The 5 C’s of Credit: Collateral
Many new businesses don’t have much collateral, or if they do, it is inventory and receivables. Therefore, they can feel frustrated when they learn that the bank isn’t accepting their assets at the value shown on the balance sheet.
Well, much like when you’ve just driven that new car off the lot, the value is worth more to you than anyone else.
Below is an approximate chart that is typical of how much a bank might lend against your assets. The term “advance rate” is used by banks to determine how much money they will lend against the value of the assets.
Here are some “typical” advance rates and an explanation of how the bank comes to its conclusion.
|Inventory||50%||Liquidation of unused inventory is usually done through auctions or bulk sales that command low pricing. It can be expensive for the bank to find a buyer. Values could be lower depending on the product (retail v. wholesale).
|Accounts Receivable||75% – 80%||Not all receivables are collected, especially when a business is in foreclosure since its buyers are less willing to pay their bills. These advance rates are usually applied to receivables that are 30 days to 90 days; receivables beyond 90 days are often given no value. The portfolio mix of receivables can also affect the advance, (i.e. if a client represents greater than 10% of overall receivables, then that particular client’s receivable may be discounted lower than 75%).
|Equipment||50%||Specialized equipment for production is very difficult to sell when a bank forecloses. The usage of the equipment can devalue beyond the depreciation schedule when the company does not keep up with regular maintenance. Banks often have to hire receivers to sell equipment if they are not experienced in the industry.
|Property and Buildings||50% to 75%||Advance rates for property and buildings can vary depending on the usage. Single use property, such as an owner occupied building, might be valued less than an income producing property because its design may be geared toward the business itself and not easily adaptable. Disposing of land and buildings is expensive for banks because they have to order new appraisals, engage a receiver, and hire a realtor. The banks have to carry these assets on their books until they are sold, which might take time.
Many startups have few hard assets, especially those that focus on data mining or software application. It will be more difficult to use your receivables for collateral since those are your only true assets.
Talk to a banker to get an idea of what kind of scenario they would consider for lending to you.
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