Deal Structures and the Minefields That Can Be Created

Excerpted from "What Every Lender Needs to Know About Working Capital Lending"

If liquid collateral can adequately secure working capital loans, and value and adequacy are relatively easy to determine, then why aren't more lenders creating working capital loans? One of the key reasons lies in the regulations surrounding bankers and how the bankers perceive working capital lending in that regulatory environment.

Asset-based lending, as well as other types of lending, is regulated. You have your direct regulators such as the Department of Treasury (including the IRS), Financial Accounting Standards Board (FASB), and each of the 50 States. In addition, there are indirect regulators and laws that impact lending from the Environmental Protection Agency, Department of Labor, Department of Immigration, Trades and Treaties, the Securities and Exchange Commission, etc., as well as State and Federal laws such as the Uniform Commercial Code (UCC) that are also frequently changing. Understanding all of these regulations is nearly impossible since the regulatory environment is constantly changing. In the last couple of years, we have seen regulations surrounding acts of Congress such as the Sarbanes Oxley Act and the Patriot Act, among others.


New regulations, as well as old, can affect loan portfolios without warning. An improper act by a client, a lack of lender internal controls, and/or ignorance to relevant laws can cause huge losses. Many times the lender is left scratching their head wondering what just happened. Often times the lender is unaware prior to the loss that a particular regulation affected the loan portfolio.

In the working capital arena, compliance is critical and the regulations that are to be chartered through focus mostly around the UCC. Compliance proof is only provided by documentation of visible information. Your working capital loans must be visible and documented for collateral adequacy. The characteristics of the collateral itself must also be verifiable, validated, and marketable. If such were the case, the information you had on hand would be more than adequate to comply with all the current regulations. The key is auditability and traceability.

Auditability and Traceability

Auditability refers to the ability to go in, subsequent to the transaction, and verify that each of the components of the transaction has occurred. Traceability involves the ability to trace a particular transaction through its normal business process. For example, take accounts receivable.

This entire transaction is auditable because the document of the accounts receivable shows that this transaction occurred. It is traceable by being able to determine at what point the receivable was created, when it was submitted, when the buyer created its payable, and when the receivable was ultimately paid. As long as all those steps are auditable and traceable, the visibility necessary for compliance is assured.

This creates what we call a compliance environment. Operating your working capital lending portfolio without a proper compliance environment sets you up for the nightmares you may have heard about or experienced yourself.


It is important and critical for the lender to be able to establish a compliance environment for the lending cycle by making sure that the collateral is adequate and that the visibility regarding regulation is intact. The working capital line ideally should self liquidate keeping it in the compliance environment at all times.