In a recent Los Angeles Times article titled ‘Bank of America Severing Some Small-Business Credit Lines‘, the issue of Bank of America closing out small business lines of credits was addressed. This brought to mind how many small businesses are victims to this type of financing dealing. This is not new. What is new is the increased number of small business owners being affected by this process.
Credit lines are certainly monitored by banks. Banks keep an eye on all accounts and will check the business and personal credit of its clients from time to time. This is not just a practice by Bank of America, but is common practice amongst banks and other financial institutions. In closing small business lines of credit, the closure rate has increased and it has even impacted the bankruptcy rate of these entities. With so many small business owners being affected by these credit line closures, instead of keeping quiet about it, they are now fighting back.
When small businesses start having financial difficulties or sudden growth, they rely heavily on their personal savings and their available lines of credit. They also tend to go the traditional route of asking family or friends. These are all great ways to raising much needed capital. On the other hand, using a business banking credit line for survival or growth can have positive and negative consequences.
With lending institutions being totally risk averse, they are canceling lines of credit when their small business clients have exceeded the maximum base line usage or ratio the banks have put in place. This ratio varies per bank. It is the reality of banking sector, so expect to see more. What the lenders are monitoring is the business’ debt to income ratio and current spending habits, so do not take on more debt than you can handle.
Who owns the asset?
The problem many small business owners face is that often they do not have any viable assets except their homes and the business’ accounts receivables. These are the primary collaterals many use to gain access to their current credit lines. When banks use the collateral presented, they then file the applicable UCC or UCC1 (Uniform Commercial Code) form with the state. This document notifies all parties that the bank is in 1st position on the business assets, and their accounts receivables. All future creditors will have to get in line behind the bank in the event that the business owner defaults on paying back their credit lines and legal action is required.
Once the bank files this document with the state, the collateral the small business used, such as accounts receivables, cannot be used or pledged in any other financing transaction. In this case, any additional future access to capital will require some other form of collateral to secure the additional financing.
Cash flow challenges
Small business owners will have to take a closer look at how they use their current lines of credit. They also have to address the issue of their business cash flow. When banks start closing lines, it means that the affected businesses are having cash flow difficulties. Oftentimes, the business owner has their business banking account with the same bank as their credit line. Bankers can tell from the business checking account what is going on in and out of your business.
This is the yardstick with which banks measure and project what could happen with the business in the coming months. They are foreseeing upcoming issues with the business’ cash flow. Cash flow issues could result in the business defaulting on paying the line. Due to these issues, the bank can cancel the line.