Business plans are taken as a given for raising equity money.  That is not the case for raising bank debt.  Far too often, a forecast is done and sent along with historical numbers and tax returns.  Maybe some product brochures or other company information is passed along.  That becomes the bank package.

The rest is covered in meetings, if you get that far with a prospective bank.  The banker then does his internal write-up to present the opportunity within the bank.

An opportunity is missed by not having a business plan.  You miss a great opportunity to market your company more effectively and stand out from the crowd.

Suppose you get that.  You are prepared to do a business plan for the prospective banks.  You wonder, how much should you put into it?

You want to put a good plan together, but recognize the role of the business plan.  It has its limits.  The goal of the business is not to get you the loan.  Nobody is going to read the plan and give you a loan site unseen.

The goal of the business plan is to get you the next meeting.  

It is similar to what a job seeker faces.  She needs a resume.  However, the resume by itself will not land her a job.  

Keep that in perspective.  Have a plan together.  Make it a good one.  But then let it go.  It is art, not science.  It will not be perfect.  That’s OK.

I have seen companies pour heart and soul into a business plan.  That is good, but not when it’s overdone:

• The markets could dry up or get more expensive while you are perfecting your plan.  A deal that could have gotten done with a good plan a couple months before can get shot down even though a perfect plan a couple months later.  If not slammed shut, it could cost you big interest, 100 basis points or more.

• Lots of management time is tied up producing the plan instead of running the business.

• No matter how great a plan is, you almost always pick up new ideas on the plan and presentation after talking to a couple banks.  It’s never perfect until it has been out there, field tested and refined.

Timing matters.  Make sure you aren’t so busy in the back room that you miss the timing in the market or chew up major chunks of your own time.

If there is one lesson that stands out from 2008 about banking, it can be summed up in one word- timing.

Equity markets have been thought to have more peaks and valleys.  IPO, private equity, angel and other equity markets can be feast or famine.  

But banks had always been thought to be in the market.  If you had a good enough company, there would almost always be some bank at some level willing to finance you.

That changed in 2008.  By the fall, the market had mostly dried up.  Deals that could breeze through committee during the summer were now getting early turndowns.  Many banks just effectively shut down new lending for the rest of the year.  Many turned their focus inward, making sure they were covered OK with their current portfolio.  They were busier trying to see who might be the next problem account that might move into workout.  They may have been heavy in some sectors that really went south like real estate or retail.

Others were waiting on the government.  Should they apply for TARP money?  Then it turned into a rush.  The money from the government was going to be cheap.  They might as well go for it.  Besides, if they did not get TARP money, it might be a signal that something was wrong.  TARP became like a Good Housekeeping or Underwriter’s Laboratory seal of approval.

Getting TARP was no guarantee a bank would loan money.  While TARP could be an accelerator, there was a brake being applied as well- uncertainly about reserve requirements.  It became like driving a car with your foot on the accelerator and the brake at the same time.

It did not dry up completely.  Some loans were still getting made.  A few, but not many banks were still in the game.  But the criteria stepped up and the rates went higher.  

If looking for new bank money, you might have to go out sooner, if the market is still open.  I know a company that went out in the fall of 2008.  If they had gone out in the summer, it would have been an easier deal.

If you have a loan coming up for renewal, consider negotiating earlier, if it looks like your renewal might come in at a bad time.  Companies whose loans came up in late 2008 or early/mid 2009 certainly fall in that boat.  If they have waited, they may be in for a tough renewal and have to hit the street at one of the worst times ever. 

If you have a large enough bank transaction, such as $15 million or more, you may think you are done when you have one bank that has given you a term sheet which you agree to.

There may be another step.  If the deal is large enough, the lead bank may find a second bank or multiple banks to take part in the credit.  The lead bank may still be the one you deal with day to day.  However, before the deal gets done, the other bank(s) have to agree to the credit and the terms.  The lead bank in other words, is syndicating part of the deal to another bank.

It could be a good thing.  The other bank may bring in additional services or talent that the first bank does not have.  For example, maybe the lead bank does not offer as much in treasury services.  The second bank might be the one where you end up having your deposit, lockbox and other accounts.

The second bank may have other talents that the lead bank does not have.  They have more experience in the industry.  They may have branches and connections in other markets, including international, where the lead bank does not.

