Perhaps one of your New Year’s resolutions is to find a new bank for your credit.

Sometimes the best solution is within.  Find a better way to work with your current bank.  See how you can restructure your loan.  Strengthen whatever else needs fixing in your relationship.  They may not be the best bank for you, but this is a tough market.  As Crosby, Stills & Nash once put it- “Love the One You’re With.”

Still, maybe your bank isn’t really a good fit.  You decide you want to see what else is out there. 

Like many things in life, how you go about it can make all the difference.  Fumble the process and even a credit-worthy business gets shut out.  Here are some mistakes to watch out for:

1. Waiting.  It sounds reasonable.  Wait for the market to get better.  Wait for our results to improve.  One problem- the market does not care when you are ready- it will move on its own timetable.  True, there have been terrible times in the market like 2009.  But while some companies waited it out, terrible things happened.  Some banks had to tighten their reserves.  Some told some clients to find another bank.  In other cases, they tightened covenants, charged renewal fees and raised rates.  The bad economy didn’t help client performance either- pushing some into non-performing (missing payments) or out of compliance (missing covenants) buckets.  The point is, even when the market is terrible, you may not have the option of riding out the storm.  Better to look early on your terms, while you have a lot more time, as painful as the market is.

2. Drips and Drabs.  Here’s the thinking behind this approach.  All you need is one bank, unless it is a very large credit that will be syndicated.  Besides, we don’t want our information all over the street.  So let’s just go out and approach a couple banks, see how it goes.  If we need to, we can then go out to a couple more later.  There are several reasons this does not work:

a. You tie up a lot of time in the process.  It could take a half year or more to go to market this way.  You tie up a lot of management time, pulling you away from the business.  

b. The market could change.  If you started this in the summer of 2008, you were barely into getting out into the street when the market slammed shut.  

c. The banks could change.  That loan officer you had been in touch with could be gone.  Their credit policy could tighten.  Your type of loan may fall out of favor.  I even saw one time when a bank that was approached later showed interest in lending to a client, but then the bank did an acquisition.  The minimum level for a new credit rose 50%, above what the client was looking for.

d. The package gets stale.  Numbers that were current for the first couple banks are out of date by the time bank #12 is approached 6 months later.  Either a lot of time is tied up continually redoing the financials and forecast, or you go out with dated information.

e. Which one to pick first.  Your full time job is not raising bank loans.  You are not close enough to the market to pick the one or two who are most likely.  The bank who ends up dancing with you could be one way back on your list.  

Better to decide on a list of the banks and approach them all at once.

3. Chasing the Banks.  My sales coach would call this “Show Up and Throw Up”.  You bring the bank in, do a big tour, put up some impressive PowerPoint’s, and give them the works.  This makes you the hunter.  Better off the other way around- make them come after you.  Have them explain why they are interested in you and why they should be one of just two or three that get in to see the big show.

4. Polishing the Car.  The bank package gets them interested, but does not get you the loan.  Nobody goes to committee just based on the package.  Nor is there ever a perfect bank package.  No matter how good a package you have, the banks will always have additional questions you never thought of.  It is similar to a resume for an executive in transition.  He wants it to be good, but nobody gets hired just based on the resume.  Losing a couple extra months getting the package together could be a killer- that’s enough time for the market to turn against you.

5. Forgetting the Treasury Side.  You are most likely wanting to change banks to change your loans.  Yet the bank may make significant, if not more money, from the treasury services to your company and employees.  Treasury can turn lukewarm interest into very serious interest.  It can improve the bank income statement on your account enough to get the approval over the top.  Remember to talk about this in your bank package and your in-house presentations.

6. Ignoring Your Risks.  The financial markets are driven by risk versus return.  The higher the perceived risk, the higher the rates and terms.  When the risk gets too high for that type of bank, there is no deal.  The company may have to look at more expensive resources.  Notice I said perceived risk.  Without any further knowledge and comfort, the bank will be biased to perceive more risk than less risk.  Even thought a company with high growth prospects can be more appealing to an equity investor (who by nature is looking for more risk than a bank), it can be too risky to a bank.  Stability can trump volatility.  So rather than talking about your great growth prospects, you may be better off talking about how predictable your results are.  I had a leasing client change their bank package to talk about the predictability of their revenues, backed up by strong data and compelling charts.

7. Fishing in the Wrong Pond.  Banks are not all things to all companies.  Each bank has their niche.  There is no point in going after a bank that does not fit in the first place.  Know their broad criteria before you add them to your list.  Consider:

a. Type of credit- Cash flow, asset based, real estate, other

b. Size- minimum, maximum size of credit

c. Industries- what industries do they not lend to

d. Geographic- where do they lend, where does their treasury cover

Thinking about going to market?  Generally don’t wait. Get a good package ready, but don’t beat it to death.  Come with the full list of banks you want to approach, based on ones that fit you.  Approach all on your list and make them chase you- have them request the package.  Narrow it down to a shorter list based on their review and response to the package.

