Old Loans, New Loans. Can You Afford The Payoff?
The single biggest impediment to securing debt financing for your business is existing debt financing. A typical scenario in today’s economy has businesses reaching out for additional working capital from a new lender while already having a loan in place. A business may have qualified for a line of credit from a bank, and over the intervening years have chipped away at the line until there is nothing left. The loan is tapped out. Seeing this, the bank will politely ask the company to pledge additional collateral or pay off the note completely – so the business needs to look for a new source of working capital. Usually the bank will convert the line of credit into a term loan with a set amount monthly payment, and no additional capital.
When the line of credit was secured and business assets were pledged, the bank filed a UCC-1 financing statement. This lets any other lender know the collateral is secured, and any additional lending would be considered unsecured. Furthermore, the loan covenants probably expressly forbid selling or pledging secured collateral, with the penalty being, immediate default of the loan. So in order to find more working capital, a business will have to pay off the old loan. This is the hardest question to answer internally with regards to cash flow. Can the business survive writing a check today for the entire amount of a loan that may have taken a few years to use up? A factoring company may be able to finance enough accounts receivable to manage a payoff, but that would mean the income that would go to operate has been used to pay off the old note. Unfortunately, this scenario is the result of poor planning, which ended up putting a company in quite a pinch. A bad situation with few options.
The biggest lesson here is to be focused and have discipline when using your line of credit. Every dollar that comes out should have designs on how it will be repaid, ideally within a short period of time. Keeping access open to outside capital is crucial when it comes to unforeseen problems like a downturn in the economy.
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