The Benefits Of Agressive Lending
In the summer of 1981, GSF Corp., an Andover, Mass., manufacturer of foam bedding materials, was beginning to develop plans for expanding a new line of modular foam furniture. Morton Owen, the company's co-founder and chairman, believed the new product, which had been in production since earlier that year, would help fuel corporate growth even when the national economy was sputtering. "I could see the business growing," Owen recalls. "And I knew that I needed more money."
Since its inception in 1969, GSF had been borrowing with its assets as collateral to meet its capital needs. By summer 1981, GSF, which had earned pretax profits of $104,000 on $13.8 million during the fiscal year that ended May 31, was shipping foam to customers throughout the Northeast by drawing on a $1 million credit line. As impressive as the company's growth had been, though, its credit had been scarred in 1979 by a reorganization under Chapter II, an event precipitated by the bankruptcies of some of its major customers.
As with the $1 million it was already borrowing, the additional funds that GSF sought to borrow would be heavily secured by accounts receivable, customer payments, inventory, and equipment. Nevertheless, the company's primary source of cash, a finance subsidiary of a West Coast bank, flatly rejected Owen's request for more credit. "They couldn't forget our Chapter II," he says.
Fortunately for Owen, this vote of no confidence was only a temporary setback. Indeed, last February, GSF got all the cash it needed to expand its new furniture product line, thanks to a brand-new financing agreement with a different lender. The new credit line of $4 million enables GSF to draw more credit whenever it books customer orders. The company pays an interest rate of three percentage points over the prime rate on whatever portion of the credit line it uses, a marked improvement from the five-point premium over prime it previously paid. While Owen, a fiesty entrepreneur, would clearly prefer to borrow at still lower rates, he says, "What I really needed most was a bank that saw growth in this business and was willing to back me."
For many smaller and medium-size companies lacking the cash, net worth, or creditworthiness to borrow unsecured funds, asset-based financing has often been the only -- and not very appealing -- way to go. But as competition among banks and finance companies heats up in many parts of the country in anticipation of looser federal restrictions on interstate banking that option could become less grim for the thousands of manufacturers, wholesalers, and service businesses in need of cash. According to Eugene Sirbaugh, president of Commercial Credit Business Services, based in Baltimore, the total volume of asset-based loans by banks and finance companies has tripled since 1970. Some lenders, at least, are showing a willingness to deal aggressively on credit terms to win a customer.
For instance, Owen says that as he was scouting around for a new lender, he found several banks and finance companies quoting interest rates below the prime-plus-five-point rate he had been paying. Moreover, there were wide discrepancies in the credit lines and advance rates on receivables that lenders were willing to offer. "We tried to play one [lender] off against the other," notes Owen. He ended up signing a three-year deal with Citicorp Industrial Credit lnc. (CIC), a Harrison, N.Y. -- based finance subsidiary of Citibank, the nation's second largest bank, which had been especially eager to enlist customers in New England.
The previous lender's skittishness notwithstanding, CIC approved a quadrupling of GSF's credit line -- at the lower interest rate -- in the belief that its problems of the late 1970s were already history. "A company's credit can be changing constantly," says John McKenna, a CIC vice-president. Impressed with the company's recent profit turnaround despite the burden of high interest payments, McKenna figures that additional borrowed capital can permit GSF to grow while building financial strength, even if the company has to pay interest rates of about 18%. On the other hand, if things were to go sour, McKenna says, CIC would be protected by its ability to collect on receivables and, if necessary, by claims on the company's inventory and other assets. "We feel we have an awful lot of cushion," he says.
The company's larger credit line lets GSF fill customer orders it otherwise might not have been able to finance for weeks or months. Moreover, it gives the company the freedom to work out volume discounts with suppliers. "If Mort Owen can double his volume, take advantage of discounts, and make a good profit, that would more than offset the interest he'll pay," says McKenna. "And if he can't make money with the cash, then he has no reason to borrow it."
Now that he has as much credit as he expects to need for the near future, Owen has been able to focus his attention once more on growth. In fiscal 1982, when the new credit agreement had been in place for just a few months, GSF's unaudited sales rose 26% to $17.4 million (earnings had not yet been reported by August). But more recently, sales growth was accelerating, and the new furniture business had begun generating around 30% of revenues.
On a typical day in late August, for example, GSF shipped orders of foam bedding and furniture worth about $94,000. On a daily basis, the company sends the shipping documentation to CIC's offices in Harrison by Federal Express. By noon the next day, it gets approval for a cash advance of 85% of th value of the orders -- in this case $79,000. "I only take down what I need, explains Owen."When I use the money, I start paying interest. "
GSF obtains credit for more than just new orders, although that is the principal collateral. On the same day GSF booked $94,000 of orders, it also received payment for $140,000 of previous shipments. According to its terms with COC, GSF deposited those funds in CIC's account at a local Massachusetts bank, and two days later the company was entitled to draw 15% -- about $20,000 -- of the new deposit from its CIC credit line. But 85% of the funds were used to repay earlier advances it had taken on shipments during the previous three months. In contrast to a fixed-dollar loan limit, notes Owen, "I always get 85% of what I ship and 15% of what I collect." The exception, of course, is when he hits the top of the $4 million credit line, when terms would be reviewed.
A larger credit line isn't apt to be needed for some time, however, considering that GSF has lately been using only about $1.8 million of the total. The average collection time on receivables has been 40 to 45 days, but delinquent accounts cannot be financed past 90 days. "After 90 days, if the customer can't pay or goes belly up," says Owen, "I own the account." At that point the collateral on the account is no longer valid and it is up to GSF to collect or write off the loan.
Having paid the price for loose credit policies with a painful bankruptcy only four years ago, Owen and his business partner, Joe Ippolito, don't want to see a repeat in the current economic crunch. As well as it can, the company is closely monitoring the terms of its 1,500 accounts, Owen says. Customers range from major bedding manufacturers and retail chains to much smaller mattress companies within a 350-mile radius. In addition to the credit ratings from Dun & Bradstreet, GSF receives reports, including some warnings, about potentially troubled customers from CIC. And while lots of competitors prevent GSF from demanding payment COD, "If a guy can't pay me in 60 days, I don't want his business," says Owen. "We've become a lot more cautious."
Owen is hoping that such caution will result in financial payoffs for the company. While GSF will probably never be able to avoid heavy borrowing, improved borrowing terms would please him greatly. Indeed, less than a year after shaving his borrowing costs by two full percentage points, Owen already hopes to trim GSF's rate by another point in a few months, even though the lending agreement extends until February 1985. "You try to accommodate your good accounts," notes CIC's McKenna. "lf they continue to do well, we'll look at reductions."
Accommodating as these words may sound, Owen is convinced that in today's competitive business environment, a company can only benefit from being aggressive in its financial relationships. In fact, satisfied as he believes he is with his current lender, Owen doesn't mind meeting with others, and he initiates and maintains contacts scrupulously. Today, he suggests,"You really ought to be out there in the marketplace talking to everybody."