Loan Types for Manufacturing Businesses
Posted December 3rd, 2018
In the decade following the Great Recession, many American manufacturing business owners have struggled to secure loans or lines of credit from traditional banks. As a result, a host of new and different lending options have sprung up to help manufacturers looking to expand, better manage their cash flow, purchase new equipment and more.
Manufacturing is a capital-intensive industry. Companies need financing to buy and repair heavy machinery, order raw materials, as well as cover labor, shipping, and overhead costs. Cash flow pinches are common and without the right funding partner, a business will be limited in how much it can grow or overcome obstacles. Often times this puts unneeded stress on the business and the business owner(s).
While there are plenty of organizations that offer loans to manufacturing businesses, it can be especially difficult to figure out where to start. The first step is to identify what type of manufacturing business loan you need. The majority of manufacturing business needs can be split into one of three categories: Real Estate, Equipment/Machinery, and Cash Flow/Working Capital.
Here is a guide to help you better understand what types of loans are available for each of these three most common manufacturing business needs.
Funding for Real Estate
Do you need to purchase a new space for your business to operate? Or is your current property in need of renovations and/or an expansion?
Finding a real estate loan can be a challenging and arduous process. Often credit scores for both the business and individual owner(s) are important factors in being approved for a real estate loan.
Often these are term loans, such as a Business Mortgage Loan or a Business Construction Loan. Like a home mortgage, these are long-term loans repaid over a period of between 5 and 20 years. There are some lenders who can issue Immediate Term loans to purchase or develop the property with repayment limited to two years or less.
Real estate loans often require a certain Loan-to-Value Ratio, which is the amount of the mortgage divided by the appraised value of the property. The higher the Loan-to-Value Ratio, the more difficult it will be to qualify and the more expensive the loan will cost. In order to offset that ratio, a down payment is often necessary. In addition, the lender will require a lien or other forms of security on the property.
Types of Business Real Estate Funding:
CDC/504 SBA Loan is another government-backed loan, the 504 SBA Loan must be issued through one of over 260 Certified Development Companies (CDC’s) and are almost exclusively designed for fixed assets, such as a real estate purchase or renovation.
While not restricted to real estate, an SBA 7(a) loan guarantee can function as a Business Mortgage Loan backed by the Federal Government’s Small Business Association. SBA 7(a) loans are up to $5 million and can cover up to 90% of the property’s value.
Hard Money Loan or Commercial Bridge Loans are types of short-term funding that allow a business to buy or fix commercial property before refinancing to long-term mortgage. Interest rates are typically between 8% and 13%, but also come with additional fees that often include closing costs.
Traditional Business Mortgages are in many ways similar to a residential mortgage. The big difference is that a Business Mortgage can only be made for commercial properties, which are those that generate income and are often zoned that way. As a residential mortgage, business mortgages require a down payment and are then paid off in equal monthly installments spread out over the mortgage’s term.
Tip: Your town, city or state may have an economic development office with programs to help your manufacturing business succeed. That may involve a program to cover the cost of your down payment, or grants to help upgrade machinery or training.
Equipment or Machinery
Equipment and Machinery Financing can be split into two categories: Rent/Leasing or Equipment Loans.
Renting, Leasing and Equipment loans are common options when shopping for heavy machinery and equipment. The big difference is that a rental or lease agreement is one in which you agree to pay for the use of another company’s property. Meanwhile, a Term Equipment Loan is for the title and ownership of the equipment or machinery. Both types frequently require a down payment and then equal monthly payments for a set period of time.
Where to get them: Term Equipment Loans are offered by a host of different lenders, from large banks to your equipment dealer, local credit unions and alternative lenders. Interest rate and terms are often dependent on your personal and business credit history, and most lenders place a lien on the equipment or machine as collateral.
Cash Flow Shortages
Outside of real estate and big equipment purchases, there are countless reasons a manufacturing business would need additional funds to better manage cash flow.
