A simple question indeed – yet one without an equally simple answer. This said, there are generally a few basic questions that can help answer this question. A little set up to begin.
Since most commercial contracts are for goods or services in return for a specified price, the payment owed typically does not become due and payable until the goods or services are properly delivered to the customer in a satisfactory manner. This means that any associated invoice only becomes bona fide – and indeed genuine collateral – once the product is delivered or the work is complete.
These standard types of contractual arrangements are typically not able to be financed stand alone – rather the resulting invoice is the financeable asset once it becomes bona fide (i.e. product or service is delivered).
You may ask – “How can this be right? I am aware of several situations where a loan has been extended against a signed contract.”
While nothing of course is impossible in a world where humans make lending decisions, typically something else is in play when a standard type contract is being “financed” – including, other collateral is being pledged to the loan, a corporate or personal guaranty is being offered, etc.
To the extent these other items are involved it is less accurate to suggest that the contract is being “financed” – rather that the lender is providing a loan to help fulfill on the contract and is really relying on other collateral pledged and/or strength of the corporate / personal guaranty to make the loan credit worthy.
On their surface these distinctions may not seem relevant in any particular case – you either received the loan or you did not – seems as simple as that – right? Well yes – we agree – and we offer the above explanation only to help those who have been denied a loan based on a contract understand why.
So what are the questions to help better understand if your particular commercial contract can be financed? If you answer “Yes” to any of the following questions, you may have a chance at this type of financing:
- Can you pledge other unencumbered assets equal to the loan size?
- Does the borrowing company have a strong financial history and current profile and is that entity willing and able to guaranty the loan?
- Does the company owner have a strong financial history and current profile and is that individual willing and able to guaranty the loan?
If the answer to all of the questions above is “No” or “Not really”, it is not likely to matter much if other seemingly relevant facts and circumstances might appear mitigating. Below are a couple of examples of “reasons” that really do not have material bearing on the loan decision:
- The contract is with the federal / state government or a multinational corporation.
Although these entities are highly credit worthy, their obligation to pay only become effective once the good or service has been properly delivered – at which time there is a financeable invoice.
- This is a service agreement and is due and payable every month whether or not any work is actually performed during that month.
Although you may not perform any work in a given month, you are typically obligated to do so if required by the client – so there is generally a performance obligation for the fee to be earned. This said, many lenders (us included) will give material cash flow credit to future income streams that are highly predictable.
Hope this helps clarify a little. As ever, we would be happy to discuss your individual situation in person and in detail. Good luck and happy contracting.