The Challenge: Traditional Bank Lenders usually don’t like funding businesses during periods of variable cash flow or unpredictable collateral – e.g., periods of very high business growth, or on the flip side, reduced operating performance.
The Solution: Non-Bank (Alternative) Lenders specializing in asset based lending or those that provide short term bridge loans can often look beyond the turbulence of a transitional period to fill a company’s funding needs until the business is able to return to a traditional lending relationship.
Key Considerations for Borrowers:
- Cash is King: Focus on the cash availability and debt service of the alternative loan, not the interest rate
- Do the Rewards Outweigh the Cost of Capital?: If the benefit of the taking on the new business is greater than the cost of the capital, high interest rates may be well worth it
- Plan Your Exit: Develop a clear plan at the outset to move back to a bank from an alternative capital source
Bank Lenders don’t like lending money to businesses when cash flow and/or collateral is in flux, for example:
- Example A: A business goes through a heavy growth spurt causing either a significant inventory buildup that requires additional working capital financing, or creating a period with uncertain future cash flows and perhaps inadequate collateral coverage depending on the cash conversion cycle; or
- Example B: A business experiences a difficult operating period due to, for example, an operational restructuring, a sales force realignment or miscalculating the scope of a major project- creating negative cash flows or earnings
In such circumstance like these, a bank lender may reduce available funds (e.g., increase the reserve in a borrowing base or carve out specific collateral), ask for additional collateral or simply ask the company to find another lender.
Non-Bank Lenders are often willing to look beyond the turbulence of a transitional period to understand and structure around the real risks in order to get comfortable providing the necessary capital
Alternative lenders are structured to lend into periods of uncertainty – they usually have greater flexibility to tailor their loans to:
- Provide additional growth capital during periods of rapid expansion, not penalizing a business for investing as may traditional lenders
- Fund a business in the early stages of a demonstrated turnaround, much earlier than when a traditional lender would lend
Alternative lenders also provide more flexible terms (cash debt service, amortization, loan maturity, covenants) and cash availability than do traditional lenders, and for this they charge higher interest rates.
Key Considerations when Borrowing from a Non-Bank (Alternative) Lender:
Businesses turn to non-bank or alternative lenders when traditional lenders won’t provide the needed capital or bank terms are too restrictive. Here are several key considerations when evaluating an alternative loan:
- Cash matters most so focus on required cash debt service (principal and interest), not the loan’s interest rate
- Often the total debt service for an alternative loan at a higher interest rate will be lower than the total debt service of a traditional bank loan because of much lower principal payments
- If the benefit of taking on the new business exceeds the cost of borrowing, high interest rates may be worth every penny
- Have a realistic plan for moving back to a traditional lender before you take on a bridge loan
- Make sure the loan will provide a cash cushion if the transition takes longer, or costs more, than expected
- Ask yourself – does the lender understand my company and appreciate me as a customer? The answer should always be yes. If it’s not, find a lender that does