Cash Flow Lending – Definition of Difficult?

Most UK business lending to small businesses is secured, in that in addition to requiring a demonstrable ability to service and repay the loan from a business’s future cash flows, there also needs to be security for the lender to enable recovery in the event of default. So what happens if security is not available? This article gives a cash flow lending definition and discusses the sources of cash flow funding available to businesses in the UK today.

Cash Flow Lending Definition

Cash flow lending is where a funder advances a loan solely on the strength of the forecast cash flows, as opposed to an asset based loan which is advanced based on the value of the underlying assets offered as security. The lenders involved will usually impose covenants on the borrower concerning the level of its’ profitability at EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) level, interest cover, or its enterprise value. If the borrower breaches a covenant this then gives the lender the right to take action such as requiring repayment.

While this sort of funding is often available through the City to large companies and has been used as part of the lines of funding for large leveraged buyouts, it is much rarer to find it available to SME and mid-market companies.

Commercial Lenders to SMEs and Mid-Market Companies

The main lending institutions in this area are the banks and asset based lenders. While banks will sometimes talk about providing cash flow loans, in practice, particularly in the current circumstances, these are rare other than at a very limited level (up to say £25,000). But they are still possible in some circumstances and there is for example a funder still providing loans of up to three times EBITDA in connection with buying a business.

Paradoxically, the asset based lenders such as factors and invoice discounters have been the most active providers of cash flow lending in recent years, both in a structured way through specific cash flow loans repayable over two or three years and usually given in connection with a buy out, through to more flexible temporary facilities by way of an ‘over advance’ on the ledger, although again, in current circumstances their appetite is reduced.

Pre credit crunch there were a few lenders providing cash flow lending in a relatively pure form through ‘block discounting’ arrangements, involving advances against future contractual cash flows such as lease or rental payments. Most of these lenders have exited the market, although there is one funder which is very active providing finance of this sort at levels of over say £10m for projects which meet their, quite strict, criteria.

Public Support

The government is aware that there are issues for businesses seeking loans but which do not have assets that can provide lenders with the security they want.

The Small Firms Loan Guarantee scheme and now the Enterprise Finance Guarantee scheme were both intended to address this by enabling firms to have the Government provide a partial guarantee of the loan (in return for an insurance premium). Neither scheme seems to have been a great success, partly since some of the lenders appear to feel they involve a degree of bureaucracy and, more crucially, the guarantee is only a partial one, so the lender will still be at risk for some of the loan in the event of default.

More direct Government help is available in some areas of the country for some projects by way of publicly funded grants and soft loans. The sources available vary widely across the country and so it can be difficult to discover what schemes are actually open to your business; however there are specialist consultancies who can conduct searches for you.

Most grants and other publicly funded support is only available on a matching basis providing part of the cash needed for a project, so you will still need to find the rest elsewhere.

Other Sources

In the absence of institutional lending in this area, many businesses have few options but to turn to seeking business angel finance, but this can be very difficult to secure and involves a sale of a sometimes substantial slice of the company’s equity in return for funding.

There are also a limited number of funders from parts of the venture capital world who are prepared to consider providing high interest short term cash flow loans in situations where there is an urgent cash requirement. They will normally be looking for situations involving a successful business with a profitable track record and a positive balance sheet greater than the loan sought, run by an individual with some net worth, that needs the funding to enable a business to achieve some cash generating objective that can amortise the loan which will provide them with an ‘equity’ rate of return.

The funders will look at deals on a case by case basis and appropriate scenarios might be a business needing to invest in order to secure and deliver a long term contract, or one which has won a large order that creates a working capital requirement in excess of the business’s capabilities to raise from normal sources.

Some of these lenders will also consider distressed business situations.

These funders will put their money in by way of a loan so there is no dilution of the owner’s equity, although there may be some convertibility in event of default, and they will expect to take a full package of company and personal security by way of debentures and personal guarantees, even though there may be no value in these on normal security formulas.

Balance Transfer and Housing Finance

The Indian immovable property has come of ages. Consumer is the King now and gone are the days of monopolistic behavior. And definitely, if you are the one with sound financial background and impeccable credit record you can strike a better deal with the banks in terms of interest rates and other payment conditions and purchase your dream property without any hassle.

Interestingly, the same criteria is equally applicable on those, as well, who have already availed a loan from a bank. Near about all the major public and private sector banks in the Indian banking system are now offering the option of ‘Balance Transfer’ on housing finance. Often, banks in the housing finance sector tend to increase the interest rates when the benchmark interest rates increase. But, such alacrity is not shown by them in decreasing rates whether the Repo rate comes down or not. In such circumstances, balance transfer help the customer a lot. He can replace the higher rate loan and avail a lower rate one by paying some extra charges. These charges are lower compared to the total payable interest.

What is Balance Transfer and how is it relevant in the housing finance?

There are times you find that the interest rate on your home loan is at a higher level. Take an example. Suppose you were paying at the rate of 10.5 per cent per annum. This rate is quite high in comparison of 9 per cent offered by some other bank. In such cases balance transfer of housing finance comes into rescue. You can trigger off the balance transfer option with your existing bank or lending institution, under which the unpaid portion of your housing finance would get transferred to your desired bank, thereby taking benefit of the difference in the housing loan interest rate.

Things to take care of at the time of balance transfer:

* Tenure of loan amount should be taken care: Ideally, you should consider taking the balance transfer option when the remaining part of your payment period is more than 5-years and in such a case you have the time for speculative gains. There is no profit in transferring the home loan from one bank to another if you end up paying early payment penalty and other processing charges even more than the difference of housing loan interest rate and the amount you had to pay towards interest in the normal condition.

* Early Payment Charges associated with the housing finance scheme: Banks like State Bank of India, IDBI and ICICI offer benefits like exemption of the early payment charges to your existing bank if you transfer the balance. So you must confirm the same with the new lending institution that are they ready to deal with this matter. Otherwise, the deal is not profitable.

* Additional charges involved with the loan amount: You must confirm that the desired amount for your home purchase loan is perfectly at par with the balance you had in your previous bank. It may be the case that that your new bank pays all early payment penalties and processing charges on your behalf and later add the amount to the principal of your housing loan. So, in such case your total owing remain the same and the transfer is not profitable. In this situation, you have to suffer the impact of debt compounding, which does not favour you in the long run.

Seeking balance transfer as a burden reduction option needs the similar degree of caution and study that you undertake while taking housing finance. Definitely with balance transfer, you can save a considerable amount of interest charges under this option once you strike the right chord!