Business Borrowers Should Consider BOTH Traditional and Alternative Lenders
By Kenneth P. Easton, Jr.
“Rules” to business borrowing! An interesting concept. True — the “rules” presented below may be considered as act-on “options”. But the consequences of not being aware of these options, achieving a successful business loan program, can be costly to your business, your fortune and your peace of mind.
“Rules” are actions businesses should adopt ensuring they obtain the best arrangements with their current lender; in good times or in worst case scenarios. These rules also apply to a new or replacement lender (whether the move is voluntary or forced by circumstances).
Observation: There is a great diversity of lenders out there — which one (or two) will be best for you? Only a few can address your specific needs or situation. However, your search process may well determine not only the success and costs of your quest, but the duration —from 30 days to possibly a year or more. No one needs that kind of a hold up.
Know Your Money Sources
The “Traditional Lenders” are commercial banks and thrift institutions (savings banks) that continue to be the most utilized sources. Many stop there simply hopeful for the best deal — unaware of the many, and probably more appropriate, alternatives. Frequently, physical convenience dictates choice — not relevant in this “connected” age. You want the best deal, not the shortest walk. These “mainstream” or “prime” lenders offer: standard loan products; rather inflexible loan structures; unattractive pricing options; and “boilerplate” loan covenants. Neither too receptive nor creative. There are, of course, unique exceptions; especially within “community banks”. Tough credit situations or specialized loan needs are best left to alternative lenders.
“Alternative Lenders” offer wide spectrums of business loans; meeting unique needs and quick turnaround requirements. Many larger credit unions offer business loans. Business membership (a requirement) usually happens at the loan closing. As with most alternative lenders, they are staffed with seasoned business lenders from banks and other alternative lenders. Most offer quick turnaround, access to decision makers with many dedicated to assisting the more difficult credit requirements. Other “Alternatives” include independent and specialized finance companies, divisions or captives of industrial or insurance companies, or even subsidiaries of some banks. Do not forget state and municipal loan programs.
Alternative loan sources may offer a variety of specialization, to include traditional loan programs:
• receivable and inventory financing
• equipment loans and leasing programs
• seasonal inventory loan advances
• purchase order financing (including government contracts)
• invoice financing (factoring)
• letters of credit
• loans to hospitality / health care businesses
• real estate / investment property mortgages
• mezzanine (quasi-capital) lending
• purchase a business
Let’s consider the first three of our Six Rules of Business Borrowing. Within each we highlight important action points. The remaining rules will be presented within the next issue of Home Business Magazine.
Rule #1: Negotiate
Loan Structures: Would a Line of Credit serve you better than a Term or Demand Loan? It’s about the flexibilities you need (not the lender). How about a combination of each? Ensure you know about loan maturities, balloon payments, grace periods, and unwanted prepayment penalties. Negotiate flexible loan covenants that work for you… Loan provisions should enable you to take funds out of your company for health or family educational requirements. What about salary increases, bonuses or unexpected personal loans from the business? Are checking accounts permissible in other institutions? What about restrictive equipment purchases and leasing covenants? What triggers a loan default? What are the default “cures” — how long do you have to fix it?
Collateral: Don’t automatically agree to “all assets” as lender’s collateral when only selective components would suffice. You may need the leverage of unencumbered collateral later. Lender must prove the reasonableness of eligible collateral (assets qualified to borrow against) and collateral advance rates. They keep it low — you must strive for the maximum borrowing potential — now and for the future. Enhance collateral eligibility via insurance, frequent receivables and inventory clean-ups, and accelerated reporting.
Guarantees: Never offer a full personal guarantee when a limited will do. Negotiate limited guarantee amounts, duration, joint and several. Resist collateralization of guarantees by your personal residence. Negotiate (and lender must document) the conditions under which guarantees will be reduced or released altogether. Would the SBA or other third party guarantors be available and beneficial to your needs?
