You need working capital. Sales are slow, a big customer is paying late, and the payments on the term loan are still coming out every month. So you decide you need to add a second lender, to provide a short-term line of credit. The other lender will lend you money, but only if it gets a lien on your assets. And that is where many owners hit a wall they did not know was there. Is there any way you can get secured financing from a second lender?
Blanket UCC-1
Take a 5-year term loan from the bank, secured by everything the borrower owns. This is a “secured loan”. The bank has a lien on everything your business owns. To protect itself, the bank usually files a blanket UCC-1 financing statement. The collateral covered by the UCC-1 includes all the business’ assets, including contract rights and cash. This means that if a second lender comes along and asks for a secured loan, you’re dead in the water. No new lender can make a secured loan until the first lender agrees to step back.
There is one exception. A leasing company or another lender who is financing the purchase of a piece of equipment or a piece of software may file a lien only on that asset. Such items are usually serial numbered, like a tractor.
Subordination and the Intercreditor Agreement
There are two common ways out of this dilemma: subordination and the intercreditor agreement.
Subordination is when the second lender asks the first lender to “let go” of a class of collateral. The most common example is accounts receivable and inventory. Accounts receivable and inventory are called current assets. They can secure a working capital line of credit. If the first lender agrees to let go of the A/R and inventory, it does so by either assigning its interest in that collateral to the second lender, or by terminating its interest in those assets. The second lender then files a new UCC-1 financing statement showing a first lien position on that class of collateral. This is the most common way lenders work together. Usually there is one long-term loan and one short-term line of credit.
In a subordination, the first bank keeps its term loan. It keeps the first lien on all assets except the specified collateral. What it gives up is 1st position on the accounts receivable and inventory (the class of assets that can secure a working capital line of credit). The “old” loan does not have to surrender all the assets. It only gives up a “class” of them for the new loan.
An intercreditor agreement does the same thing, but the lenders “split up” the collateral so each lender has a first lien on its own class of collateral. The structure of the agreement is different: both lenders file a UCC-1. When lenders file a UCC-1, the first lender who files has a superior claim on the collateral. The agreement between the two lenders says that, regardless of those filings, the collateral is split up the way the agreement says. The usual wording in the agreement is the first lender has a first lien on the assets it keeps, and a second lien on the assets given to the second lender. The second lender has a first lien on the assets given up, and often a second lien on the remainder. What if one of the lenders is paid off? The collateral given to the other lender reverts back.
Second lenders generally prefer subordination over intercreditor agreements because intercreditor agreements don’t follow the normal tried and true UCC procedures. Either way, the borrower benefits: now it has access to more credit, and the lenders are working together.
Is a New Loan the Best Thing for the Business
All of that assumes a second loan is the right move. For an owner who is already behind on payments, the real question comes first: is a new loan the best thing for the business, and can I even afford a new loan? How can the company, faced with present financial and payment challenges, keep from “going belly up” on its older loan while also servicing the new loan? The honest answer is that it depends on the situation. If cash flow is weak and the business can’t generate sufficient income to service the debt, adding a second line of credit might just push the problem further along. However, if cash flow and business income are solid and the second credit line will simply allow expansion, then it makes sense. For business owners on shaky financial footing, you need to honestly evaluate your situation and see what it will take to get on solid ground.
If more borrowing will not get you there, the better conversation may be with the creditors you already have. A debt settlement company can help a business come to terms with those already owed. That is the work we do at Delancey Street: our senior advisors negotiate with funders and lenders for less than the full balance owed, and we do not sell another loan.
If you take one thing away from this, it is this: yes, it is possible to get secured financing from a second lender, but unless the first secured lender agrees to “let go” or split the collateral under an intercreditor agreement, a second secured loan will not happen. If you do go that route, identify which class of assets you want the second lender to have a lien on (inventory or accounts receivable are the most common), and ask the second lender how it wants the first lender to step back. And if you are not sure a new loan is the answer at all, talk to us before you sign anything. A first consultation with us is free and confidential, and if a cheaper option exists, we will say so on the first call.