Why do banks syndicate?  One reason is to share the risk.  Another is to bring in more capital, which allows them to spread the capital they have to more deals.  A third reason can be give and take.  Syndication can be two ways.  I will let you have a piece of this deal and you will let me have a piece of one of yours.  We both get to hedge our risks without the time and management drain of always being the lead bank.

As a client, there are risks with syndication.  It usually can mean another set of questions during the due diligence process.  It can be additional documents you have to sign at closing.  There is another bank that you have to report to.

Perhaps even more significant is the credit risk.  Something could happen at the second bank.  They may decide not to renew when your loan comes up.  Or you may trip a covenant and the second bank may hold a hard line and not be as flexible.

So what do you do when looking for a bank loan?  First, know the legal lending limit and the effective lending limit of the bank.  A bank could have a legal limit of $40MM, but decide that they will only go up to $15MM.  Second, as you get deeper into discussions about their term sheet, ask them if they intend to syndicate part of the loan and if so, how much and to whom.  It should be out in the open.

Syndication has its benefits but as in most things, there is a corresponding risk.  Ask and know what you are getting into.  It is not a bad thing and can help a deal get done that might not otherwise take place, especially in tight markets.

Also realize the market may be shrinking.  I heard a talk where someone said that 57 is now 13.  In other words, the number of banks has fallen dramatically, so there are fewer avenues to syndicate.  It is an interesting dynamic.  On the one hand, banks may be working together on one deal.  But on another deal, they could be competing against each other.  As a result, banks will tend to be selective who they syndicate to.

The year is over and you probably have finished your income statement, balance sheet and perhaps even a cash flow statement.

Those are all good for your bank to see.  There is another schedule to prepare that could also help you toot your horn.

It is looking at it from the bank’s eyes.  How well do you do for the bank(s) last year?

• How much bank debt did you pay down?

• How is the cushion on your borrowing base?  Did it go up or down?

• How did you do on your covenants?  Did you build up cushion or did they get tighter?

• How much cash or other funds are invested with them?  Did this go up or down?

• What did they earn in interest expense, points, or unused line fees?

• What type of bank fees did they earn from treasury services?  Remember to include all sources, such as merchant accounts for your credit card receipts you collect from customers.

• What other types of fees did they earn?  For example, there may be inventory appraisals, audit fees or other non-treasury fees.

It is a good exercise to go through.  It can be eye opening to see how much is going on with your bank.  If you are splitting your services, it can help you assess if you need to consolidate or move some services around.

It’s good to show your bank too.  You earn points for showing that you look at things like they do.  If you have some results to show, you might as well take credit for it.  For example, maybe this past year you paid off more debt than any prior year.  In a year when many companies ran into default with their banks, that would be something to crow about.

If you are like most companies, you have are a calendar year end firm.  You are finishing up your year end numbers.  You may spend a little extra time since it is year end.  You may also have an audit or review scheduled with outside auditors.

You get the year end done and then send the numbers off to your bankers.  You may also pass along your projection for the new year, trued up to tie out with your year end numbers.

Then you are done, right?

If you think so, you are missing out on a golden opportunity.  Now is the chance to show your stuff with your bank team.  Get all of them together, from both the loan and the treasury side, along with the members of your team.

Two reasons it works so well now:

1. One year has finished and a new year has begun.  It is a good break point to highlight the old and ring in the new.

2. You are doing it before you need it.  Bankers like to hear from clients on a regular basis, not just when clients need more money or are in danger of crashing covenants.  It makes a psychological deposit that you can cash in later when you need it.  Otherwise, if you wait until you have to talk to your banker, your well could be dry.

You might be surprised how few firms do this.  Often if it gets done, it is only because the banker requests it.

By taking the initiative, you are already one leg up.  Combine it with a great presentation and you could become one of the stars in their portfolio.

I have a client that does this every year.  The bank always appreciates it- it draws the entire team that services the account.  And the bank inevitably closes by saying the client is one of the best run clients that the bank has.

Take the initiative.  Reach out to your bank after year end.  Then when you really need them later, they will be more available for you.  They will be more likely to go to bat for you.

Sometimes provisions in bank agreements with good intentions can end up having unintended consequences.

For example, a client had a clause in their bank agreement that would reduce the inventory portion of their borrowing base if their inventory fell below 90% of the latest inventory appraisal.

