As banks continued to tighten up their lending activities and bankruptcies and other economic headwinds intensify, alternative lenders will play a critical role in helping companies exit banking relationships and/or rehabilitate to become bankable once more.

Much has changed in the years since the world began to slowly emerge from the height of the COVID-19 pandemic back in 2021 and 2022. During this emergence, many businesses faced unexpected supply chain troubles that added a layer to their financing challenges. However, funding from government programs offered short-term assistance for many companies and, as a result, banks continued to support clients who may not have deserved such support. At that time, bank asset-based lenders were offering deals with aggressive structures, including some that simply were not prudent for alternative lenders to try to match. Against this backdrop, maintaining structure was paramount and pricing became much less important.

Eventually, the government funding programs dried up, leaving companies that had gained a lifeline struggling to stay afloat. For some companies, the government support merely masked problems that were either caused by the pandemic or, in many cases, predated it, leaving their bank lenders in a position where they could no longer kick the can down the road.

ALTERNATIVE LENDING MARKET SHIFTS

For alternative lenders, beginning in the early days of 2023 and continuing to today, better quality deals have become more prevalent. Appropriate structures, such as reasonable inventory caps, the re-introduction of inventory to accounts receivable balancers, a pull back on stretch or over-advance facilities and even the obtaining of personal or corporate guarantees, were seemingly back on the table. Once the regional banking crisis hit, alternative lenders found themselves even better positioned and with more opportunities to take a closer look at the quality of deals again. Deals that were on the cusp of becoming non-bankable were now prime prospects for alternative lenders. And when banks began to pull back to focus on deposits and reducing loans, alternative lenders saw an opening to jump even further into the fray.

Of course, there are now more pools of liquidity and financing options available to borrowers today with the abundance of private credit funds now in the market, not to mention funding from revenue-based lenders and merchant cash advance lenders.

As these shifts in the alterative lending market continue to develop, companies eyeing an exit from a bank relationship or sensing they may be getting pushed out should know that there are options, many of which offer more flexibility than their banks are either able or willing to provide.

When faced with a client in a potential exit scenario, alternative lenders should conduct an immediate deep dive to understand why the business has a reason to exist, determine how appropriate their financing ask is beyond the need to find an exit and then evaluate and set appropriate advance rates on collateral. While pricing may be a bit higher than at a bank, with interest rates as high as they are, the flexibility that a non-bank finance company can provide — over and above a covenant-driven lender like a bank — often outweighs the added cost of borrowing.

Although there are currently numerous opportunities for alternative lenders to work with banks as their clients are being rehabilitated or at the point of exiting the banking relationship, finding the right solution for the situation is critical.

ABL AS A REHABILITATION TOOL

For asset-based lending scenarios, an alternative lender can help to rehabilitate the client and provide much-needed working capital to help the business get back on track. One such client of Rosenthal’s — a Florida-based
manufacturer of bathroom tissue and paper products — was faced with a conservative borrowing base and tight availability with its existing commercial bank lender. Knowing an alternative lender might be able to offer a less cash-constrained way forward, the company engaged a debt placement consultant who referred it to Rosenthal, which provided a $5 million ABL facility against receivables and inventory to support the client’s working capital needs. The facility provided additional borrowing base availability in the low seven figures, far above what the bank had previously been providing. Ultimately, the exit from the bank enabled the client to sell the business at a significant multiple. In other cases, some ABL clients may even be able to “graduate” from an alternative lender and move back into a commercial banking relationship.

FACTORING CAN MITIGATE RISKS

Like ABL, factoring can also offer a respite for companies that are struggling with maintaining growth and taking advantage of sales opportunities without introducing the risk of a total company breakdown. Factoring helps with concentration risk and helps to mitigate retail credit risk, both of which can upend a company’s financials if not managed properly.

One recent Rosenthal client — a century-old, family-owned manufacturer and distributor of plastic parts and hardware — experienced pandemic-related challenges and supply chain issues and was refocusing its core businesses when one of its largest customers unexpectedly went out of business. As a result, the company’s existing bank was unwilling to continue to lend to the company, and while the client exited the bank on good terms, it still needed working capital to keep the business intact. Rosenthal worked with the company to lend on both account receivables and inventory through a $3 million non-recourse factoring facility, which included a $400,000 letter of credit sub-limit and much-needed credit protection.

In some similar circumstances, clients may even borrow from a bank but choose to factor their receivables through an alternative lender, which can help to make the bank more comfortable with its lending position, as these “collection” factoring relationships can provide much more real-time visibility to the receivable performance of the borrower.

