Can refinancing proceeds pay off past-due vendor payables?

How a lender reads a stretched AP aging

An accounts payable aging lists what the business owes each supplier, split into columns by how old each invoice is: current, then each month past due. Owners tend to look at the total. A lender looks at the shape, because the aging is the one report that shows how much of the business is being financed by its suppliers without anyone having agreed to it.

• Payment days against terms. A business on net 30 terms that pays at 75 days is borrowing from its vendors for 45 days on every invoice. The lender compares what the balance sheet says the business owes to what it buys, and asks how far behind that puts it.
• Who is aged. A disputed invoice with a minor vendor is noise. The one supplier whose product the business cannot operate without, sitting in the oldest column, is a risk to the earnings the lender is lending against.
• The trend. An aging that has been stretching month by month tells a different story from one that spiked once and is recovering.
• The tie-out. The aging total should match accounts payable on the balance sheet. Where it does not, the lender asks what is missing, and accrued but unbilled items often turn up.

The lender is also looking for the point at which trade credit has quietly become debt. The signs are specific: a vendor has converted an old balance into a promissory note; invoices carry interest or late charges; the vendor has moved the business to cash on delivery or cash in advance for new orders; a balance has not moved in months; a vendor has sued, obtained a judgment or filed a lien; or the owner has personally guaranteed a supplier account. Any of those turns an operating liability into something a lender will count as funded debt, with its payments included in debt service coverage.

Payables to tax authorities are a separate problem with separate rules, because the government's claims can outrank a lender's lien. See unpaid payroll taxes and IRS tax liens.

When a lender will use proceeds to bring vendors current

Paying past-due suppliers is a legitimate use of refinance proceeds, and lenders fund it regularly. What they need to believe is that the money fixes a problem that has ended, rather than filling a hole that will open again.

• A cause that has passed. A customer that paid very late or failed, a one-time loss, a growth spurt financed out of payables, a line of credit the bank cut or froze, or cash-advance debits that drained the account, now being refinanced as in a cash-advance refinance.
• Earnings that carry both. The business has to cover the new loan's payments and pay vendors on terms going forward. A refinance that brings vendors current but leaves no room to keep them current will be back where it started within a few months.
• Money that reaches the vendors. Lenders usually pay the named suppliers directly at closing, from current vendor statements, rather than wiring the amount to the borrower. Some ask for a letter from each major vendor confirming the account is current and terms are restored.
• Priority to the suppliers that matter. Proceeds go first to the vendors whose supply the earnings depend on. A lender is far more willing to fund bringing a critical supplier current than to clear every aged invoice on the report.

Payables carry no collateral of their own, so the loan that pays them is secured by the business's other assets or lent against its cash flow. An asset-based lender can reach the same result another way: a new line sized to receivables and inventory creates availability that pays the vendors down. Asset-based lenders typically advance 80% to 90% of eligible receivables; see how a borrowing base works.

How it shows up in sources and uses, and in working capital

In a refinance, the vendor payments appear as their own line in the sources and uses, next to the loans being paid off. In this example, a business refinances a bank term loan and an equipment note and brings three key suppliers current.

The effect on the balance sheet is where the lender's attention goes next.

Working capital went from nothing to about 570, and the business did not earn a dollar of it. The past-due payables moved from current liabilities to long-term debt, and the new loan's longer schedule shrank the current portion. That is a real improvement: suppliers are paid on terms, credit holds come off, and a current ratio covenant becomes passable. But total debt rose by 550, the payables plus the closing costs and the cash left on the balance sheet, and the lender will test that debt against earnings. Senior cash-flow lenders to lower-middle-market companies commonly lend 2x to 3.5x EBITDA; see how much debt a business can carry.

One structural question comes first. If the payables stretched because the business is growing and its receivables and inventory are growing with it, the gap is permanent working capital, and a term loan is the wrong tool: it will be paid down while the need keeps growing. A revolving line fits that shape better; see sizing a working capital line and line of credit vs term loan.

The alternative: a payment plan with the vendors

Not every aged balance needs a lender. Suppliers generally prefer a customer who keeps buying and pays down the old balance on schedule to one who stops buying, and many will agree to a written plan.

A plan that holds up needs to be in writing: the old balance, the installment schedule, the vendor's commitment to ship on stated terms for new orders while the plan is kept, no further late charges if payments are on time, and the release of any lawsuit or lien once the balance is paid. A lender refinancing later will ask for the plan documents and proof it is being kept, and where a vendor holds a note, may require a subordination agreement.

The two routes combine well. Refinance proceeds can bring the few critical suppliers current, while written plans handle the rest.

What a lender will not fund

• Payables run up by ongoing losses. If the business is still losing money, paying vendors with borrowed money only moves the shortfall to the lender.
• Disputed balances. Settle the dispute first; a lender will not pay an amount the business says it does not owe.
• Payables to related companies. Amounts owed to the owner's other businesses are treated like owner loans, and most lenders will not repay them with new debt. See shareholder loans in a refinance.
• Payables that funded distributions. If vendors went unpaid while cash went to the owners, the lender will read the refinance as funding a distribution. SBA loan proceeds cannot fund a distribution to owners, or refinance debt that did, and conventional lenders take a similar view.

Preparing the file

For a conventional term loan the AP aging is sometimes optional. When proceeds are going to vendors, it is the center of the file. What to have ready:

• P&L and balance sheet, and a year-to-date P&L through last month-end.
• An AP aging by vendor, with invoice ages and each vendor's stated terms.
• Current statements from each vendor to be paid at closing.
• Any vendor notes, payment plans, lawsuits or liens, with their current status.
• A short list of the key suppliers and what the business buys from each.
• A debt schedule covering every loan, lease and advance.
• A plain account of how the payables fell behind and what has changed since.

Transparent's financing model carries the vendor payments through sources and uses and the pro forma balance sheet, so the lender sees working capital and leverage after closing on the same page as the request. See the package and how we underwrite.