The intentions were good.  The bank did not want the company just liquidating inventory in order to keep up with payments on the bank loans.  They wanted to see that payments were coming from real operating performance.

But what if the company put stronger inventory management practices in place?  That happened with this client.  They launched a number of operating improvements that allowed them to operate at the same level of business with lower inventory.

In addition, what if revenues were down?   Shouldn’t the company want to reduce its inventory levels and keep up its cash flow?  What if there is a market like 2008 and 2009 where business is just down in general?   Wouldn’t it be prudent for the company to reduce its inventory levels?

The bank agreement was meant to discourage artificial liquidations.  However, like a medicine with side effects, this clause by itself would encourage the company to keep inventory levels higher than they ought to be.

In this example, the company went ahead and reduced its inventory.  It helped their cash flow tremendously, without lowering their customer service level.  They could still respond just as quickly if not more quickly to customer orders.  Yet despite this, they still had to reduce their borrowing base for the penalty clause in the bank agreement.  It felt like being punished for being good.

Before signing a bank agreement, take a close look at the provisions.  In addition to the covenants, take a close look at the borrowing base calculations on your revolver.  If something does not seem to make sense, ask the banker why it is there.  Maybe there is an alternative version of the clause that can be put in.  Test the provisions with both sales growth and sales declines.  See what happens and if any unintended results can occur.

If you are already in a bank agreement and spot something similar, see if you can renegotiate the particular provision.  You may not have leverage and may have to wait for renewal.  It does not hurt to try, however, particularly if there is a win-win for the bank as well.

Covenants are there by banks for good reason- they hold companies accountable for results and can serve as early warning signals. Before an interest or principal payment is missed, a covenant could be missed and action taken before more serious damage is done.

There are often several covenants, covering things like:

1. Operating results

2. Debt payment coverage

3. Leverage

4. Net worth

Banks will put in a number of covenants.  But if you are not careful, it could be too many.  You could be setting yourself up for covenant indigestion.

The more covenants you have, the more likely it is that one will get broken.  Sometimes, several indicators can be in the right direction, but one has gone the other way.  It is like a sports team that has won the game, even though they fell short in one area.  A football team may have outgained the opponent, controlled time of possession, had more first downs, but gave up one more turnover.

A sports team ultimately gets measured on one stat- did they win or did they lose.  If they came up short on one leading indicator, it is still OK.  They still won.

A company may not have that luxury.  It can be profitable for the year.  It can feel like it won the game of business that year.  But it better also hit 5 out of 5 covenants.  Miss one and it might not matter.

A client was just like that.  They had record cash flow.  They paid down bank debt and reduced their leverage.  Their net worth grew since they were profitable.  However, EBITDA was down since it was closely tied to sales in a tough economy.  Management made the right moves to preserve cash flow but there was just no way to meet the EBITDA level.

At worse, it can mean be putting out on the banking street- go find another bank.  At best, it can be open season to renegotiate- higher interest rates, points and legal and other fees.

It can often happen at the wrong time.  The time you trip that one covenant may also be the time that the banking market has dried up.  

The best time to fix this is before you sign on that new loan.  Fewer covenants are better for you.  More important, make sure the ones you do have are really important and are consistent.  Ask yourself, could you be doing very well as a business, yet tripping one of the covenants?  If so, should a different covenant be used in its place?  Should it be cut out all together?  Is the covenant OK to have, but does it just need to set at a different level?

Know what you are getting into.  Fight for less.  Fight for consistency.  Otherwise, you could be setting yourself up for covenant indigestion.  The price to cure the heartburn will be high- higher rates, higher points and higher fees.

An important part of approaching a bank for a loan is to be in the right place at the bank.  One key distinction is whether you are a cash flow loan or an asset based loan.

Most companies will be asset based loans.  There is sufficient collateral to support the revolver, usually consisting of:

• Receivables.  Typically these can range from 70 to 85% of the receivables, less deductions for ineligible accounts (such as balances over 90 days or to certain types of customers)

• Inventory.  These could range from 25-50%of the value of the inventory, with less for inventory in process or raw materials and more for finished products.  Some inventory may be excluded as well, such as older items, certain types of inventory or inventory in transit.

A company with $20MM in receivables and $30MM inventory could support a $20-30MM revolver, depending upon the quality of the receivables and inventory.

