Is a Line of Credit Right for Your Glass Business?

By Marco Terry
September 30, 2016
RETAIL : MANAGEMENT

For many glass contractors, a revolving line of credit can be the best financing option to help them grow. Revolving lines of credit are flexible, affordable and fairly easy to use. On the surface, they appear to be an ideal product. However, lines of credit can be hard to get—and keep.

A line of credit works much like a credit card. A company can draw funds up to a pre-established limit. The company then makes payments, which reduce the balance and increase borrowing availability. The bank charges a fee on the outstanding balance, which is how it makes its revenues. The fee is usually based on the prime rate plus a certain percentage. For example, the fee might be “prime rate + 2%.” Banks may charge other fees on top of the interest rate, such as maintenance and availability fees.

Secured vs. unsecured

A secured line of credit uses corporate and/or personal assets as collateral for the line. Consequently, the bank can foreclose on the collateral if the line is not repaid.

An unsecured line is not secured against specific collateral. However, it can have a personal and/or corporate guarantee which gives the bank powers to collect. Ultimately, an unsecured line can become secured if the bank sues the creditor, wins, and attaches the judgement to an asset.

Qualification requirements

Qualifying for a line of credit is actually difficult, but not because banks don’t like to lend. It is difficult to qualify because their rates are fairly low, so banks can fund only those clients that have the least risk.

Just remember that lenders provide funding based on the three Cs: cash flow, collateral and credit. Some qualification factors to consider:

  • The role of the Small Business Administration
    Many small business loans and lines of credit are backed by the Small Business Administration. Keep in mind that the SBA does not provide financing. It acts as a guarantor on a business’ behalf to the lending institutions that provide financing. However, it acts as a secondary guarantor. This point is very important. In the event of a default, the lender must first try to collect from an owner and their business. Only if that attempt fails will the SBA step in and help.
  • Corporate assets
    Lenders expect that the line of credit will be paid back with a company’s cash flow and assets. As a result, a business must have cur2016rent cash flow and assets to justify the amount that is requested.
  • Financial ratios
    As part of its underwriting, a lender reviews financial reports to determine certain important ratios. Financial ratios enable banks to see how a business is performing. Each bank has its own ratio preferences, but many banks examine the debt service coverage ratio, the fixed charge coverage ratio, and the current ratio, among others.
  • Guarantees
    Most lines of credit require that they be guaranteed by the business and, in many cases, by the majority owners and stockholders. This requirement means that, quite often, individuals are pledging and providing their personal assets as a guarantee for the loan. Many business owners cling to the incorrect notion that business financing does not require personal guarantees. It often does.
  • Personal background
    Lenders usually check the personal background of owners, major stock holders and executives. They scour public record sources to find judgements, criminal actions and similar things.

Covenants

Lines of credit usually come with covenants. Covenants are contractual terms, or rules, that a company must follow in order to keep the line of credit. Some common covenants that banks use:

  • Net worth
    Lenders may require that a company maintain a minimum net worth. This requirement helps ensure that the business assets (and thus the lender’s collateral) don’t lose too much value.
  • Liquidity and debt
    Lenders may require that certain liquidity ratios are maintained at a certain level. Examples include the current and the quick ratio. Likewise, a company is expected to maintain certain debt ratios above a minimum, such as the debt service coverage ratio.
  • Monthly certification
    Some lenders require that a business provide monthly information requiredabout accounts receivable, inventory and other assets. To provide this information, a business needs good accounting and inventory tracking systems.
  • Material changes
    This catchall clause requires a borrower to disclose any material change to the business. A material 2016change is a change that could seriously impact the business, such as losing a major contract or losing a key employee.

Benefits vs. drawbacks

Lines of credit have a number of benefits. The most important one is their flexibility. They can help improve cash flow and can be used to pay critical company expenses. Additionally, they are much cheaper than most alternatives.

However, lines of credit have drawbacks. It can be difficult for a business to qualify for lines of credit. And, once a company gets them, it must make sure to comply with the covenants. Otherwise, the business could find itself out-of-covenant and out of financing. One important drawback is that a company can’t increase the limit quickly. Therefore, owners should make sure to negotiate a credit limit that supports business growth plans.

The author is managing director of Commercial Capital LLC, a factoring company and leading provider of invoice financing to companies in the glass industry. He can be reached at 877/300-3258.