Run the process well and you have a better chance of finding the right bank, getting better terms and save your management a lot of time.  Take control of the process or else the market will take control of you.

The current Harvard Business Review has 10 breakthrough ideas for the year.  Number one is what really motivates workers.

http://hbr.org/2010/01/the-hbr-list-breakthrough-ideas-for-2010/ar/1

Managers ranked the top 5 motivators in order as:

1. Recognition

2. Incentives

3. Interpersonal support

4. Clear goals

5. Support for making progress

Unfortunately, the managers had it wrong on the rankings.  The people who worked for them said progress was number one.

That is good news.  It is less expensive than elaborate incentive systems.  It is very controllable.

The other 4 items are good, but it says people really want is to be part of a winning team.  Incentives, recognition, interpersonal support and goals have diluted value if the company performs lousy.

I have been fortunate to have been part of 3 companies that grew very rapidly after losing serious money early and rebounded to become very profitable.  The energy was incredible.  Even when I run into alumni of those firms years or decades later, they still talk about the great times and what we achieved.  It was a highlight of their career.

I have seen companies put in very elaborate incentive programs, set clear goals, and do a great job of recognizing stars.  However, they don’t invest anywhere near as much time removing roadblocks which impede progress and keeping people from succeeding.  That can make matters even worse.  The people are fired up and want to do well, but the way the company operates holds them back.

Suppose you wanted to lose weight.  You set a goal for how many pounds.  You promise to reward yourself with a nice trip when you hit your target.  You get your spouse and close friends to support you.  You get set to track and recognize your progress. 

But despite all this, you are stuck at the same weight.  Incentives, goals, recognition and support were all good, but you didn’t work on what really held you back.  It could be a number of things- not joining a gym, needing a personal trainer, the wrong food in the house, or just not enough time.  

You feel discouraged, because no progress is being made.  Were you starting to see the pounds melt away, you would be much more motivated to keep going.

Your team might be in that same boat.

A company had a number of sales people.  The GM came from a sales background and considered them a key part of the firm.  They put in place a powerful incentive system.  They did a terrific job of recognizing top performers each month.  They also provided one-on-one training.  4 of the top 5 incentives were covered very well.

But sales did not grow as much as they wanted.  To the firm’s credit, they listened to the sales force and worked on a number of roadblocks.  They moved to smartphones so the sales team could keep in touch faster with customers without pulling over and firing up their laptop.  They installed a CRM system.  They invested heavily in their website to help the sales team keep customers up to date.  They looked at their sales and customer service processes to eliminate steps that diverted sales people from selling.  

Progress is the big motivator and all these steps gave the team a big lift.

The article mentions that negative forces which hold back progress can overrule positive motivators.  Look for things like indecision, bureaucracy, forever changing direction, poor systems and holding up resources.  Get these roadblocks out of the way and then get ready to celebrate and recognize progress! 

Another year is done.  It’s time to lock down the numbers.  While the banking market still feels colder than the weather, some companies are busy finishing business plans and looking to test the market in search of a better bank.  Bankers are looking to get off to a good start- if there is a month to go out even in a tough year, January could be it.

The business plan and forecast is an important part of the package.  It can be shorter and less in depth than a business plan raising equity.  However, there is something extra to add to the bank version of a business plan.

I call it tooting your horn from a banker perspective.  Have a section that looks at your world through bank lenses.  Consider some things that would be on their radar to put in this section:

1. Payment History.  What is your history of payments over the past 3-5 years?   Can you show reductions in your debt?  Have you been on time with all your payments?  If you use a seasonal line of credit, were you able to pay this off during the year?  How was excess cash generated in the business used- did some of it go to reduce bank debt?

2. Covenant Performance.  What financial covenants were you under?  How did the covenant levels change each year or during the season?  Were you in compliance with all of them?  How much cushion did you have on the covenants?  Did you have to get any covenants reset?  

3. Collateral.  Was collateral involved in your loans- such as receivables, inventory, equipment or real estate?  How did your collateral values hold up?  How much cushion is there with your collateral versus your loan?  Were there any surprises in your collateral, such as write-downs?  How did bank appraisals stand?  What comments came up during bank audits? 

4. Treasury.  What treasury services did you use?   Were they all from your existing bank or did you use other banks?  What services would you like to have used that your bank did not offer?  How was the service- what would you like done better?

5. Reporting.  How soon do you report monthly, quarterly and year-end numbers?  When did the bank require these statements?  Were there any restatements?  Do you get an annual audit or review?  What were the results?

6. Compliance.  Were there any other compliance issues that came up?  Anything else as a result of bank reviews or field audits?

7. Predictability.  How predictable are your results?  Do you have a steady flow of revenues and customers?  Do costs fluctuate with revenues?  Do you have control over prices?  Did the bank require a budget and when?  How have actual results matched against budget?

8. Bank Income.  What income has the bank made from your company during the past few years?  Include income from treasury services as well as income from loans.

9. Relationships.  Have you been involved in the same part of your bank?  What bankers (position) have been involved?  What changes have taken place?  How often have you got together?  Who has been the point person in your company?  Have there been changes?

