Too Good to Be True

Recently, I ran into a situation where a company got an offer that was Too Good to be True. 

Why was the offer Too Good:

• The pricing was well below market rate
• The “collateral” being financed was questionable - something that no bank, or finance company, would even consider
• All the hard questions relating to augmenting the advance rates were answered by “we will figure that out”

Why it’s Too Good:

Pricing below market rate: 

A finance company that is willing to provide below market rates is typically desperate and not likely to be around for the long term. Undercutting the market eventually results in unsustainable losses. Imagine losing your company’s financing in the middle of a contract ramp up because your lender ran their business into the ground.

Financing the “un-financeable”:

Financeable collateral is collateral that will be turned into revenue in the relatively near term; receivables, equipment, inventory, etc. With respect to receivables, the receivable needs to be to a credit worth entity that will, in fact, pay their bills. The “too good” situation involved financing receivables to a shell company with no assets and owned by the borrower; or a contra account. For the obvious reason, banks and finance companies loathe to accept this as acceptable collateral. 

A finance company taking a risk on your collateral is probably taking outsized risk with other companies. Consistent patterns of outsized risk represents lack of internal controls; in the financing world that leads to losses. 

Chickens do eventually come home to roost:

If your lender is willing to finance something that no one else would finance AND at a below market rate – this is a clue you are dealing with a company that may be on its last legs. There is nothing worse than expecting money for payroll and finding that the well has run dry on your financing partner.

Recommendation:

All finance companies borrow from banks, hedge funds, private equity groups, wealthy individuals and other means to finance their businesses. Ask for a letter from your lender’s bank or capital source confirming that they are in good standing and have plenty of availability on their credit line. If they won’t provide such a letter, you have found out the deal is Too Good to be True.