Top 3 Credit Products for GovCons
Tony Gray and Matthew Gillman walk through the three credit products government contractors use most, the asset-based line of credit, invoice factoring and the contract line of credit, plus the financial support letter that shows a contracting officer you can perform.
What is an asset-based line of credit?
Matthew Gillman: An asset-based line looks to collateral first to provide liquidity, where a term loan or cash flow loan looks to cash flow first. A manufacturer has plant, machinery, equipment, raw materials, inventory and receivables to borrow against. A service business, which many government contractors are, mainly has receivables. The lender gives you a line secured by those assets, with the limit set by a formula.
Many lenders advance 85% against outstanding receivables, so $1 million of receivables gives you about $850,000 to draw. On finished inventory it might be 50% at cost. Unlike real estate, these assets move every day as receivables are collected and inventory is sold, so the lender monitors them.
Can I get these products from a bank?
Matthew Gillman: These are not products built for an unbankable market. Banks offer asset-based lines, contract lines and invoice factoring. They just offer them to the middle market rather than to small businesses. Private credit took products larger companies use and made them available to small and medium-sized businesses. The question is whether you are large enough to get them from a bank.
What are accounts receivable?
Matthew Gillman: You delivered the service or the product, sent the invoice, and now you are waiting to be paid. Lenders like receivables because they are short-term. On net 30 terms you wait roughly 30 days. But a manufacturer that bought materials, produced, packaged and shipped before invoicing might have 90 or 120 days of cash out, so accelerating the receivable can make a huge difference.
Tony Gray: Net 30 is your customer’s commitment to pay within 30 days, and a lender watches whether that holds. If net 30 starts turning into 45 or 60 days, that is a concern.
Why does a lender watch my customers’ payments?
Matthew Gillman: Because the lender and the business owner want exactly the same thing: the bill paid. Use us as a credit department. The federal government or a large prime should plainly pay. But a company doing $300 million in revenue might show up in our reporting with its credit utilization way up, vendors going unpaid, or payments that used to arrive in 30 days now taking 48. We want to know that early, and so do you.
Tony Gray: If you do not get paid, we do not get paid. We are not adversaries. A borrower who withholds information is a red flag; treat your lender as an advisor.
What is invoice factoring?
Matthew Gillman: Asset-based lending is a loan against your receivables. With invoice factoring you are technically selling your invoices at a discount. You have a $10,000 invoice; the factor advances money against it for a fee, and you are paid today instead of waiting for your customer.
Take away the contractual difference between a loan and a purchase, and it works much like a line of credit, with what you can draw based on what you have billed. A service company makes payroll every week or two and bills on net 30 or net 45 terms, which is exactly the gap it fills.
When does factoring fit better than a line of credit?
Matthew Gillman: Generally when customer concentration is high: a small business with 70% of its revenue from one place. With 10, 20 or 30 customers, it is easier to set up an asset-based or contract line against the pool of receivables.
Tony Gray: Lenders always look at concentration: all your eggs in one basket. If you just won your first contract or subcontract, or your work is all with one agency, factoring could be the right product, and high concentration does not mean you will not get private credit.
Matthew Gillman: For B2B companies it is an optimal solution because there are no payments. A loan has monthly payments; a line has monthly interest. With factoring you wait for the invoice to pay. It is a pure acceleration of money.
How do advance rates and reserves work?
Matthew Gillman: Think of a mortgage: you put down 20% and the lender gives you 80. On a $100 invoice we might advance $90, and when the invoice pays we release the remaining reserve, less a fee. The reserve exists because invoices sometimes pay short, billed wrong or partly disputed, so instead of advancing 100% and chasing the shortfall later, there is an advance rate. In government work, what you bill is normally what you get paid, so over time the advance rate can increase.
Tony Gray: With an asset-based line you make payments to the lender, like a credit card. With factoring it runs the other way: the lender pays you up front, because it now owns the invoice, and pays you the rest when the invoice is paid, keeping its fee.
Matthew Gillman: To be clear, a 90% advance rate is not a 10% fee. It is a reserve that is released later.
Is the factoring fee worth paying?
Matthew Gillman: Some business owners balk at the fee. But if your customer offered to pay you right now in exchange for a small discount, would you take it? Almost everyone says yes, when they need it. It is the same concept. It is about having access to capital when you need it, not using it every time.
The best business owners apply for money before they need it. A three-day gap in an invoice payment can be the difference between making and missing payroll, so have something in place, whether a bank line, factoring or cash reserves, before you are scrambling for expensive online loans.
What is a contract line of credit?
Matthew Gillman: It is a revolving line built to solve the pain points we know government contractors face, with several products inside it. First, a mobilization advance: the contract is starting, people need to get to site and you need laptops, and you will bill for it in the next cycle or across the next 12 invoices. Then payroll: people are working but you cannot bill yet, so the line funds earned but unbilled work. If the contract starts January 1 and the first payroll is January 15, we fund it. It is billed in early February, and then we advance against the receivable.
As the contract runs, profit catches up. By the end of the base year many contractors are advancing only against invoices, and by year two or three they may not draw on that contract at all, but they have won three more.
Tony Gray: Reach out early, not at the last minute, when you have no room to negotiate.
What is a financial support letter?
Matthew Gillman: We provide financial support letters for existing customers to include with their bids, showing they have a line of credit and the financial capability to perform. It also answers the question people ask themselves: what if I win? A contractor with five proposals out, expecting to win two, wins six. With the letter set up, they know what we can fund, so they are not scrambling to pay 40 new people.
Tony Gray: The government is asking the same question. Contracting officers and source selection boards evaluate you on risk, and a solicitation may require a financial support letter, sometimes called a financial feasibility letter, from your lender.
Read more on this
- The credit products government contractors actually use
- Invoice factoring
- Financial capability letters
This is an edited version of the conversation: spoken repetition is removed and each answer leads with its point. Every figure and example is as said in the episode. For financing specific to your business, talk to us.
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