A positive relationship between a company and its lender(s) is always a good thing. So, how does one accomplish that?
Let’s begin with what is important to lenders. Simple:
They want to be repaid and they want the terms of the loan agreement honored.
Fundamentally, in assessing repayment risk, lenders look at what they call the “Three Cs” — Cash flow, Collateral, and Character (integrity).
Cash flow
is what pays back the loan.
Collateral
is what lenders seize and sell if cash flow is insufficient to pay back the loan.
Character
is the lender’s confidence that you will do what you agreed to do. It is a combination of integrity and capability.
Lenders also
want the terms and conditions of the loan agreement honored.
So, not just complying with covenant ratios, but timely and accurate reporting as well. It usually also means not taking on additional debt as well as using the bank’s services, such as cash management, credit card processing, and so forth.
Finally, lenders hate surprises.
So don’t surprise them. That means your company needs people and processes in place to see ahead financially. Then the company should keep its lender abreast of what may lie ahead — good and bad.
With that as background,
here are some things
NOT
to do…
DON'T
: Fudge the reporting to the bank (particularly the borrowing base).
Borrowers are often tempted to do this when their company "needs the money."
Unfortunately, this amounts to fraud and once you are caught, your credibility is shot.
And not just with the current lender — any future lender will likely find the misstatement as well during the due diligence process.
One former client of mine, for example, would
"refresh" the invoice date of old, large invoices so they would be current and eligible to borrow on.
Yes, doing so allowed them to live another day, but not many. I came in after the fraud was discovered, but the ramifications continued. The prospective "take out" lender found the fraud in its due diligence and walked away. Ultimately, the company was liquidated in bankruptcy.
In another case, the controller would provide the detail in an Excel spreadsheet for the borrowing base report to the CFO.
The CFO would then manually manipulate the invoice dates.
Once discovered, some of the banks (there were four participating in the loan) filed an involuntary bankruptcy petition and would not fund a full-fledged process to sell the company for maximum value to pay back the lender and other creditors. The PBGC, (the government agency that guarantees pensions), then chased the absentee owner for the unfunded union pension liability.
Remember that
once fraud is discovered,
everyone
in the company is suspect and trust is gone for all.
As the last example shows, that makes it hard to fund a true sale process that maximizes recovery to creditors and minimizes personal liability of owners and officers.
DON'T
:
Provide late or questionable financial reports.
When lenders can't see the numbers, they don't know how your business is doing.
Given their past experiences, they usually assume the worst.
Moreover, they are concerned that
you
might not know where your business is headed either (a real problem). Delays in reporting usually mean the accounting function is understaffed, something which will make a lender assume there are weak controls in place.
A related issue is saying you will have your financial statements audited but then providing a review or, even worse, a compilation.
Once promised an audit, the lender is counting on a strong form of assurance
and will be unsatisfied with something substantially less. Moving from a public accounting firm the lender knows and trusts to a firm no one has ever heard of (perhaps the single-shingle CPA) also contributes to lender worry.
DON'T
:
Take on new debt.
This is a concern for a number of reasons. First,
new debt means that there are fewer dollars to service the older debt.
So default is more likely.
Second, if the new debt is not subordinated, now the lender may have to share the proceeds with the new lender from any liquidation, reducing their recovery and further increasing the odds of default. Yes, debt service covenants may
allow
the additional debt, but that doesn't mean the lender's anxiety level won't rise.
DON'T
:
Use the loan proceeds for non-business purposes or purposes other than agreed to in the loan document.
One client of mine borrowed from the bank and took cash to buy antique cars (he was a collector). The buyer was in the scrap metal business and he called these purchases "scrap." I have also seen companies buy equipment for other businesses and other interests, all outside what was agreed to.
Okay, so don’t do any of those things.
But here are a few things you
should
do:
DO
: Guard your integrity.
This means everything to your lender. Once lost, you may never gain their trust again.
DO
: Invest in your accounting and finance function.
Make sure you have adequate controls in place and are properly staffed to close the books and report in a timely fashion as well as make financial projections.
DO
: Read the loan document (and do what it says).
DO
: Have your financial statements audited or reviewed by a reputable firm.
Unless your loan amount is tiny, this is critical.
Make sure the firm you use is appropriate for your loan size.
If the lenders are national (or simply lenders who are not local), a national name for the auditing firm helps. As you step up in loan size and complexity, one of the Big Four may be worth the money. [More
here
on how to pick the right accounting firm.]
If debating between an audit and a review,
most auditors privately tell me a review isn’t worth the paper it’s printed on,
including their own. However, from a lender’s perspective a review is better than nothing.
DO
: Alert your lender to changes in plans and financial conditions.
Thinking of making an acquisition or buying some equipment? Talk to your lender sooner rather than later. Likewise, if you see storms on the horizon.
Be candid and always tell the lender about the risks, upsides, and downsides.
This way, when something different happens, the lender doesn’t discount your ability to operate.
DO
: Make accurate financial projections.
Be conservative and always project cash flow and the balance sheet, something that most controller types struggle with. Get outside help when needed.
A good relationship with your lenders is always important. Don’t neglect it!
