Banks and Collateral

All too often we have a prospective client interested in using PRN Funding’s factoring services, but their accounts receivable are already pledged as collateral for a line of credit with the company’s bank.  This type of situation throws a wrench in the factoring equation for a number of reasons.  We stumbled upon a blog that explained the details of this kind of situation, so we’ ve posted it for the benefit of our readers.

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When we get an inquiry for invoice factoring we find this situation more times than you can imagine. An early stage company is just getting going and they need some extra cash to start out. Because the owners are unfamiliar with accounts receivable financing they instead go to their local bank and ask for a loan. Being an early stage company they don’t have historical profitability or real assets. What they usually have are personal assets, like home equity, or stocks to put in escrow, or even a well off friend or relative that will sign the loan as a “guarantor”.

Given enough personal credit or liquid equity the bank processes the loan request and gives its approval. Knowing not much is happening at the business, the lender is not making a credit decision based on the value of any business assets. When loan closing happens papers are slid across the table for the borrower to sign. Being happy to get a bank loan, the borrower signs away. But, there’s one particular item that could have significant ramifications to future success and capturing any additional commercial capital.

It’s called the UCC-1 financing statement. (read Lenders as a normal course of business assign all the tangible assets of the company. What this means is, six months or a year later when the borrower is looking for more operating capital, they find out about a factoring company and ask to have their accounts receivables financed. Well the factor can’t because ownership of the accounts receivable are secured by the bank.

Access to capital has just become more complicated just by signing a form. The options are to pay off the bank, pay down a significant portion of the loan, or get the bank to simply “subordinate” the A/R which effectively releases their ownership of it. Also beware, leasing companies, suppliers that offer credit terms, previous owner financed loans, all of these potentially will secure your receivables as collateral. As the borrower you can negotiate the terms of the UCC. If there are no receivables when you get the loan, tell the bank to leave them out of the financing statement.

When securing commercial credit, ask about the UCC-1. Ask what collateral will be secured. If it’s not what you have agreed on, tell them before going to closing. That way you can still use invoice factoring as an option.