Question from Alan Lukachko: I'm looking at financing some contracts with a term of three to six months. The contracts would be in the $100,000 to $150,000 range. I require a 35 per cent deposit with the contract, another 35 per cent payment at one to two months as work progresses, and the balance on completion. We would get one or two contracts a month for the next two years. What is the best way of doing this? Term loan or line of credit? Could signed contracts be used as collateral? What kind of interest rate would the financier expect? Any other comments or caveats would be welcome.
Mary Gagliardi : Depending on the current situation of the business it may be beneficial to look at both options individually and assess the best strategic approach for the business vis-à-vis a line of credit (LOC) or term debt.
A LOC is a revolving solution for financing a project over a short period of time to support day-to-day operations. If the company can manage the short-term strain on cash-flow by not having access to this portion of the LOC, then this may be an appropriate option. If you are looking to finance the project over a longer period, a term loan would be a suitable option to consider. A term loan will free up your operating credit line for the day-to-day operations.
The security and/or collateral to be taken for the LOC or the term loan could only be determined after an assessment of the company. Typically the LOC interest rate would be lower than that of a term loan. The interest rate can range significantly depending on the type of project being financed, the type of security being provided and the level of risk that the lender attaches to the business.
BDC has created a specific loan solution, the Market Xpansion Loan, dedicated to expansion financing that has similar features to a LOC but is structured as a term loan. The Market Xpansion Loan product is a term loan that allows the entrepreneur to request BDC re-advance any repaid portion of the loan.
Other financing options that may be appropriate for your business include purchase order financing and factoring. Both offer advantages in specific situations and may be appropriate if a line of credit or term loan facility is not available.
Zenon Iwachiw : In order for a contract to be assignable to a lender and therefore treated as a receivable, the “work” must have been completed and thus payable on negotiated terms. Contracts that are essentially agreements to provide future service or labour have no value to a lender, since the agreement to pay is fully dependent on the completion of future services, which by definition may or may not happen to the satisfaction of the buyer and thus may be challenged or refused.
If your up-front deposit is for the purchase of materials, which can be substantiated, and then future deposits obtained are for work that has been completed, a lender will be able to treat this as an acceptable business receivable, which can be margined. Traditional low-cost lenders, such as credit unions and banks, offer operating lines of credit against the current assets of a business (receivables, inventory). Rates would be based on a prime-rate-plus-spread variable, dependent on the evaluated risk and strength of the business (retained earnings/capital).
Robert Bissett: Rather than a term loan or a line of credit, normally we would recommend a financing program allowing the company to draw down on the credit facility against the value of the assigned contract. The loan advance is repaid as the various contract milestones are met and funds are received from your customer. The signed contract is taken as security, although additional security may be required depending of the financial strength of the borrower.
Banks frequently partner with companies such as Economic Development Canada, under its Export Guarantee Program, and Northstar Trade Finance Inc., to enhance our customers' ability to finance export-related contracts. It is important for your bank to understand your business model and target market, so they can customize financing solutions to ideally suit the needs of your business.