It is no secret that commercial banks are less likely to provide credit to small and medium-sized businesses than in the past, and government contractors are certainly not immune to this trend.
For those companies in need of working capital and lacking a traditional commercial banking option, the specialty finance market may be the best option.
The good news is that there is an abundance of finance companies providing alternative lending options for government contractors and other businesses. In fact, 76% of the members of the Commercial Finance Association are non-bank financial institutions. And, according to a recent article, noted hedge fund manager Daniel Zwirn is forming a fund to “occupy the competitive space evacuated by traditional lenders.”
Many of these non-bank financial institutions are largely agnostic as to the types of companies they fund. Some, however, specialize in specific industry sectors. In general, it is preferable to work with a finance company that understands your industry. This is especially true for government contractors, given their unique customer base and the sometimes baffling rules and procedures which govern the market (see “FAR”).
The good news regarding the specialty finance companies that serve government contractors is that they are typically more affordable and more customer-centric than finance companies that serve other industries – such as factoring companies serving the garment industry.
There is a simple, four-point checklist that a government contractor should consider when selecting a finance company:
- Rate. The all-in rate, or cost of funds, should not be more than 1.25%/month (i.e., effective annual interest rate of 15%), often much less. Advance rates should not be less than 90% for prime contracts and 85% for subcontracts.
- Terms. Make sure that there is as much flexibility as possible. For example, some finance companies require multi-year commitments that include significant termination fees to get out of the contract early.
- Recourse. If the finance company is a factor, rather than a lender, there ought not to be recourse, personal guarantees or liens on the company’s assets required.
- Growth. Make sure that the finance company can support your growth by providing increasingly larger facilities and commitment letters in order to win large contract opportunities.
While the above check-list is important, remember above all that the relationship between you and your finance company is key. Never forget that you do business with people, not with companies.