Cash Flow Financing Can Create a Strategic Advantage

A key source of growth capital available to SME’s is cash flow financing, or subordinate debt (sub-debt)financing. Businesses that can create steady, predictable earnings growth have greater access to debt financing sources. Until earnings are established, borrowing capacity is restricted to how much you leverage business and personal assets.

As a business grows and solidifies its sales and receivables collection process, it develops arguably the most important components from a financing and valuation perspective - cash flow.

While all lenders want to see strong cash flow to solidify debt repayment and reduce the risk of borrower default, many primary lenders in the senior or first security position will still not provide enough debt for small and mid sized companies.

Even asset based lenders have their limits as to what they can extend against the asset composition of a particular company. And as companies become mid sized, their financing options become more and more squeezed.

Here’s where cash flow financing comes into play. Like any other type of lender, cash flow financing sources have their own specialized business models that focus on things like age of business, type of business, and industry.

The market for cash flow financing is limited due to the fact that this is a subordinate lending source of debt, meaning that other lenders are already in a first position. Viewed to be a higher risk loan due to a lack of hard security, cash flow financing can vary tremendously from lender to lender and business to business.

The majority of significant cash flow financing is available to mid sized companies that have the following attributes:

• At least 3 years old
• Have two years of solid cash flow statements
• Strong Management Team
• Strong Professional Advisors
• Manufacturing or Service Based

The Main applications of cash flow financing are:

• Expansion to new markets
• Acquisitions
• Management Buyouts
• Improve Current Position on Balance Sheet
• Bridge Financing

The rates for cash flow loans, like asset based lending, can be quite broad. Rates are always relative to risk and competitive financing alternatives. Lending rates and the amount of cash flow borrowing available is also impacted by how well the lender knows your business, and how long they have been dealing with your company.

Some cash flow financing sources will grow their lending position with you over time as your company grows and demonstrates its ability to increase cash flow and market share.

This is where the strategic advantage comes in. If the nature of your business application or industry requires cash flow financing at some stage of development, you can gain an advantage over your competitors if you work at developing a strong subordinate debt lending relationship early on in your growth curve.

For whatever reason, lending relationships are usually created based on immediate need, not projected need, and as a result, it can be difficult to get the capital you want, when you want it. It is one of the key growth inhibitors with mid sized companies that are experiencing strong market growth.

By proactively getting yourself in a position to receive subordinate debt financing if required, you can not only maintain a strong market position, but you can gain or overtake a leader if they fail to set up their financing far enough in advance.

The ability to acquire and utilize sub debt financing can also be critical to keep your business on its growth path towards future private or public share offerings to raise equity capital.

Smaller companies have the same types of cash flow financing needs. However, financing sources are rarer and the amount of debt that can be acquired is limited due to smaller companies being vulnerable to larger competitive forces and more unpredictable growing pains.

Small company cash flow lending programs that are institutionally based are normally capped at $250,000 with individual programs typically capped at $30,000, $50,000, or $100,000 increments.

Private money cash financing programs are focused on business scenarios where the lender and would be prepared to take it over and operate it in the event of default.

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