credit landscape, but I’d like to paint a picture for you.
The first thing I notice is an incredible white sand beach that is smooth and inviting. Looking out into the ocean there are powerful waves crashing. Kids venture out into the pounding waves, eventually retreating to the safety of shore. A surfer paddles out and rides the momentum provided by the waves. An hour later the wind kicks up and he stops for the day. A sailboat cruises by at a rapid clip.
A thought occurs to me – they are all in the same ocean. The success of each was driven by managing the environment and using the right tools. This is exactly what companies need to do to be successful in the current credit landscape.
Let’s say yours is an established company with moderate growth. You’re the sailor, with a steady breeze at your back. Banks want your business. Why? The competing forces in the banking industry have created internal frustration. The credit committees don’t want to approve a bad loan.
They need solid deals. Business development officers are pressuring their credit departments to move quickly, create flexibility, require few covenants or guarantees, and offer competitive rates. With the right technique, you can get an effective interest rate below 2 percent. In fact, for established businesses, there hasn’t been a better credit environment in our lifetime.
But maybe your company is a start-up. You’re a novice surfer and no banks want to fund you. So you’re looking for a cash injection from friends and family, with nominal rates and flexible payback terms—but, of course, this limits your ability to grow as you need more capital.
You could also consider credit cards, which are expensive but easily obtained. Both options can help fund the start-up phase, but they’re focused on sources of repayment outside your business.
The next step is typically an asset-based loan, in which advances are based on percentages of accounts receivable and inventory. These loans generally entail a lockbox scenario or other forms of “dominion of funds” to protect the lender’s interest. Their security puts them in front of trade creditors—this way, in the event the company is unsuccessful, these lenders get paid out of an asset liquidation, leaving your trade creditors empty-handed. Since these deals are riskier, they have higher rates—5 to 7 percent, with a commitment or monitoring fee that varies with the size of the deal.
The two scenarios above occur daily in the current credit landscape. If you don’t have the board, boat, or technical ability, get some help. Now more than ever, learning to ride the waves or the wind is crucial.