Some companies, however, cannot rely on collateral alone to give them enough bank financing to cover their growth needs.  They can be good, solid, profitable, cash generating businesses but just do not have the underlying assets to go on.

An example can be a leasing company.  Their receivables just cover one month of lease payments, so their accounts receivable balance is relatively small.  Their real asset is the stream of future lease revenues, but that does not show up on the balance sheet.  They are a cash flow rather than a collateral based type of credit.  The lender needs to look past the receivables balance to the entire flow of future lease payments.  This is a cash flow credit, not an asset based one.

Banks will have different people covering cash flow credits.  It will be a waste of time to pursue people on the asset based end.  Hopefully, a good banker will steer you in a different direction in their shop.  Some banks will not really do cash flow credits at all.  You will need to go to banks that specialize in this area.

The other thing to consider is timing.  Cash flow lending can dry up in tight banking markets, which happened in late 2008.  Collateral lending can have its moments too, depending on the underlying collateral.

Know what type of lending you fall under.  Approach the right section of the bank and go to banks that deal with your type of credit.  Consider the timing as well.

Raising bank money is a marketing effort.  Since it is marketing, let’s go back to the 4 P’s and marketing and see how they can help you raise money from a bank.

1. Product.  What type of performance do you have to offer a bank?

a. How are your operating results?  What cash flow can you offer?

b. What is the underlying collateral?

c. How is the management team?  How would a bank rate your competence and character?

d. What type of loan are you looking for?

2. Price.  What kind of rate and terms are you looking for?

a. How does the rate you look for match up with the current market for your type of loan?

b. What length of loan, collateral base and other key terms do you seek?

c. What covenants can you handle and how risky are your projections.

3. Placement.  Where are you going to look for financing?

a. What type of institution- factored, commercial finance, traditional bank or other party?

b. What size of bank- large, medium or small? 

c. What treasury services do you need and can the bank offer them?

4. Promotion.  What are you doing to promote your company to the banking community?

a. What kind of business plan have you put together?

b. What presentation and site visit have you set up?

c. How does your website and collateral help promote your business?

d. Have you been regularly promoting yourself to the banks or just calling them now?

You need all 4 parts to effectively market your business to customers and prospects and grow your business.  You need the same as well to get the best banking package to fit your company.  Treat the marketing of your company to banks just as seriously.  Get a jump on it long before you need money.

If it is too late to be early and you need money now, then you need the 4 P’s even more.  

Don’t just do it alone- considering having an outside opinion on your marketing program for bank financing.  It could be a board member, your accountant or other consultant.

Do your covenants match the level of risk your bank has?  Or are you subject to a common trend in bank covenants?  Here is how it works:

• • In the near term, there is less uncertainty.  Covenant levels are set high.
• • As you go farther out, there is more uncertainty.  The bank sets tighter covenants over time to cover for the risk.  For example:
  • o You are required to have higher EBITDA levels
  • o You have to keep higher interest coverage
  • o You need to show less leverage on your balance sheet
  • o You have to show higher net worth

At first glance, there may seem to be nothing wrong with this.  However, look at it from a different angle.   The bank is probably having you make payments on the debt- revolver, term or otherwise.  Your total bank debt starts at a higher level, then works it way down.

Here is where the problem is, as a former banker put it to me so well.  

• • The covenants are loosest when the bank loans are the highest.
• • The covenants are tighter when the bank loans are the lowest.

The bank has the greatest protection, i.e. the tightest covenants, when their exposure is lower.

Meanwhile, as a company, the farther out you go, the more uncertain you are on your results.  But instead of having more total cushion, you have covenants set much tighter.  You have to be surer of how you will perform at a time you would expect to be less certain.

The fix is to balance out your covenants and the debt level.  Say you have debt of $20MM and an EBITDA covenant of $6MM starting out.  After 3 years, you are to have paid your debt down to $15MM.  Suppose the bank wants to escalate your EBITDA covenant to $8MM.  

What should you look for?  In an ideal world, since the bank debt is down 25%, the EBITDA covenant should drop by 25% as well down to $4.5MM.  Rather than go up, the covenant should come down.

Suppose the bank has their way.  3 years from now, you have grown, but not as much as the bank wanted.  Your EBITDA only climbed to $7MM.  You are technically in default.

