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SBA, ABL, Cash Flow Lending, and Mezzanine Debt – How Do You Decide Which Financing Path is Right for Your Business?

The biggest question on the minds of business owners right now is how to find funds and support in order to keep operations afloat and weather the storm of COVID-19.

The increasingly important answer: there are several unique ways to source capital. 

What about the popular SBA loan programs?
The Small Business Association (SBA) works with lenders to set guidelines for loans made by its partnering lenders, community development organizations, and micro-lending institutions. Loans guaranteed by the SBA range in value and can be used for most business purposes including long-term fixed assets and operating capital. The most recent SBA loan program is called the Paycheck Protection Program (PPP). A loan through the PPP is eligible for forgiveness, and requires no collateral or personal guarantee, but must be used to fund payroll related costs and a few other specific expenses. In general, eligibility for an SBA guaranteed loan is based on what a business does to receive its income, the character of its ownership, and where the business operates. Normally, businesses must be within established size standards, be able to repay the loan, and have a sound business purpose. Those with bad credit may qualify for startup funding. The SBA also assists with export loans for financing day-to-day operations and advance orders with suppliers. As of the date of this article, the Paycheck Protection and Economic Injury Disaster Loan programs have experienced a lapse in appropriations, and are unable to accept new applications.

What happens if the government assistance programs determine you are not eligible or the programs have run out of funding?

What if your current bank is unable or unwilling to extend further credit to your business?

Don’t lose heart. There are many other opportunities in the financial markets that may be the white knight in a business’s future.

Asset Based Lending (ABL)
ABL encompasses a broad range of lending activities and funders ranging from commercial banks and financial institutions to specialized lenders focusing on specific types of transactions. It covers a range of industries including hedge funds and subprime lenders. ABL is among the most common type of non-equity funding available to small to medium-size companies.

The most common ABL lenders are those that provide revolving credit to companies based on the pool of their inventory and accounts receivable. Under the typical ABL arrangement, the lender advances a percentage amount against the company’s pool of assets and bases the percentage amount on the type and eligibility of the collateral. For example: the advance rate for current accounts receivable may be 85%, 60% for finished goods inventory, and 50% for raw material. (Note – collateral rates will vary by bank and by circumstance). The company typically submits a borrowing base certificate on an agreed upon frequency in support of continued funding under the arrangement. While the ABL lender only advances against the most liquid assets, the collateral agreement between the company and the lender typically encompasses all otherwise available tangible and intangible property.

While ABL arrangements can be the most cost-effective source of commercial borrowing, the cost ranges significantly depending on: the nature of the underlying assets against which the company is borrowing, the financial health of the borrower, and the lender and its business model. An ABL loan is a more followed loan from the lender, which regularly carries a higher interest rate but does allow the borrower to leverage their balance sheet more than a traditional commercial loan – in other words – more cash now but more expensive later and increased oversight from the lender.

Leveraged Cash Flow Lenders
Leveraged Cash Flow Lenders differ from ABL lenders as described above in that these type of loans advance against underlying enterprise value (EV) of the business, customarily a multiple of Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) or cash flow of the business. Although multiples will vary by lender and circumstance, senior cash flow lenders typically cap out at a multiple ranging from 2-4.5x EBITDA depending on the industry and time in the credit cycle. These are often augmented by additional leverage from either Junior-Secured Lenders or more likely Sub-Debt Lenders going to a higher EBITDA multiple such as 5-6x +/(-). One advantage of a cash flow loan is the potential for the borrowing business to obtain financing much faster than with an ABL as there no appraisal of collateral here.

