Is Getting Credit Worth the Effort?

December 03, 2021

A line of credit might be the largest financial commitment of your life, but it can unlock the full potential of your BHPH operation.

The end of summer signifies change. Change in the weather, change in schedules, and change in the scenery. All this change often prompts Buy-Here-Pay-Here dealership owners to begin planning for the year to come. Dealers want to finish the year strong, but they also need to be evaluating their businesses and preparing for the upcoming tax season.

As you’re thinking through your priorities for ending 2021, here are a few questions to consider:

• What can you do today that gives you the best chance for success in the future?
• Do you need to revamp your policies and procedures?
• Where should you focus our staff training efforts?
• Do you have the right inventory for your customers and portfolio? 
• Do you have the right compensation plan for your employees? Do the incentives match your goals?
• Will you have the capital you need to execute your plan?
• Is cash flow holding you back?

In our 15 years working with Buy-Here-Pay-Here dealerships, we’ve seen how constrained cash flow can limit growth. For dealerships that are trying to break through into new locations, expanded inventories, and higher revenues, securing a line of credit can make all the difference. However, getting an LOC can wind up being more of a burden than a boost to business.

So, is it worth it?

Running the Numbers

Over the past decade, changes in the BHPH industry have made it difficult for operators to remain cash-flow positive and profitable.

Generally speaking, vehicles are more expensive, reconditioning costs are rising, and down payments are falling. Those factors, along with increased competition, have led to a significant increase in the average cash in deal.

Using reputable industry benchmarks, let’s look at that impact in terms of dollars for a dealer selling an average of 50 cars per month:

Today, the above business model would require $1,186,200 more in capital annually than was needed in 2011. Add rising operating expenses, longer-term notes and an increase in charge-offs to the equation, and the need for more capital becomes increasingly obvious.

While there are numerous ways owners can raise capital for their businesses, for many, a line of credit has proven to be a fundamentally sound choice. But for a BHPH dealer, that is not always as simple as it sounds.

Traditional lending options such as local banks or credit unions generally do not have an appetite for the BHPH space. And yet, many dealers have been profitable for years, have produce substantial revenue, and operate in full compliance with state and federal regulations.

So why is it challenging to secure traditional financing at low interest rates?

The bottom line is that BHPH dealers tend to sell higher-risk vehicles to higher-risk customers. This produces lending collateral traditional banks often find unappealing.

Without a deep understanding of our industry and without prior experience lending to BHPH dealers, those banks are unlikely to provide capital.

A Beacon of Hope

Thankfully, there are financial institutions that specialize in providing capital to BHPH dealers. They understand the customers, the collateral, and the business model.

While the interest rates and expenses are typically higher than traditional lending sources, these specialized lenders offer the best alternative for providing the capital you need, structured in a way that allows you to succeed.

Best of all, after a few years of solid growth, financial reporting, and portfolio performance, these lenders can provide the bridge to negotiate more favorable loan terms or even “bank rate” financing options.

So how do you get there?

For most dealer principals, a line of credit for your business is the largest financial commitment you will ever make. With it comes significant responsibility to pay attention to the details in all aspects of management – not only of your dealership, but of the loan application process and, ultimately, of the line of credit itself.

To best prepare you and your business for the lender’s due diligence, here’s what you should plan to deliver:

• A loan request letter including the commitment amount, expected initial funding, and a usage plan.
• A company profile including the dealership’s origins and locations, executive and key management bios, your business philosophy, company affiliations such as any state associations or groups you belong to, your unique competitive advantages, an organizational chart, and any business awards or recognition you’ve received.
• Company tax returns (typically for the past two years).
• Business financials including the income statement and balance sheet for the past two years or more.
• A year-to-date company cash flow statement.
• Company bank statements covering the past 90 days.
• Your personal tax returns and financial statements.
• State licenses including selling and finance licenses, if applicable.
• Company formation documents such as articles of incorporation.
• Policy and procedure manuals for all underwriting, collections, and cash controls.
• Static pool loss data (a report generated from your Dealership Management System).
• A direct log-in so the lender can access your Dealership Management System.

All of these required documents should already be part of your standard operating procedures.

Following the delivery of these items, most lending institutions will evaluate the information provided, review the credit history, and analyze the collection performance of your current portfolio of accounts. This will help the lender determine whether your business is a viable fit for its program offerings.

If it is, you will likely receive a Letter of Intent outlining the size, scope, and expenses associated with the line of credit. The LOI will show, for example, an anticipated commitment amount, loan term, interest rate, due diligence fees, and legal expenses.

The document will also spell out any key performance metrics and financial covenants you will be expected to maintain.

Closing the LOC Deal

Once you have negotiated agreeable terms and executed the LOI, most lenders will schedule an on-site visit.

On-site due diligence is important in building a relationship with your lender and ultimately, in receiving credit approval.

The purpose of the on-site visit is to validate the documentation you’ve provided, conduct management interviews and a loan file examination, and complete a payment testing review.

While each step in that process is important, the management interviews are the most vital. Use them as an opportunity to shine a spotlight on your team’s expertise and demonstrate why you will be a solid partner for the lender.

At the conclusion of that process, typically an updated LOI will be delivered to account for any adjustments that needed to be made as a result of due diligence findings. Be sure to have legal representation that understands your business and how the funds will be used and secured.

Once both parties agree on final terms, the closing will typically occur within two to three weeks, depending on the legal team, the lender and other circumstances.

All of this might seem complex and intimidating, but it will be worth the effort.

If your concern is cost versus benefit, reach out to any of the specialty lenders in the BHPH space and ask them about it. They will be happy to assist you in completing your analysis and establishing the value of the capital they provide.