Brianna Wilson,
Editor,
Monitor

Working capital, an indicator of a business’s short-term financial position, is calculated as a business’s current assets minus its current liabilities, indicating the liquidity levels for managing its day-today expenses. A working capital loan is either a lump sum or a line of credit that can be used to finance a business’s needs — often, the company’s day-to-day expenses or new opportunities — with a short repayment period of around six to 24 months.

Surveying The Market

The market for working capital historically revolved around retail-driven companies but has since migrated into more capital-intensive small and midsize businesses operating in industries such as construction, transportation, medical and manufacturing. A significant

overlap exists in the customer base for working capital and equipment finance, which Channel’s founders noticed in 2009. “If you’re doing a traditional equipment finance agreement, oftentimes, there is something positive going on in that business; that’s why they’re making the equipment purchase,” Adam Peterson, managing director at Channel, says.

Small businesses, which make up a significant portion of the companies that take out working capital loans, have everyday opportunities that require additional capital. “Small to medium-sized business owners have opportunities that come across the desk each day,” Peterson says. “That owner has to make the decision whether they are going [to] realize an opportunity or not — and if they are, how they are going to pay for it. If we only offer equipment financing to our customer base, we are missing the chance to build a much deeper relationship with our customers by solving a broader array of their business financing needs.”

When Channel began offering working capital to the marketplace, many in equipment finance were paying little attention to the space or creating their own working capital offerings. There was a massive disconnect in how companies solely dedicated to equipment finance or working capital thought about transaction flow between the two types of financing. Channel began offering working capital because there was a need for it in equipment finance, as the company’s management team and founders understood that this disconnect existed and that there was an opportunity to stand in the middle to facilitate that bridge.

A New View of Risk

Peterson notes that some of the potential challenges for equipment finance companies entering the working capital space are the major differences in mitigating financial risk for the two products. Where equipment finance products mitigate risk predominantly by rate, with conventional repayment offerings of 36, 48 or 60 months at a higher rate for tougher credit qualities, working capital products mitigate risk by term, offering 12 months to more than 18 months for higher credit qualities vs. short periods of six to nine months for tougher credits. Equipment finance underwriters are generally unaccustomed to dealing with these scenarios.

“Working capital loans or advances provide a great deal of flexibility for an SMB,” Peterson says. “The funds are transferred directly to the SMB and they may use them for any business- related need. When identifying whether this product is right for a specific opportunity, it’s our job to help the business owner clearly identify the [return on investment] associated with the opportunity they have available to them and present options to the customer.”

Channel offers two products in the working capital space: a business advance, which is like a merchant cash advance product in that it entails a purchase and sale of receivables, and a conventional working capital loan, which is a secured promissory note. Each product functions similarly but with its own nuances. Channel also offers a hybrid line of credit. If, for example, a customer is approved for a $150,000 loan but only needs $50,000, the additional $100,000 is available to draw upon if the client ends up needing it. The client will not incur non-utilization fees or associated costs for taking only part of the loan. Each time a customer borrows, the additional draw is placed into a termed out note, offering flexibility for the customer to draw it up as needed while also allowing them to take the right amount of money and avoid paying for unused funds.

Expanding Customer Base

The gap between equipment finance and working capital is gradually closing, according to Peterson. If one broker is not offering working capital loans, dozens of others will, which makes it essential for third-party originators, independents and banks to consider adding this product to their toolboxes. With working capital being so accessible, customers may easily receive these loans from competitors. Repeat customers are vital to equipment finance businesses; if customer finds working capital loans with a competitor, and that competitor also offers equipment finance, the customer may switch to the competitor that offers them a convenient place to finance multiple areas of their business.

“A lot of our customers today are bankable credits,” Peterson says. “The reason they come to Channel or a working capital company in the space is ease and convenience.”

Currently, the banking market has been heavily affected by the crash of Silicon Valley Bank and other institutions, but working capital accelerates through a recessionary environment, as the number of bankable customers becomes smaller when banks tighten up. Previously bankable customers still need capital, but their local banks may no longer be an option. This pushes higher quality credit into working capital and accelerates funding volumes.

“It’s our job as finance professionals to present our customers with options, whether those options fit every opportunity or fit every business, that’s not really for us to decide; it’s for the end-user to decide,” Peterson says. “I think what is most important for an equipment finance company is, don’t make the decision for your customer; present their options and let them make the decisions.”

Comparing Options

Historically, Peterson says equipment finance companies have looked at the working capital space and assumed the rates were too high or the payments too frequent. Additionally, many small businesses may choose alternatives to working capital loans, such as MCAs, factoring or a company credit card.

Each product has its place where it fits and where it doesn’t. Factoring is great for specific industries, such as transportation, where it can help level out cash flows within a trucking business. However, if that company is choosing between engaging in a factoring relationship to replace a blown engine or expand its business, there are better financing alternatives available that are likely going to be more cost effective and flexible.

There’s similarity when comparing credit card options to working capital loans as well. Some credit cards may be cheaper, where others may be significantly more expensive. It comes down to how structured the borrower is and how quickly they intend to pay off their credit card balance. If they plan to make payments on their credit card for the next five years, that financing is going to be exponentially more expensive than a working capital loan. Conversely, if they are going to pay off their credit cards in 30, 60 or 90 days, that is likely their most cost-effective option. The benefit of working capital is that it gives borrowers the structure to ensure the loans are paid back in a defined period of time without maxing out revolving availability.

“The reality is, if you go look at the working capital space, our portfolio today averages a 725 FICO and 10 years’ time in business. That’s an A-B lease credit. For those folks, this product is viable when it’s talked about or sold in the right way or it’s presenting options they do not have otherwise,” Peterson says.

Getting in the Game

Challenges will inevitably arise while onboarding a new product or lender when a company is still learning the new space. “The main goal is to always minimize disruption to your existing business and people. We typically would advise folks to start with one or two sales representatives, convert them to working capital salespeople and have them become subject matter experts before you expand. Additionally, who you choose to partner with in the working capital space really matters; aligning with companies that represent your company’s values in a consistent manner is vitally important,” Peterson says. “I think it [comes down to] understanding your customer’s opportunities and helping them understand what financing options are available and best suited to their need. That is what really differentiates or makes working capital successful for them.”

ABOUT THE AUTHOR: Brianna Wilson is an editor of Monitor. Rita E. Garwood, editor in chief, interviewed Adam Peterson for this article.