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Using Non-Bank Lenders to Finance Short-Term or Transition Business Financing Needs

The challenge: Traditional bank lenders generally do not like to finance businesses during periods of variable cash flow or unpredictable collateral, for example, periods of very high business growth or otherwise reduced operating performance.

The solution: Non-bank (alternative) lenders who specialize in asset-based lending or those who provide short-term bridge loans can often look beyond the turbulence of a transition period to meet a business’s financing needs until that the company can 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 exceed the cost of capital?: If the benefit of taking on the new business is greater than the cost of capital, the high interest rates may be worth it.
  • Plan your outing: Develop a clear plan early on to return to a bank from an alternative source of capital

Bank lenders do not like to lend money to businesses when cash flow and/or collateral are constantly changing, for example:

  • Example A– A business undergoes strong growth that causes significant inventory buildup that requires additional working capital financing or creates a period with uncertain future cash flows and perhaps inadequate warranty coverage depending on the cash conversion cycle; Prayed
  • Example B– A business experiences a difficult operating period due to, for example, an operational restructuring, sales force realignment, or miscalculation of the scope of a major project, creating negative cash flows or earnings

In circumstances like these, a bank lender may reduce available funds (eg, increase the reserve on a loan basis or create specific guarantees), require additional guarantees, or simply ask the business to find another lender.

Non-bank lenders are often willing to look beyond the turbulence of a transition period to understand and structure themselves around the real risks in order to feel comfortable providing the necessary capital.

Alternative lenders are structured to lend in periods of uncertainty; they generally have greater flexibility to tailor their loans to:

  • Provide additional growth capital during periods of rapid expansion, without penalizing a company for investing like traditional lenders do.

  • Financing a business in the early stages of a proven turnaround, much sooner than when a traditional lender would lend

Alternative lenders also offer more flexible terms (cash debt service, amortization, loan maturity, covenants) and cash availability than 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 do not provide the necessary capital or bank terms are too restrictive. Here are several key considerations when evaluating an alternative loan:

  • Cash is most important, so focus on required cash debt service (principal and interest), No the interest rate of the loan
  • Often, the total debt service of a higher interest rate alternative loan will be less than the total debt service of a traditional bank loan because the principal payments are much lower.
  • If the benefit of taking on the new business outweighs the cost of the loan, the high interest rates may be worth every penny.
  • Have a realistic plan for going back to a traditional lender before taking out a bridging loan
  • Make sure the loan provides a cash cushion if the transition takes longer or costs more than expected
  • Ask yourself: does the lender understand my business and appreciate me as a customer? The answer should always be yes. If not, find a lender that does.

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