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Early Stage Growth - Case Study

The following case is based on a true story of an early stage growth business that successfully used factoring with Evergreen as a bridge to success. The financial statements and business circumstances presented are factual, while the identities of the business, banks and individuals involved have been changed for confidentiality purposes.

Overview

A Louisiana manufacturer (the “Company”) of drilling tools for the oil and gas industry, just completed year 3 of operations and recorded its first profit, when the owners learned their bank (“Start-Up Bank”) could no longer support their growth. The owners were baffled because everything was finally going according to plan, and the upcoming year held the promise of doubling sales with a projected six figure profit. Unfortunately, the Company’s growing pains produced a lot of red ink and the banker didn’t buy the new rosy projections.

Background

The Company was organized by three individuals with a collective 50+ years of experience in oil and gas drilling operations. The owners contributed a combined $250,000 in capital (from savings and 2nd mortgages on their homes), and Start-Up Bank loaned $360,000 for equipment purchases along with a $50,000 line of credit for working capital. The Company appeared to have a safe balance of debt and equity to start the business. The business plan forecast showed an operating loss in the first year of $50,000 followed by profitability in the next two years of $100,000 and $250,000, respectively. Start-Up Bank had high confidence in management’s abilities and took comfort in the fact the owners were heavily invested in the business in addition to personally guaranteeing the loans.

Actually revenues grew slower than projected in the first 2 years of operation, as extensive customer product testing and long approval processes caused delays in orders. Instead of operating at an overall profit, the Company produced a cumulative loss of $214,000 for the first two years which eroded nearly all of the contributed capital. In year 3 the Company became profitable earning $12,000. During those early years, the Company’s cash reserves diminished and management instinctively turned to the bank for additional support. The bank resisted and the Company began to use credit cards to fill the gaps, slowing payments to vendors and delaying payroll tax deposits.

After repeated overdraft problems, Start-Up Bank raised the line of credit to $70,000 and again a short time later to $100,000. The bank did not want to continue to fund losses and recommended the owners contribute more capital to stabilize the Company. The owners had no new funds to invest and rejected the idea of bringing in additional investors.

Big Moment

After three years of hard work, the Company landed several large orders, putting year four on track to nearly double revenues to 2.5 million. Management projected a profit from operations of nearly $400,000. The existing facility and equipment had plenty of capacity for growth, but management estimated the Company would need to increase their bank line to $400,000 for working capital. Armed with the Company’s latest financial statement, sales orders and projections for the upcoming year, management presented their account officer with the loan request.

The account officer was surprised by the request based on the Company’s recent problems, and quickly dashed any hopes of approval by the bank. The bank management had grown weary of the Company’s financial struggles, and believed the Company was in no condition to take on more debt. Again the loan officer recommended new capital investment to repair the damage caused by the losses, and implored them slow down their growth.

Turning Point

Management didn’t take the news well and saw the loan rejection as a sign the bank had lost confidence in their company. In addition, the owners could not understand logically how turning away sales orders would help their business. Management decided it was time to bring the loan request to other banks.

The owners first brought their loan package to a bank known for making small business loans, Old School Bank (OSB). The request was for a $400,000 line of credit and a $250,000 loan to refinance the equipment. The OSB loan officer’s first question was “how much equity do you have in your building?” The owners replied they were in a lease arrangement with plans to purchase the building within the next couple of years. The lender quickly told them that OSB doesn’t lend on receivables unless they also have real estate for collateral - conversation over.

Next the owners visited New Visions Bank (“NVB”) to pitch their loan request one more time. The owners explained how the Company turned the corner last year, and the upcoming year’s volume would be tremendously profitable. After an initial hesitation, the banker started to get creative. Believing in the Company’s opportunity to be successful, he felt compelled to help them solve their financial dilemma.

First, the NVB officer suggested raising capital as a conservative way to fund growth, but the owners quickly stated their objection to that idea. He then asked if the company had looked into factoring their receivables. One of the owners said he thought factoring was just for companies in financial trouble and the other two knew nothing about factoring. Fortunately for the Company, the banker knew enough to ease their concerns and provided them with a referral to Evergreen Working Capital.

Solution

The meeting with Evergreen went well, and the owners were convinced that quickly converting their invoices to cash after the sale would allow the Company to keep up with the growth. No matter if the business grew 50% or 150%; the resulting cash flow would be positive.

The Company entered into a factoring agreement providing immediate cash advances for their invoices with a small reserve amount due after collection.  The Company’s customers paid on average in about 60 days and the discount was set accordingly. The owners were encouraged by the opportunity to negotiate a lower discount at a later date based on higher volume.

The Company began factoring in February of year 4 with an initial sale of invoices totaling $250,000. The line of credit at Start Up Bank was paid off and the remaining proceeds were used to jumpstart production for the backlog of orders. The obvious benefit of factoring was having access to the cash from sales right after delivery – meaning cash flow improved by 60 days!

The owners were very pleased with the banker at NVB for his guidance, and immediately moved their checking account to the bank, vowing to move the rest of their business as soon as NVB could take it.

Making payroll on time and keeping suppliers satisfied hadn’t been this smooth since the company’s first year of operation. As the year progressed, the Company’s profitability and operating cash flow continued to improve, and the owners were able to catch up on the past due payroll taxes and pay down the credit card balances to a reasonable level.

By the end of the fourth year, Company nearly doubled revenues as predicted to $2.5 million and produced a record profit of $339,000. The higher production level increased the plant’s efficiency and profitability which completely offset the cost of the factoring fees. See Table 1 for a recap of the balance sheet and income statement for the Company’s first 4 years in business.


Outcome

The Company continued factoring as needed through early May of the following year (for a total of 15 months). The NVB banker was finally in a position to offer the Company a $500,000 line to replace the factoring and a loan to refinance the equipment balance remaining at Start-Up Bank. The time was right to pay off Evergreen and return to a bank line of credit. The owners took pride in Company’s success and were happy to have made it through tough times without giving up any ownership in the Company.

The victory was especially rewarding for the banker at NVB, as he took the time to help the business owners a year and a half earlier when they weren’t bankable from a lending standpoint. He easily could have turned down the loan request and moved on to other business, but he saw the potential and believed it would be worth his time to help the owners resolve their financial predicament.

In the final analysis, this was a perfect situation for factoring. Quickly converting sales to cash reduced the need for debt financing, and allowed this business to essentially self-finance and naturally grow capital in the process. The benefits of factoring greatly outweighed the cost, making it a win-win situation for the Company and Evergreen.

The reality is young businesses often have a narrow window of opportunity for success and have to make the most of their opportunities. When a company’s sales are outpacing its financial support, it may be time to convert those sales into real cash flow and grow organically. Sometimes fast growth is the best way forward. Cheers!

Louis Greenblatt, President
Evergreen Working Capital LLC



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