A Working Capital Line Should Never Fund Growth

The crane was still parked on the new gravel pad when the first invoice for it landed on my desk, and I remember standing in the yard thinking we had just turned a short term facility into something we would be paying down for years. My name is Rosser Newton, and the draw that funded that pad went out with my blessing, which is exactly why I remember every detail of how it went wrong.

The company was a services business I had backed, the kind that keeps pipe and pressure equipment staged for jobs that can start on four days notice. The revolver existed so the company could buy inventory ahead of a job and collect from the customer afterward, the ordinary gap between spending cash and getting it back. That gap is seasonal and it is predictable, which is exactly why a bank will size a line against it without blinking. Then a piece of ground came open next to the existing yard, priced right, gone in a week if nobody moved. The operator drew $380,000 off the line to grade it, fence it, and pour the pad. Nobody called it a mistake at the time. It felt like speed, and speed is the thing every operator in this business is trained to chase, because the jobs that get staged first are the jobs that get won.

I want to be precise about what the line was actually for before I describe what it became. The company's customers paid on terms that ran forty five to sixty days past delivery, while the inventory sitting in the yard had to be bought and staged weeks before any of that revenue showed up. The revolver bridged exactly that window, dollar for dollar, and it had done so cleanly for six years before the new pad. The bank that extended it reviewed a borrowing base certificate every quarter, tied to receivables and inventory on hand, never to the company's plans. That is a narrow and specific job, and the pad was not that job.

Why Do Companies Draw On A Working Capital Line?

A working capital line exists to smooth the gap between buying inventory or covering payroll and collecting what customers owe, nothing longer than that. It is sized against receivables and inventory, not against the company's future earnings, and a bank renews it every year on that basis alone.

That sizing is the whole point, and it is also the trap. Because the line is revolving, drawing it feels like using a credit card rather than taking on debt, even when the draw has nothing to do with the receivables backing it. I have watched three different operators make this exact leap, each time certain their situation was the exception.

What Happens When A Working Capital Line Funds Growth Instead?

The draw does not get collected back the way a receivable does, so it sits on the balance sheet as debt the company priced like it was free. A year later the bank renews the line against a receivables base that now has to carry both its original job and a permanent new yard.

Here is where I misjudged it. I told myself the pad would pay for its own draw within two quarters once the extra yard space let the crews stage more jobs at once. It did not work that way. The extra jobs came slower than the equipment did, the line stayed drawn through the slow months that followed, and the bank's next renewal came back with a tighter borrowing base precisely because the company's receivables had not grown to match the draw. We spent the better part of a year explaining to our own bank why our short term line carried a long term asset, and no explanation changes what the number on the borrowing base certificate says.

A revolver prices like a utility bill and behaves like a mortgage the moment you draw it for something that will not turn back into cash on its own.

A minimum cash balance would have caught this before the draw went out, which is the entire argument for treating that balance as a covenant rather than a suggestion, a point I made in A Minimum Cash Balance Deserves Covenant Treatment. A board that will not commit to a floor on cash is a board that will eventually discover its working capital line has quietly become its growth capital, with none of the pricing or covenants that growth debt should carry.

The Case For Drawing Anyway

I want to give the other side its full weight, because an experienced director on that same board could have argued against me and had the research to back it up. Small firms often cannot wait for permanent financing to close before a window to expand closes first, and a body of banking research on lines of credit as a source of long term finance has found that firms do legitimately draw revolving credit to fund longer lived investment, provided the draw is refinanced promptly and the covenants are tight enough to force that refinancing rather than let the draw drift. Under that reading, what sank my operator was not the draw itself but the absence of a deadline attached to it.

That argument has real force. A company that refuses every opportunity that requires moving before permanent capital is in hand will lose real growth over the years, and a board that treats the revolver as untouchable on principle is making its own kind of error. The honest answer is that the tool can be used either way, and the difference between the two outcomes is whether anyone wrote down, in advance, how and when the draw would come back out.

My operator never wrote that deadline down. The pad got built, the line stayed drawn, and eighteen months later the company refinanced the whole mess with a term loan that cost more than planning ahead would have. The growth was real. The pricing of it was not.

A working capital line should never fund growth without a refinancing date attached to the draw before the money goes out, not after. That is the rule I would have written on the wall of that yard if I had known to write it before the crane arrived, and it is the one Rosser Newton follows on every board he sits on now.

Stacked steel pipe in an industrial storage yard
Steel beam frame of a structure under construction

Rosser Newton is a Dallas businessman, energy investor, and the author of Richard Coke: Texan.

Photos by engin akyurt and Di on Unsplash.

Sources

Biden Harris Administration Launches Working Capital Pilot Program
Bank Lines of Credit as a Source of Long Term Finance

Comments

Post a Comment

Popular posts from this blog

The Alamo Story Most Visitors Know Is A Front Door

Image
I am Rosser Newton, and I have stood in the courtyard at the Alamo often enough to know exactly which story a new visitor already carries in his head before he reads a single marker. He knows the thirteen days, a line that may never have been drawn, and the ending. He does not know that the mission church he is photographing was a minor building in 1836, that the walled compound covered roughly three acres, or that most of the real fighting happened in the open ground around it rather than inside the walls everyone photographs. For years I treated that gap as a problem to correct. I thought the job of anyone who cares about the fuller record was to walk a visitor past the famous version as quickly as good manners allowed and get him to the material that actually rewards attention, the muster rolls, the land records, the letters written by men who were nowhere near the mission the day it fell. I have changed my mind about that, and the change came from watching which visitors actuall...
Read more

The Order Of A Folder Is Evidence In Its Own Right

Image
I keep a copybook from a nineteenth century Texas household open on my desk more often than I keep any single letter open. On facing pages, in the same hand and the same week, sit a land dispute, a note about a daughter's fever, and a request for a political favor. Nobody sorted those three things apart before they went in the book. They arrived that way because that is the order the week actually happened in. That fact matters more than most researchers give it credit for. I am Rosser Newton, and most of what I write here comes out of two kinds of work that keep running into each other, private investing and archival research for a book on a nineteenth century Texas governor. The habits transfer more directly than people expect. What the arrangement itself tells you A folder, a letter book, or a box of estate papers carries two kinds of information. There is what each document says, and there is what the person who filed them thought belonged together. The second kind rare...
Read more

Fixing A Wrong Historical Marker Without Erasing It

Image
The marker stands at a fence line on a farm road in a county I am not going to name. Cast metal, the state seal at the top, four tight paragraphs of raised capitals. A date in the second paragraph is wrong by three years. I have read the letters and the county papers that cover the month in question, and they do not leave it open to argument. I am Rosser Newton, and I spent a long stretch of years in reading rooms before it occurred to me that a marker is itself a document. Somebody wrote it. Somebody wrote it on a particular afternoon out of whatever a committee could lay hands on. That is the part a visitor never sees. The text arrives cast in metal, bolted to a post, and metal reads as settled. A paragraph that would draw three questions in a footnote draws none at all once it has been poured. Why do historical markers carry wrong dates Most of the errors I have run across are not anybody's fault in the ordinary sense. A marker application gets assembled by people wh...
Read more