A capital option: finance companies

Nation's Business, July, 1992 by Joan C. Szabo

Margaret Thacker, who owns and operates a warehouse distributorship for automotive Paint and body-shop supplies in Atlanta, has always maintained a good lending relationship with her local banker. Last year, however, the bank tightened !its credit requirements and began increasing the cost of funds to Thacker's firm.

The bank told Thacker the interest rate on her credit line was going up, she says, "because the company's sales ratios were not in compliance with our loan requirements." To avoid Paying higher rates, Thacker began looking for an alternative source of financing.

Started in 1945 by her father, Thacker's firm, official Products Co., Inc., has annual sales of $9 million. Fortunately for her company, Thacker located and obtained an attractive revolving-loan agreement with an asset-based division of Textron Financial Corp. Textron Financial, a subsidiary of Textron Inc., is a major financial-services company headquartered in Providence, R.I.; the asset-based division is in Atlanta.

Obtaining capital through Textron has supplied the company with needed operating capital. Says Thacker: "A finance company is easier to get along with. It sees your needs. As long as the assets are there, Textron doesn't panic."

Official Products is similar to many small firms that continue to find bank financing too costly or too difficult to obtain. As a result, many small businesses that once were eligible for bank loans are now turning to finance companies.

Finance companies are secured lenders. They provide funds that are backed by the borrower's assets. This collateral includes accounts receivable, inventories, and plant and equipment. Thacker's loan is secured by the first two.

Secured lending generally involves a revolving-loan concept. The borrower establishes a pool of working capital with the lender. Funds are drawn only as needed--and in the amounts needed--to pay bills, build inventory, meet payroll, or to achieve various other corporate purposes.

The dollars available from asset-based financing also let borrowers take advantage of cash discounts from suppliers, which helps defray financing costs.

The performance of a business receiving capital through a finance company is monitored daily, enabling the free company to reduce its loan exposure if a business begins to deteriorate, says Steve Rosencranz, president of Creekwood Capital Corp., in Houston.

Creekwood is a small finance company that makes loans of $1 million to $5 million to small and midsized companies. "Every day I know what my customer's sales were for the previous day," he says. "In this way, we have control over what we are going to lend to the company."

It is easier for a company to win a credit line with a finance company than with a bank, say experts in the industry. "A bank's credit requirements are much higher than a finance company's," says Irwin Teich, division president of Barclays Business Credit, Inc., in Atlanta.

Finance companies do charge small-business borrowers higher interest rates than banks generally charge, however. The higher rates are in part a result of the greater amount of loan servicing that finance companies perform, says Teich. The interest rate can be 3 points or more above the prime rate on the money the finance company advances a firm on its collateral.

The ability of smaller finance companies to lend to small firms has been somewhat hindered recently. This is because the finance companies borrow their funds from banks, and the banks have not been lending to them as readily as they had in the past, says Rosencranz.

Having less difficulty with obtaining capital are larger finance companies that obtain their funds from the commercial-paper market. Textron, for example, raises funds in this manner. "We are seeing a lot of small lenders coming to us for capital because many banks are not lending to [smaller] finance companies the way they used to in the past," says B.J. Carter, vice president of Textron.

If your firm is small and you want to borrow from a finance company, you first must have collateral. "We have to have what we consider liquid assets, such as accounts receivable and inventory," says Jack Hoekstra, senior vice president of Transamerica Business Credit Corp. in Chicago.

Next, ask your attorney, accountant, or even your banker to recommend a good finance company. Also, the Commercial Finance Association, in New York City, can provide a roster of its members, which are asset-based-financing companies.

Know exactly how much you wish to borrow. Some finance companies lend only to firms needing $5 million or more; others lend in the range of $1 million to $4 million. Because of their lending requirements, finance companies may not be useful for start-ups or very small firms. If your company qualifies, however, this financing source can be a useful alternative to traditional bank borrowing.