Subordinated or Mezzanine Debt Lenders
Subordinated or Mezzanine Debt Lenders are similar to junior-secured lenders (reviewed below), except typically there is no collateral support, limited to no rights, and subordination to the secured lenders in terms of exercising rights, liquidation preference, and remedies. Oftentimes, as a result of the higher risk of their debt, Sub-Debt or Mezzanine providers will typically receive a much higher interest rate then bank financing and also pricing “kickers” such as warrants and success fees. This type of financing, through the warrants, normally provides the lender certain rights, which may include, among others, the right to convert to an equity interest in the borrowing business and increased management oversight and control. One thing to note – it is not uncommon for mezzanine lending to go hand-in-hand with an acquisition or buyout where the new owner(s) can be prioritized in a bankruptcy situation. With the high risk that comes with mezzanine debt financing comes also the potential for more generous returns than more standard corporate debt options. This lending scenario is most commonly seen with businesses looking for funding for a specific project, acquisition, expansion, or for a specific period in time.

Junior-Secured Lenders
Junior-Secured Lenders provide incremental financing against specified assets of a business pledged on a first lien basis to another Senior Lender. Structures can vary, but often these advances are predicated on a higher advance rate relative to Senior Lenders against such collateral or assets. Loans made by Junior-Secured Lenders are typically considered Senior Debt with rights and remedies similar to first lien lenders, but with limits vis-à-vis first lien outlined in either an inter-creditor agreement or within a singular loan document with “waterfall” and other provisions addressing relative rights of the lenders. As a type of subordinated debt, Junior-Secured Lending has a lower priority around repayment than others when in default.

Invoice Financing
Bill discounting involves a financial intermediary advancing funding against a company’s account receivable. The funder obtains a lien on the revolving accounts receivable but the company remains in control of the sales/receivable ledger and responsible for collection. The customer makes payment to the company and as such, the arrangement between the company and the funder is not known to the customer. The administrative charges, fees, and interest are calculated based on the risk of non-payment, payment history, and creditworthiness from the customer, rather than the company, to whom it is advancing payment.

Invoice factoring involves a funder who is placed between the company and its customer. The funder, commonly referred to as “the factor,” purchases a company’s accounts receivable at a discounted rate. The factor takes responsibility for the sales ledger (how much credit to a specific customer it will fund) and collection from the customer. The customer settles the outstanding invoice directly with the factor. Accordingly, the customer is generally aware of the factor arrangement in place. Like bill discounting, the factor looks to the creditworthiness and payment history of the customer, rather than the company from whom it is purchasing the accounts receivable, to determine the amount of discount and level of availability to allow for the sales to the individual customers.

Reverse invoice factoring is a supply chain accommodation usually arranged between a large manufacturing company and the factor to benefit smaller suppliers to the manufacturer, which originated primarily in the automotive industry. The manufacturer enters into an agreement with the factor to fund the supplier’s invoices immediately rather than have the supplier wait for the manufacturer’s normal payment cycle. The arrangement benefits the manufacturer by helping to stabilize its supply chain and the supplier receives its funding more quickly. These arrangements are generally only available to the supplier through its supply chain relationship with a large manufacturer or retailer.

Purchase Order Financing
Purchase order financing (“PO financing”) is an advance from a lender that pays a company’s suppliers for goods the company is reselling or distributing to a customer. Funding under a PO financing arrangement requires a written purchase order against which the lender advances up to 100% of the purchase order costs. The arrangement involves not only the company and the lender but also the customer and supplier as well. PO financing is typically used for large one-off transactions or to address seasonal supply issues. Typical fees and commissions for this type of financing fall between 1.15% and 6% per month.

Merchant Cash Advance
Not technically a loan, a Merchant Cash Advance is the sale of future credit card receivables. A company receives a lump sum payment from the funder, which represents a percentage sale of future daily credit card receivables. The advance is repaid by the funder taking a percentage of the company’s credit card collections on a daily basis. Funding typically falls in the range between $2,500 and $250,000. With advance factors between 1.14 and 1.48, equating to interest rates of 15% to triple digits, it is one of the most expensive forms of financing.

Equipment and Real Estate Financing
Equipment financing is the use of a loan or lease to obtain hard assets such as production machinery, rolling stock, or computer and office equipment.