Cash flow refers to the funds coming in (revenue) and going out (costs). It is inevitable for a business to find itself in a cash flow pinch at some point when revenue falls short of costs and expenses. These cash flow pinches can be caused by accelerated growth in the business, a slow-paying customer, unexpected expenses, natural disasters, or a ramp-up in business where you need to increase labor or make a big material order. But at the end of the day, the mortgage or rent still needs to be paid, payroll needs to be met, and materials ordered.
Many businesses use multiple strategies to overcome cash flow pinches without taking out a loan. Those include:
- Negotiate with customers to get a partial payment up-front.
- Ensure the business has cash reserves in place to get through slow periods
- Communicate with material suppliers or vendors to secure extended payment terms, allowing more time to pay invoices.
- Say no to new revenue opportunities – turning down new business is not what owners typically like to do!
- Sell equity in the business to a new partner who will provide the needed funds.
- TIP: Selling equity is the most expensive type of funding you can ever take out, as it is permanent.
Line of Credit for a Manufacturing Business
If those efforts still won’t cut it, manufacturing business owners should turn to a local credit union or traditional bank and apply for a Traditional Bank Line of Credit. That will allow the business to borrow as needed up to a certain amount (called a Credit Limit) and then make at least the minimum monthly payment until you have the funds to pay it off.
Lines of Credit from a traditional bank or credit union generally have lower interest rates than if secured through an alternative lender, and the business only pays interest on the amount borrowed at one time.
Work In Progress (WIP) Financing
Another option for businesses is to finance their raw material and labor costs associated with the production of orders, referred to as Work In Progress (WIP) Financing. In this loan option, the lender will purchase the needed materials on behalf of the business, which will then create the product. Upon delivery of the product, the customer will pay the lender, which will deduct the cost of the materials plus the interest and financing fees, and then pay the remaining balance to the business. This allows the business to grow and fulfill orders while financing that growth with a portion of their gross margin on the order versus their overall business. This product can also be referred to as Purchase Order (PO) Financing, however, each is slightly different depending on the type of business and its needs.
If a cash flow pinch occurs at the end of the production cycle and outside funding is needed while the business waits on payment for a particular invoice, a good option is to Factor that receivable.
Factoring is when a receivable or invoice is purchased by the factoring company via a direct Assignment of that receivable or invoice from the companies’ customer (referred to as an Account Debtor). The factoring company will advance anywhere between 60% and 90% of the verified invoice amount to the business, and when the factoring company receives payment from the Account Debtor, it will deduct the amount of the advance, plus interest and fees, then send the remaining portion to the business.
Tip: Be aware of the specific terms of the Factoring Agreement. Some companies will charge a flat fee per month (1 – 4%) if the invoice is paid within 30 days, but can go up significantly after 30 days if the payment from the Account Debtor has not been paid yet. If your customer takes too long to pay, that rate hike can be a major dip into your profit margin on the job.
Merchant Cash Advance (MCA)
Merchant Cash Advances (MCAs) are offered by many alternative lending companies around the country. While not specific to manufacturing, MCAs are available to companies that do not necessarily qualify for other lending products.
MCAs are available based almost exclusively on the amount of cash/deposits flowing through the business bank accounts. Funds are generally issued as a lump sum and then the funding provider will begin making daily, weekly or monthly automatic withdrawals (via ACH) from the business account until the receivable advance is paid in full, including all fees and interest.
Typically, MCAs cannot be paid off early. Since this product is a purchase of future receivables typically the entire amount must be paid off in full regardless if the Merchant wants to pay it earlier than the scheduled term.
Funding for Your Manufacturing Business
Whatever type of funding you are looking for, Mobilization Funding is here to help. Our experienced team of professionals can help you to identify the right program or loan to help your manufacturing business achieve its goals, either through our lending program or through one of our trusted funding partners. Contact us today for a free consultation and we’ll help you find the best fit for your business.