Good lender communications is important.
It minimizes surprises for both parties and facilitates the lender(s) support of your business.
Here is how to go about it…
First Principles
- Demonstrate your financial control of your business and of the lender’s collateral. No surprises.
-
Build trust. Always be honest, of course. Just as important, build trust in your businesses
capabilities
by following the first two principals.
Recommendations
Understand any restrictions regarding what your business
cannot
do, such as borrowing money elsewhere, paying dividends or distributions, and limitations on capital expenditures and acquisitions.
Comply with these restrictions — or seek permission not to.
Put in place the people, processes, and systems needed.
There are two parts to this.
The first is routine and timely reporting.
Typically, there are monthly, quarterly, and annual requirements (sometimes even weekly). If your business takes 45 days after month’s end to produce financial statements, and the lender requires them in 30 days, something has to change — now. Same for CPA-compiled, reviewed, or audited statements. So make sure you have a CPA firm that can
meet your needs
.
Make sure the detail in any report ties out to
all
the reports. For example, total receivables in an aging report should be the same as total receivables on the balance sheet and the same as receivables on a borrowing base calculation. If there is a valid reason for the difference, provide a reconciliation.
The second part requires looking ahead financially
to make sure there will be availability on any credit line and that in the future, ratio-type covenants are met. For short term liquidity, a rolling 13-week
cash flow projection
should be used. Also, do
longer term projections
, making sure to project cash flow, the balance sheet, and the covenants.
And be honest with yourself. Don’t do what one of my clients did and plug sales and margins to meet the projected covenants!
Manage expectations.
The previous section was about working to spot future changes — now make sure to
communicate these changes
with the lender.
Remember: no surprises.
For example, if the lender is already expecting you to ask for an increase in a credit line to support higher sales or request an over advance due to an upcoming period of tight liquidity, they will be more receptive to your company’s needs and already thinking about a solution.
Always outline upsides and downsides when sharing any projections.
That will build credibility should either of these things occur.
Understand the lender’s perspective.
Lenders want to get paid back.
This happens by cash flow from the business, selling the business and/or liquidating the assets, or by a new lender refinancing the company. Once they are concerned that these three ways of payback are at greater risk than when the loan was originated, they rightly get worried and react differently than in other situations. For example, a tax lien has priority over the lender’s liens — the government gets paid first in any sale of the assets or of the entire business and a new lender will reduce the amount it will loan by the amount of the liens.
Lenders also want to get paid for the risk they take.
If your risk profile increases, they will want changes that offset the risk or that compensate them for taking the risk.
Understand which kind of loan you have; there are fundamentally three types: those that lend on the value of the collateral, such as real estate, accounts receivable, inventory, and equipment; those that lend on the cash flow of the business; and a hybrid type that relies on
both
cash flow and asset value (aka, a commercial and industrial [C&I] loan). A tax lien will be a big issue for an asset-based lender or a C&I lender. Less so for a cash flow lender.
Whether your lender is a bank or not also matters.
Banks are regulated in the risks they can take, so a now-unprofitable business is a problem. A non-bank that lends on assets, however, only cares about collateral value, not profitability.
Some Tips…
Respect the relationship.
If you have more than one lender, understand the relationship between them. Who has liens on what collateral and who gets paid first in case of default.
If several lenders are participating in one loan, typically one lender is designated as the agent and is responsible for administering the loan and communicating with the other loan participants. Rarely does it make sense to go around them. The agent has responsibilities to the loan participants and if the agent fails at those responsibilities, they can be on the hook to the other lenders.
Also, if the business agreed to do certain things that pay the lender fees, make sure you do them. For example, if you agreed to use the lender for payroll and cash management or credit card processing, do so.
Be proactive.
When challenges arise, get in front of them. And, when you inform the lender, make sure to also tell them what you are doing about the situation. Keep in mind that what you view as opportunities, the lender may see as challenges. For example, rapid growth usually means rapid increases in working capital that needs to be financed. Depending on the situation, the lender may not be willing to finance all or part of that need.
Report bad news early.
Waiting, particularly if the lender will soon find out, is a great way to undermine trust and damage your relationship with the lender.
One of my clients in such a situation, was scheduled to close a refinancing with a new lender at great terms. On the Friday afternoon before the scheduled close, my client received a surprise notice from the IRS about a significant lien on all assets that had just been filed. Frankly, my client probably could have closed the loan before the lender learned of the lien. Instead, first thing Monday morning, we talked to a special tax accountant, determined it was a common IRS Covid snafu, and developed a plan of action. Then we called the lender. A minor change to the loan documents was made and the loan closed as scheduled. Not surprisingly, this action increased the lender’s trust in my client tremendously.
Understand the difference between
systemic and idiosyncratic events
.
Systemic means everybody, or at least your entire industry. Idiosyncratic means just you — that erodes lender trust in your ability to execute. In the above example, the fact that the IRS lien was a systemic problem mattered.
Be as transparent as necessary, but no more.
While I am a big advocate of transparency with lenders, there is no need to give them a spotlight when a candle or flashlight will do.
Final Thoughts
As with all significant business relationships,
entering into a long term and productive relationship with a lender requires honesty, clear and timely communication, and mutual respect.
Take steps now to ensure that you are adhering to these principles in your lender relationships.
