Five Tips to Effectively Procure the Ideal Secured Business Loan
In today’s hyper-competitive and dynamic market, businesses need to keep a sharp eye on managing cash flows and controlling costs. Undoubtedly, companies from time-to-time need working capital, and often look to secured loans as one of the primary means of providing the cash necessary to fund operations. Secured loans (loans in which a borrower pledges collateral as security for repayment and performance) generally offer distinct advantages over unsecured loans; most notably, there appears to be significantly more secured lenders than unsecured lenders in the market today, and the cost of capital (loan rate) tends to be less with secured loans compared to unsecured loans.
Not surprisingly, a company’s collateral base will be a significant if not determining factor in the type of secured loan sought. Start-up and early-stage technology companies (which lack inventory or real estate) typically seek secured loans in which the company pledges its patent, trademark or other intellectual property assets, while a retail concern may find that an inventory-secured loan is ideal for its business model. In fact, there are a myriad of choices and issues involving securing debt financing and credit advances, and many factors to consider beyond a company’s collateral base or just securing a loan with the lowest interest rate.
Further complicating matters, many companies require multiple secured loans; some businesses today seek both a traditional bank loan (which generally involves providing the bank with a “blanket” security interest in all of its assets), with its typical lower cost of capital, and a loan secured by either inventory (also known as revolver) or accounts receivable (typically through a factoring arrangement). A company that does not qualify for a bank loan, either because it lacks sufficient collateral (for example, a service company) or does not have the historical numbers to merit this type of loan, will often look to a revolver (if there is inventory) or a factor arrangement (involving the pledge of eligible accounts receivable) for its working capital needs.
With all of these choices and the need to procure secured debt funding on advantageous terms, here are five strategies for selecting the secured loan that best fits your company’s particular needs and provides for sufficient funds at an optimal cost:
- Know Your Company.
This may seem obvious, but the importance of really knowing your company, its collateral base, its ability to provide accounting and financial reports and its working capital needs cannot be overstated. Secured loan documents typically contain requirements and terms that, if not addressed, can result in significant damage to the borrower. For example, most secured loans require, within set periods of time, that a borrower must deliver interim financial statements (generally unaudited except for the annual deliverable of an annual audited financial statement), along with “flash” budget reports, cash-flow forecasting and other financial information. If your company does not have the staff or expertise to undertake these delivery requirements, your company will most likely be in default. So too, successful companies understand both the amount needed and timing associated with their particular working capital needs; knowledge that business seasonality can significantly affect cash flow needs at various times in the year may well lead to choosing a secured loan with multiple or interim advances (compared with a term loan facility in which one draw is permitted).
- Establish Internal Coordination.
Successful companies do not leave the decision as to appropriate financing options to either the chief financial officer or company counsel alone; rather, successful companies adopt a team approach involving financial, operational and legal input primarily because the ideal secured loan has to make sense for both cash flow/financial and operational reasons as well as for legal purposes. Too often, the legal team is only brought in after the loan term sheet has been agreed upon. Consequently, key considerations that can and should be addressed in the decision process, including, by way of illustration, careful consideration of the loan’s affirmative and negative covenants, are left for the lawyers. As a result, by not addressing these “boilerplate” provisions at the commencement of seeking secured financing, unsuccessful companies too often find that the loan document legal requirements dictate business behaviour rather than supporting desired business action.
Successful companies recognise that procuring the loan is just the first step in the process.
- Properly Evaluate Each Loan.
Successful companies understand their loans from both a business and legal perspective, presumably because they have taken the time to properly and carefully analyze and evaluate their options. By way of illustration, a loan’s stated interest rate is just one component in pricing the loan. Often, secured loans include a variety of fees and costs separate and apart from the loan’s interest rate — including unused line fees, facility fees, advance fees, prepayment fees and monitoring costs and expenses; some loans also require appraisals, title insurance (if in connection with real estate) and even legal opinions. All of these items should factor into the true “price” of the loan. So too, most secured loans limit certain indebtedness (whether by type or amount). If your company sometimes needs a boost from time to time by its shareholders (in the form of shareholder loans) or requires capitalised leases for equipment acquisitions, which indebtedness may not be permitted under a particular loan offer, you may not want to seek this funding without further negotiations. Along these lines, if your company requires seasonal increases in trade debt to finance additional inventory acquisitions during peak seasons, which additional trade debt is in excess of established debt limits, you may want to rethink the loan absent further negotiations.
- Prepare a Plan For Growth and Develop Meaningful Projections.
As John Wooden, the legendary UCLA Men’s Basketball Coach, once said: “Failure to prepare is preparation to fail”. Successful companies plan for growth and develop budgets based on meaningful projections and sensitivity analysis. In fact, most secured loans require some type of contemplated budget; by creating meaningful projections at the outset, a company can stay in compliance with its loan requirements consistent with its budget (based on said projections) and intelligently use the funds generated from the secured loan as a tool for sustainability and possible growth, rather than being saddled with a loan obligation under which the company stands to lose a significant amount if not all of its meaningful assets pledged for said loan.
- Implement and Monitor Performance and Results.
Successful companies recognise that procuring the loan is just the first step in the process. Secured lenders almost invariably require constant monitoring of performance and results; successful companies generally stay one step ahead of their lenders. How is the company doing against the loan’s financial covenants? How do projections look against actual results? What market changes have occurred that may affect the company’s bottom line or collateral base? Has the company lost a key supplier or customer? All of these questions may need to be addressed both internally and, depending upon the terms of the secured loan, with the secured lender. Do not wait until notice to the secured lender is required without at least developing a game plan for addressing issues that arise and need to be addressed. Successful companies continue to challenge their assumptions, evaluate results and take corrective action at the earliest opportunity and certainly before the secured lender learns that corrective action is needed.
Secured loans represent a vital source of working capital for today’s businesses, and come in a myriad of forms and types. Although a company’s collateral base will almost certainly have a significant impact on the choice of secured loan that works for that company, the ultimate choice of a secured loan that best meets a company’s needs should be based on an intelligent and informed approach to secured lending. Simply looking at the lowest interest rate will not work!