Equipment loans are borrowings undertaken to buy a specific piece of equipment. The lender takes a collateral lien against the equipment as security until the loan is repaid. Depending on the nature of the equipment and its retained value on the used equipment market, lenders generally consider equipment loans as less risky. Equipment loans are among the most cost-effective financing vehicles. One potential downside is the amount the company must front since most equipment financing lenders will require the company to provide a down payment at around 20%.

Non-conventional real estate lenders, sometimes known as hard money lenders, will advance against certain types of real estate, but the difference with these lenders is that they look at the valuation differently. While we are all familiar with the “market value” of a property, that value assumes that there is a reasonable period to market and sell the property. Hard money lenders value the property based on what it will sell for in a short period of time; maybe as short as three (3) to six (6) months and they subsequently only advance 50% to 60% of that valuation. If the loan cannot be repaid, a quick foreclosure and sale follows to recover the loan. For certain situations where a borrower is asset rich but cash poor, it fills a gap.

Sales leaseback or sales and leaseback is another option as possible way to generate capital. This type of transaction is where the business or its shareholder is the owner of the real estate property where the business operates and owner sells the real estate to a buyer, and the business simultaneously enters into a long-term lease arrangement with the new owner. The cash received on the sale can be injected into the company for working capital. In the way the transaction functions as a loan, with payments taking the form of rent. There are potentially significant tax implications that are implicit in this type of financing related to the financing structure, term and payments.

Lease financing works as leasing capital assets conserves cash for working capital and allows for necessary investments in plant and equipment. The cost of a lease will be higher than bank financing but the savings in liquidity from the down payment the company did not have to make is likely to be more valuable in the near term.

There is also an active market and many mainstream and secondary market players who will purchase a company’s unencumbered capital assets such as property, plant, and equipment and lease those assets back under a sale and leaseback transaction.

Whether by an initial lease or from a sale and leaseback transaction, leasing arrangements have a number of variations usually involving the disposition of the equipment at the conclusion of the lease term. With a Fair Market Value (FMV) lease, at the end of the lease term the company has the option to turn the equipment over to the lessor or to buy the equipment at fair market value. A $1 Buyout or Bargain Purchase lease is one where the company fully owns the equipment with the payment of the final dollar at the end of the lease. This is very similar to a loan arrangement aside from technical differences. A 10% Option lease is essentially the same as a Bargain Purchase lease but at the end of the term, the company has the option of purchasing the equipment for 10% of the original equipment cost. 10% Option type leases tend to carry lower monthly payments than the Bargain Purchase leases.

With all of these options – how do you make the right choice?
It is without a doubt, a complicated choice and there is no one-size fits all or even a one-size fits most solution. Alternative financing strategies are both an art and a science to determine where your specific business belongs. Multiple factors go into this decision including your unique circumstances, your financial situation, leverage capacity you can support, your projected freed up cash flow to cover the debt service, your business size in both revenues and debt requirements, industry, location(s), understanding which lenders play in your space, and how much risk both the lender and you can take on. In your search for this type of funding, be prepared to provide several pieces of financial documentation including (but not limited to) prior financial statements, tax returns, cash flow projections, balance sheet forecast, an inventory of fixed assets, and future business plan.

It is critical not to go it alone, work with an advisor who understands your business model, unique circumstances, and industry. Citrin Cooperman has a dedicated team of partners and professionals working with clients in businesses like yours to help them navigate through their options in today’s COVID-19 environment. Our COVID-19 Response Unit (CRU) is focused on providing middle market businesses like yours with guidance and solutions around cash flow management, SBA application and navigation, COVID-19 endurance, and crisis management and recovery. For more on how we can help, you can access our CRU Service Guide by clicking here. Additionally, our team works daily to provide the latest information and thought leadership articles, webcasts, podcasts and more via our COVID-19 Response Unit Resource Center found at



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