The Trouble With Financing Government Contracts
by James Parker, LEONID Co-Founder
Finding, bidding on, and winning a government contract can be a powerful boost for any company. These contracts can raise your profile in your sector, Aerospace & Defense, Education, and Agriculture, enabling you to win new clients. In addition, they can help increase your projected earnings and overall revenue. But for small to medium-scale innovators looking to make a difference in the world, becoming a government contractor can come with genuine financial difficulties.
The Trouble with Government Contract Financing is pretty straightforward:
Traditional banks won’t finance government contracts for a few key reasons.
- The US government can cancel a contract at any moment, with no penalty and a 30-day notice. In short, no bank wants to loan out 5 -year money against a 3-year contract that could be canceled on Tuesday.
- Traditional banks have high minimum and long terms. Larger banks don’t want to write loans less than $5 Million and/or for less than 5 years. Even then, they want to see asset/collateral coverage (i.e., cash, real estate, or accounts receivable) in excess of the loan amount (i.e., they only loan to people that don’t need it) – which makes it a poor fit for any emerging government contractor or those working on shorter contracts.
- Banks worry about the “collectability” of their collateral. In other words, “ we can’t force the government to pay us if you default.” There are so many things wrong with this perspective that it is not even worth discussing.
- Personal Guarantees – Banks will often require personal guarantees as excess collateral for any transaction that is not right down the fairway. What’s a personal guarantee? It’s a pledge from the government contractor principals that if the company can’t repay the loan, the bank will recuperate its capital by requiring the signers to cover any shortfall personally. Personal Guarantees are a considerable concern for owners and principals, especially if they have other significant shareholders.
The above reasons have traditionally left government contractors with one financing option: Factoring.
What is Government Invoice Factoring?
Quite simply, it is selling your verified accounts receivable ahead of collection, accelerating the payment cycle. Government Invoice Factoring is a traditional working capital cycle solution, and it can be helpful if your company has payroll cycle/collections disconnects or one-off tactical shortfalls.
A traditional government factoring arrangement will include the following:
- An advance rate- the amount you get paid upfront.
- A reserve- the amount held back to cover the borrowing fees after collection.
- A daily rate- is charged against the face value of the invoice.
- Other fees and terms- most come with fees, long-term contracts, and a miscellaneous fee schedule that you will have to take into account when determining your final cost of capital.
The downside of invoice factoring is the following:
- You have to have earned-but-unbilled (at best) a submitted
- A business must have a confirmed invoice (at worst) to finance
So, you are only really solving the 30-60 day payment delay, not securing capital to make long-term strategic investments.
So, what’s the solution?
This is where government contract financing companies like LEONID come in. As former engineering government contractors turned finance wonks, we recognized the shortfalls in the system and built a better suite of products to help small-to-medium-sized government contractors.
The key thing we do is take a company’s contracts and use them to size (50-75% LTVs) and structure a government contract financing solution, and then use those contracts as vehicles for repayment. What does this mean? It means you don’t make payments until you get paid on those contracts – no monthly debt service or mortgage headaches. And best of all – no personal guarantees.
Our Government Contract Financing Structure:
Government Contract Term Loans– Single lump sum loans, paid back over the line, based on the total remaining value of your signed government contracts. Best use for companies with capital needs above $500K that are looking to make strategic investments.
Government Contract Revolving Lines of Credit – A credit line that allows you to borrow up to a certain amount of the remaining value of your government contracts. You can use these like a credit card, take some capital down as you need it, and pay some back as you feel like it. Under $500K, best used as a flexible working capital solution.
Government Invoice Factoring– And yes, Factoring. But Factoring without the strings. 90% advance rates, one daily fee rate, no long-term commitments, and no schedule of excess ticky-tack fees. Best used for those with temporary needs or anyone with long-term commitment issues.
For more information, contact us online or call (562) 548-4399 to speak to one of our government contract finance experts.