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Small Business

In Small-Business Lending, the Devil Is Often in the Lien

When small-business owners consider a loan, their primary concerns are generally what you would expect: What is the interest rate? How big is the loan? What will the monthly payments be?

But another issue often lurks in the background and gets overlooked. What liens will the lender take and how will that affect the owner’s ability to borrow in the future? Sometimes the answers to these questions can be devastatingly important.

When a lender files a lien, it places the lender in a position to be able to take a borrower’s assets in case of default. Sometimes additional liens are filed by other creditors behind the lender’s first lien — but these creditors assume subordinate positions and would be able to claim proceeds in a liquidation only after the holder of the first lien has been paid off.

Naturally, lenders prefer to be in the first lien position. If a lender does take a second or third lien position, the loan is riskier — and often requires a much higher interest rate. And that is why paying attention to the lien is critical. When you give up first lien position on some or all of your assets, you really want to make sure that you are getting the money you need at the right price — because subsequent loans are likely to be either more expensive or impossible to obtain. Unfortunately, many small-business owners don’t pay attention to this.

My loan brokerage firm recently helped a rapidly growing client that had outgrown its line of credit with a bank. It was growing fast, but it was not profitable enough for the bank to extend more money. Instead, the company chose  to take money from an accounts receivable factoring company.  We made our client aware of the higher cost associated with factoring, but given the company’s relatively high margins and growth prospects, the owner was willing to pay the higher price for faster access to capital.

As part of the process of setting up the factoring relationship, we learned that the company’s current lender had placed a blanket lien against all assets of the business, including the accounts receivable. We worked with the client to evaluate the option of using some of the proceeds of factoring to pay off the existing bank line. The factoring arrangement still made sense, and our client made arrangements to pay off the existing line of credit at closing, at which time the bank would remove its lien on the receivables to be replaced by a new lien owned by the factoring company.

But as we moved toward closing, we were surprised to learn that the company had entered into a purchase-finance agreement for a small piece of equipment a few months earlier, and the equipment seller had placed a blanket lien on all of our client’s assets, including its receivables. Without removing this lien, the transaction could not proceed because the factor, understandably, insisted on being in the first position on the asset they were lending against. Much to our surprise, the equipment company would not agree, and the client had to make the difficult decision to pay off the equipment loan with proceeds from the factoring agreement at a much higher rate and on less favorable terms.

We are also currently trying to help a borrower that is operating two franchises and wants to open a third. So far, this small franchisee has managed to build its business with only one loan – a fairly small Small Business Administration loan that it used to purchase a trailer truck to take to events.

While the loan represented only 20 percent of the amount needed for the new location, the business was now stuck because the new lender required a blanket first position lien, which the Small Business Administration would not accept. In this case, the client is likely to have to refinance its equipment at a higher rate with a lender that will take a lien only on the equipment and allow the business to proceed with its expansion.

I hope that these examples convey how critical it is to think through the lien and collateral requirements of your lender to make sure that when you’re giving up first lien position on some or all of your assets, you’re getting the best possible loan return.

Have you ever gotten tripped up by a lien? What was your experience and how did you handle it?

Ami Kassar founded MultiFunding, which is based near Philadelphia and helps small businesses find the right sources of financing for their companies.

By AMI KASSAR | October 21, 2013

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