Interest Rate / Loan Payments: Will fixed or variable rates best benefit your situation? You must know and challenge rates and fees when they appear unreasonable. Lenders can be quite flexible if you are adamant. What are your payment options and grace periods? Be careful on automatic charging of your checking account for loan payments. You must control loan payments (cash flow) — not your lender — to maintain flexibility.
Fees & Costs: Most all fees are, and should be, negotiable. These include legal, lender fees and loan closing costs. Apply fees and costs to your loan balance to ease cash flow immediately following loan closing. What are the prepayment penalties, calculations, and duration? There is much room here for successful negotiations.
Reporting Requirements: Understand the types and frequencies of required financial reporting. These may include interim performance reports, year-end financial statements, and periodic collateral reports. Are certified financial statements really required? Depending on the loan size, and accounting costs to you, the less expensive Reviewed or Compilation statements may suffice. Get specifics on appraisals and environmental inspection requirements — are they required within the loan agreement? Work for “up dates” rather than new appraisals — again less expensive. Make sure your lender gets at least three bids for new appraisals — and you want to see them.
Rule # #2: Benchmark
Loan Covenants: Have the lender establish parameters — the conditions under which your loan covenants can be modified. Likewise, document under what circumstances a lender’s limitations on salaries, officer loans (and bonuses) and capital purchases can be improved. It is imperative that the lender document understandings, on letterhead, copying you.
Collateral Advance Rates: Following the lender’s experience with the borrower (six months to a year) specifically when will collateral advance rates and eligible collateral be re-evaluated? Lender changes should be sought following improvements in business performance, receivables agings, and inventory quantity and quality. Your efforts here can improve cash flow (more loan availability).
Guarantees: Determine, on a continuing basis, when guarantees may be further Limited and/or released based upon your collateral and/or business performance. You should especially press the lender when a personal residence is backing up your guarantee.
Interest Rates, Fees & Costs: Continue to challenge all fees and expenses — at least semi-annually. They may not have changed since your loan closing — and a lender usually is not going to volunteer. If a forbearance fee (loan in trouble) is sought by the lender, seriously work to reduce or eliminate. These fees are large and are substantially a “blue-sky” lender fee — ripe for negotiations.
Performance Expectations: Qualify financial forecasts. Input the caveat, “Financial forecasts are subject to a 5% – 15% variance due to conditions beyond our control.” (Percentages are samples.) Cut yourself some slack. While lenders may seek to hold you to specific numbers, this caveat is to your benefit (flexibility). Confirm with your accountant.
Rule # 3: Communicate
Whether or not it is required — provide lenders with periodic (monthly?) reports as to business progress, new products, customers, personnel, awards, and highlighting possible future needs. Start lender’s subscription to your industry publication — good relationship management.
Provide similar reporting to your partners, guarantors, and select customers and suppliers. Include your attorney, accountant and board in significant business and financial activities.
There should be no surprises for your lender! Inform them before the fact of potential late payments or pertinent financial difficulties. But first, seek advice from your legal counsel as to the extent of information provided.
Know your loan officer’s assistant and superior’s name, title, cell phone, and e-mail address. These may be valuable emergency contacts.
Part II of “The Six Rules of Business Borrowings” continues next issue, dealing with business borrowers’ danger signals, taking charge of your business debt, and maintaining credibility. HBM
Ken Easton has over 40 years of business finance experience and is a business finance consultant to both businesses and commercial lenders. He is the author of “$urviving Your Business Debt”. Amazon 5-stars. His book instructs businesses how to survive everyday financial challenges as well as the most difficult of financial scenarios. He is the principal of The Easton Group, LLC, Manchester, NH, a consultant, seminar leader, and keynote speaker. Visit the website at www.SurvivingYourBusinessDebt.com. E-mail Ken at firstname.lastname@example.org or call direct at (603) 533-1935.
Previously published on page 44 in the December 2009 issue of HOME BUSINESS® Magazine, an international publication for the growing and dynamic home-based market. Available on newsstands, in bookstores and chain stores, and via subscriptions ($19.00 for 1 year, six issues). Visit www.homebusinessmag.com