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Good communications with a company’s lender is always critical to the relationship.
But what exactly is “good lender communications?”
Today’s newsletter answers that question and provides tips on how to do it well.
Lenders want to know three things about you and your business:
#1. Can your business pay back the loan?
Most lenders rely on cash flow for payment. Back-up sources include collateral, accounts receivable, and fixed assets. Even asset-based lenders prefer to get paid by cash flow. So, lenders look at some variation of the
fixed charge coverage ratio
and are also concerned about collateral.
#2. Are you financially on top of your business?
That means from a financial perspective, you know where the business has been and where it is headed.
#3. Can you and your business
be trusted
?
That means doing what you say you will do, always taking the high road, and respecting your business partners (in this case, the lender).
A business’ lender communications should strive to answer those three questions. Doing so requires remaining in financial control of your business.
Not only do lenders want to see this, but without financial control, it is hard to satisfy the lender’s other requirements.
This means…
Have timely, accrual-based financials and review them monthly.
“Timely” means no later than the second week after the fiscal month end.
Any later than that and you can’t react quickly enough each month to have an immediate impact.
Many years ago, in my first controller assignment, financials were reported by noon of the third day after month end — and that was with a
manual
general ledger and the company consolidated results arriving via telex! So, no excuses these days. Of course, the financials should be accurate. (Lenders know they are not when there are lots of month-to-month variances explained as “missed expenses.”)
Have annual GAAP-compliant financial statements prepared that are reviewed — ideally audited — and (at a minimum) compiled by an outside CPA.
Why? In one client situation, the senior lending officer told me he liked the company and the owners, but unless things changed, the loan needed to go. So I brought on a regional CPA firm to audit that year's balance sheet and the next year's financial statements.
That gave the lender confidence in my client's ability to meet its commitments and they agreed to stay in.
Know where your business is headed from a financial perspective.
That starts with the business knowing where it has been — good, timely financials are the starting point.
The income statement, balance sheet, and cash flow should be projected periodically as well as any required covenants in the loan. Lenders will often require an
annual budget or projection
in the loan agreement. Don’t ignore the balance sheet; lenders look at it and it should matter to you, too.
Understand your lender and their position.
Are they a regulated bank or a direct, non-bank lender?
Banks are highly regulated and restricted in what they can do
because most funds they lend are from deposits such as checking accounts and CDs. They fundamentally borrow short and lend long. As such, they are subject to bank runs, which means they don’t take a lot of credit risk and can’t lend very long. So if your business heads south, banks will take actions quicker than a lender that can take more credit risk.
Non-bank lenders are funded by investors with a different time frame and risk appetite.
They can do different things, however their investors have different requirements. It is important to understand exactly what niche they want the lender to lend in — don’t expect them to stray from that.
Respect the relationship.
If you have several lenders, understand the relationship among them.
Who has liens on what collateral and who gets paid first in case of default?
If several lenders are participating in one loan, one of them is typically 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 they fail at those responsibilities, they can be on the hook to the other lenders.
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.
For example, one of my clients was scheduled to close a refinancing with a new lender on great terms. But on the Friday afternoon before the scheduled close, my client received a surprise notice from the IRS about the filing of a significant lien on all assets. 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.
Read the loan agreement.
Yes, it is long and boring. But
the document contains things you agree to do (e.g., reporting deadlines) and agree not to do
(e.g., breaking financial covenants, making unauthorized distributions, acquisitions, not taking out new loans).
Often, the agreement will require that certain services such as deposits, credit card processing, and so forth be done with a particular company or bank. You can’t do what you said you would do (a key element of trust) if you don’t know what the company is supposed to do.
Manage expectations.
Lay out risks going forward, so if they materialize, the lender is not surprised. Be conservative with projections. If you are planning on major changes in your business, tell the lender
before
you make them so they are not alarmed when they occur.
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.
Above all, remember that a loan is both a contractual agreement
and
a relationship. Understand, respect, and perform what your company agreed to do. But don’t forget that lenders are organizations of people, so it is important to build and maintain that relationship.
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