International factoring, which focuses on foreign receivables, can also be immensely helpful to clients that need assistance exiting a banking relationship. Because sellers now face a host of new challenges in the current economic environment, they require more creative and flexible financing options that can support their businesses and mitigate risk at the same time. A sound export factoring program can allow sellers to get paid at shipment on their international sales so they have the liquidity they need to expand in foreign markets.

For example, a recent client of Rosenthal, a global manufacturer of antimicrobial technologies, needed a new financing solution that would accommodate its domestic and international sales. The company experienced pandemic-related losses that led to the termination of its existing banking facility. Recourse factoring was an attractive solution for the company, as it already held its own trade credit insurance policy. Rosenthal stepped in to provide a collateralized accounts receivable solution in the form of a $1.75 million recourse factoring facility for the client.

In another example, a private equity-owned pharmaceutical and healthcare products company was seeking a new alternative financing facility to support its seasonal needs. The company had been exploring traditional ABL facilities with banks but was unable to secure a facility that would support its needs, both in terms of size and structure. In fact, the deal was referred to Rosenthal by one of the firm’s own banking partners. Rosenthal stepped in to provide a $25 million recourse factoring facility that was uniquely structured to include multiple A/R advance rates (based on the type of client’s revenue stream with its customer base) and more flexible criteria for customer terms.

THE POSITIVES OF PO FINANCING

Purchase order financing is another alternative financing tool that can help rebuild trade terms that may be lost with suppliers so that companies can take advantage of new sales opportunities. In an exit or rehabilitation scenario, PO lenders can structure a carveout with an existing lender and therefore take on the additional inventory financing required in lieu of the existing lender providing an over-advance. PO lenders are often much more well-versed on how to manage inventory in transit, finance international trade and provide funding and risk mitigation solutions when a bank is coping with increasing inventory reliance with a client. Both domestic and international PO financing that can be paired seamlessly with a factoring facility, or existing financing from a current bank lender, can give companies the competitive edge they need to execute on critical sales and growth opportunities without an equity raise that would dilute the existing ownership.

In one such case, a recent Rosenthal client — a New York-based electronics technology company — was seeking a new financing facility after partnering with a new supplier for purchases of large shipments to a major creditworthy customer. The company was also in the process of refinancing its existing term loan, so its third-party bank factor brought in Rosenthal to provide a purchase order financing facility that would work in tandem with the company’s existing funding. Rosenthal entered a tri-party intercreditor agreement with the new term loan lender and bank factor, providing a $2.5 million purchase order facility with a $10 million volume commitment. As with many new supplier
relationships, the supplier was initially looking for large cash deposits from the client, but Rosenthal negotiated with the client’s new overseas supplier and convinced it to agree to utilize letters of credit in place of cash deposits to fulfill the large orders.

In another example of how PO financing can support a client in a potential exit scenario, a ready-to-drink beverage company received a sizable purchase order from a big box retailer. Rather than utilizing its existing ABL line, the company wanted to explore alternative financing solutions to fulfill the order. As the company’s domestic supplier was looking for pre-payment, Rosenthal issued a domestic purchase guarantee to allow the supplier to complete production, with Rosenthal making payment as cash on delivery. The $1.75 purchase order financing facility worked seamlessly with the company’s existing ABL line and the order was fulfilled on time.

COLLABORATION, CREATIVITY AND FLEXIBILITY

All of the examples presented in this article illustrate how flexibility and compatibility are the keys to structuring effective alternative lending solutions, especially when they present an attractive option to raising equity. When paired together, many of these financing options, particularly PO financing and factoring, can help alleviate concentration risks and decrease inventory reliance well before a client begins to suffer.

The right lender should be able to intervene in a variety of different situations and offer liquidity options that are sound alternatives to raising more equity to fulfill a short-term working capital strain. After all, when a business is struggling, it’s not always the time to turn to raising more equity, especially when alternative finance companies offer so many viable solutions to fill the growth gaps and address working capital needs for things like increased orders, new sales opportunities, building more inventory and wholesale expansion.

Effective education, collaboration and open communication between banks and alternative lenders have proven to be some of the most critical components of doing business in the current environment. Alternative lenders are often able to find solutions for bank clients, whether taking over the relationship — should the bank be pursuing that option — or stepping in to assist with part of the relationship to offer much-needed, extra liquidity. Banks will still own the depository relationships in these situations, and, in many cases, an alternative lender can transition the lending relationship back to the bank once the business is rehabilitated.

As the business climate becomes more and more complicated and nuanced, it may take more than one financial partner in a deal to keep a client on track and moving forward. Recognizing the value that alternative finance companies bring to the table in these situations can make all the difference for a struggling business and be a win-win in the end for all parties involved. •

Paul Schuldiner is an executive vice president and chief lending officer of Rosenthal & Rosenthal, a factoring, asset-based lending, purchase order financing and inventory financing firm based in New York.