But are you really more risky?  If the bank liked you at $6MM EBITDA to lend you $20MM, shouldn’t they like you more at $7MM EBITDA on $15MM debt?

This can happen more often than you think.  In an economy like this, you could be tripping a covenant even though your bank is much better off with you than they were when they took out the loan.

Save yourself some heartache down the road.  Don’t let covenants automatically tighten.  Get breathing room up front by having the covenants match the level of your debt.  Less debt should translate to lower covenants.

What is the biggest question on banker’s minds these days?

How will the companies they have lent money to hold up if their revenues fall 20%?  Will those companies survive?  Or will they miss covenants, struggle with cash flow and end up in the workout group?  Can the company make it through the current recession without becoming a problem case?

If you are out looking for bank financing now, take a closer look at your business plan.  The bank is going to take it and discount it 20%.   Save them the effort.  Be proactive.  Take your own cut at it.  Show them how you are going to be able to make it.  You can treat this as an alternate plan, one that you are prepared to put in action if your leading indicators show your revenues are going south.

What covenants are you most likely to trip?  What adjustments will you have to make in order to pull through?  Use this to help you think through the proposed covenant levels, to give yourself enough breathing room.

If you are not currently in the market for new bank financing, that is good news.  However, you are not on easy street either.  You still have the heat on- you have to make the covenants.  Now is no time to trip any covenants and be put on the street by your bank.

Go through the same exercise.  Do a version of your forecast with revenues down 20% and see how you hold up.  Where would you have to adjust to pull through?  Consider if you should take action sooner rather than later.  What costs could you cut now, without affecting your revenues and turning a downturn into a self-fulfilling prophesy?  Be proactive and take action sooner rather than later.  

Then show your banker how you are still able to survive on fewer revenues and still comply with your loan.  Be one less client that your banker has to worry about.  Let them focus their attention elsewhere.

You have heard of vertigo, the fear of heights.  You might be a fearless mountain climber.  You scale up a cliff with hardly a sweat.  Your heartbeat barely rises.

But mention finance and you break out in a cold sweat.  You have a fear of finance heights.  You hold yourself back.

You may say, “That is not me.”  Yet you just might be doing it without even knowing it.

Here are some ways it shows up:

1. You hold back on spending money.  You sit on the marketing program.  You stall on product development.  You wait to hire that new person.  These make perfect sense to spend money on, but you just cannot pull the trigger.

2. You do not sign that bank loan.

3. You decide not to go ahead with the equity investment.  You rationalize your behavior.  You say it was too low a valuation, when really you are just afraid to give up some control.

4. You keep a tight leash on the money.  You do not let go and give your key people some breathing room to spend the dough.

Jon Paul

The Business Eye Doctor & Corporate Financial Expert

Providing Business Clarity & Financial Resources

• Set guidelines and stick to them.  Make it clear to your people.  Do not reimburse when they go astray or you in effect set a new guideline.
• Follow them yourself.  Nothing hits home like a good example from the top.
• Get the help of an expert.  A good travel agent might save you money.  There are firms that specialize in going over your T&E costs and suggesting ways to cut expenses.
• See what you can simplify.  You might move to per diem reimbursement for out of town meals and cut out a lot of paperwork.
• Consider the value of your people’s time.  Balance that against saving some money on airfare.
• Keep up on ways technology could eliminate having to travel for a meeting.  A conference call, webcast or video conference might do the job instead.
• Insist on documentation you need for IRS purposes.  Get guidance from your accountant or tax advisor.  Insist on documentation or hold back payment.  Remember this includes local vehicle use as well.
• Make the reimbursement process simple and quick.  In this electronic world, things can move a lot faster than the old paper days.

It can feel like a vacation to your people.  They spend on things they would not normally.  Or they may treat it as a cost of doing business.   They are sacrificing by being out of town.  So why not splurge a little as a reward?   You may agree.  You may want to treat people well on the road so they make the trips that they should.  But it could go overboard.

There may be good intentions to travel inexpensively.  But it may not be done well.  You could think you are being tight but could be spending more than you need to without realizing it.

Your people may also be traveling when it is not needed.  Technology is changing the landscape and may allow you to have face to face interactions without hitting the road.

You could cost yourself money in other ways too.  You could lose out on tax deductions without proper deductions.  You could also be wasting a lot of time for your people and accounting with cumbersome reimbursement processes.