Cash Flow Line of Credit: A Closer Look

Businesses often fall short on cash flow during extended sales cycles, which provokes the urgent need for capital in order to cover short-term working capital expenses. A Cash Flow Line of Credit is a working capital line of credit that covers the period between the purchasing of raw materials until payment is received from a point of sale. 

Quick Breakdown

Capital Type: Cash Flow Line of Credit or Cash Flow Revolver
Typical Use: Finance working capital needs
Funding Mechanism: Can be drawn within covenant limits and repaid at will without any prepayment fees
Security: Senior secured first priority lien
Collateral: Typically, all assets of the company and pledge of equity. In certain circumstances, personal guarantee from the owner of the business may be required
Payment Priority: Usually first to be repaid from the proceeds of liquidation of its collateral. When paired with another debt facility with a first lien on the same collateral, will be repaid in equal proportion, or ratably, with other first lien debt

Who Should Consider a Cash Flow Based Lending? 

Businesses with the following attributes are strong candidates for a cash flow line of credit: 

  • EBITDA greater than $7MM – $10MM, and ideally above $15MM
  • Stable, largely predictive cash flows, and a demonstrable track record of consistent financial performance
  • Ample liquidity, whereby the use of the line of credit is largely limited to support working capital needs
  • Senior debt to EBITDA ratio of less than 2.5x. Under most circumstances, total debt to EBITDA ratio of less than 3.5x unless paired with a term loan provided by a direct lender for a PE lead transaction. 

Advantages of Cash Flow Based Lending

  • Low Cost: When comparing interest rates across debt products, cash flow lines of credit are a relatively cheap form of debt capital
  • Flexible Terms: The aforementioned ability of borrowers to pay back their outstanding balances either all at once or over a period of time, adds a measure of flexibility that many borrowers appreciate
  • Low Maintenance: Reporting obligations are limited–typically to company financials and the Revolver’s covenant compliance certificates
  • Competitive Market: Revolving lines of credit are a well-established capital type provided by virtually every bank, leading to a plethora of choices and efficient pricing for capital seekers

Drawbacks of Cash Flow Based Lending

  • Stepping Stone: Lenders often issue cash flow lines of credit as a first step to other forms of business, such as cash management or depository relationships. So expect a lot of correspondence from your lender, as they seek to drum up additional business
  • Commitment Fees: As mentioned above, lenders often try to tack on commitment fees to this otherwise cheap form of capital
  • Limited Structural Flexibility: Cash flow based lending maintains a low profile on the debt capital markets totem pole. As such, don’t expect too much structural flexibility from your lender. This is a straightforward, meat-and-potatoes form of lending

Underwriting Process for a Cash Flow Line of Credit

Below are the underwriting process and maintenance requirements for a cash flow line of credit:

Capital Providers: Banks
Underwriting Thesis: Recovery through ongoing cash flow generation of Capital Seeker, or through refinancing. In distressed situation, recovery through sale of Capital seeker as an ongoing concern
Underwriting Focus: Confirmation of business’ ability to consistently generate cash flow and repay debt, liquidity in the business at the time of funding and the ability of owner or sponsor to inject additional equity in the event of distress

Underwriting Process:

  1. Typical credit underwriting process focuses on the ability of the business to generate consistent cash flows and risks that may disrupt consistent cash flow generation. Underwriting involves analysis of business model, competitive dynamics, customer base and commercial terms, ownership history, historical financial performance as well as financial projections, operations and background of key stakeholders, including key executives
  2. Some banks may want to conduct a collateral exam to review and analyze accounts receivable performance, inventory records and record keeping systems
  3. Analysis of owner’s personal financial condition may be required when personal guaranty from the principal owner(s) of certain smaller businesses is supporting the credit

Financial Covenants:   Most commonly, leverage ratios (senior secured debt to EBITDA and total debt to EBITDA), fixed charge coverage ratio and minimum net worth requirement. Less frequently, maximum capital expenditures and interest coverage, typically measured and reported quarterly
Ongoing Reporting: Company prepared unaudited monthly financials, audited annual financials and annual financial projections.

Learn More

If you’re interested in obtaining a cash flow line of credit, and you would like to discover the benefits of expanding your lender outreach to ensure the lowest cost of capital, please click the button below to speak with one of our debt experts.

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