If you’ve got it, flaunt it.  Break the ice in a frigid banking market if you can show you’ve done well after a year when many companies have fallen short of what their banks want. 

An owner asked me for advice about starting a board and asked several good questions.  Should he have one?  Who should be on it?  How do I invite them?  How often would they meet?  What fees should I offer?

His company has been growing nicely over the past few years.  He said that growth was challenging him in new ways.  He wanted to get the perspective of outsiders to guide him along.  He had been part of a peer group before and missed the insights.

A key question to ask as an owner- what drives your desire for a board?  Are you looking for guidance or do you need to put more structure in place?  How involved do you want the board to be in the business?  Do you want more than just advice, such as opening doors to customers, suppliers or the government? Would they have voting rights?  Are others requiring that you put a board in place- such as an angel investor, private equity firm, bank or other debt holder?  

Based on that, here are things to consider when setting up the board:

1. Board of Advisors or Board of Directors.  If you are just looking for guidance, a board of advisors could suit you just fine.  If you have outside money coming in (other than regular bank debt), then you probably need the board of directors.  Your attorney that set up your company could tell you what your bylaws require and if you have to go the director route.

2. What Role.  While a structured board of directors will tend to be more active, even there you have broad ranges.  Will you have committees set up- such as compensation or audit?  What decisions will require board approval- such as new bank lines, acquisitions, capital expenditures over a set level, annual budgets, etc.   Your attorney can help you as well, letting you know what your bylaws, bank or other agreements might require.  Another thing to consider is what happens between the meetings.  Ideally, you would like to be able to contact board members and bounce ideas off them or use them to help with introductions.

3. How Many.  You probably will keep it pretty small and normally an odd number.  I would suggest at least 5 and no more than 9 to start off.  If you are starting a board of directors for outside money is coming in, they may dictate how many seats they get and what voting rights.  

4. Who.  For a formal board of directors, outside money will get to say who gets their seats.  If you have family involved in running the business or as an investor (such as your spouse) you may have 1-2 spots going to them.  Beyond that, now is a great time to think creatively and consider who could bring in the perspectives and guidance to move your business to the next level:

a. Industry.  Experience from your industry can help but so can the perspective of outsiders which has transformed many industries.

b. Function.   What functions would complement your strengths and those of your team- do you need more guidance in finance, marketing, strategy, operations, etc.

c. Channel.  Come someone from an entirely different channel or conversely, from one similar to your core customer base help expand your thinking such as lines of business or customer groups?

d. Familiarity.  Should you invite current people involved, such as your attorney, banker, consultant or accountant to be on the board?  Alternatively, you have them sit on parts of the meetings without being full members.

e. Style.  You want different perspectives.  Otherwise if everyone behaves the same, why do you need the board?  I like to look at behavior styles using the DISC framework.  Ideally you want someone from each style on your board- Director, Influencer, Stabilizer and Calculator.  DISC is a separate topic- but can be assessed very quickly on two dimensions- task vs. people oriented and change vs. stability oriented.  Usually a board is not thought of this way- if you can get all 4 styles, you can get some interesting interactions and a board that can push farther.

5. How Often and How Paid.  I normally see 3-4 meetings per year, plus infrequent contact between meetings as needed.  Fees can be modest, based on the size of the company.   Usually they are doing it for the honor and to help, not for the money.  Of course, in this era, get the D&O insurance that they will need.

A board, advisors or directors, can be a big step forward.  The board can hold you and your team accountable.  They can bring new insights and stretch your thinking and strategy.  They can open doors and take you farther than you ever imagined.

Unfortunately it does not always work out that way.  Sometimes board meetings are just ceremonial, dog and pony shows.  They become another process just to get through.  The board just walks a straight and narrow path.  The CEO never gets challenged.  The big stuff never comes up.

It doesn’t have to be that way, but it’s your call.  Sure it is tough to put yourself on the line.  But think how much farther you can go.  As long as you are going with a board, why not put one in place that will stretch you.

The organization chart looks sold.  All the key slots seem to be filled. So why isn’t the team working well together?  How come the strategy is falling short?  Perhaps the traditional view by position doesn’t really tell the story.  It shows what people are supposed to be doing, but not how people behave and interact with each other.

A different chart can explain why.  Rather than by position, map the team based on behavioral style.  Take a blank sheet and draw 2 lines to divide it into 4 squares:

• Vertical line- task oriented (left) vs. people oriented (right)

• Horizontal line- change oriented (top) vs. stability oriented (bottom)

Now you have 4 behavior quadrants where you can insert your team:

• Upper left- Director- task, change

• Upper right- Influencer- people, change

• Bottom right- Stabilizer- people, stability

• Bottom left- Calculator- task, stability

This is a quick basis on assessing behavior using the 4 categories above from the DISC method.  Even better would be to have each team member take a quick 10 minute online DISC assessment which we offer.  Sometimes a person’s real style doesn’t come out in a work environment.

By using DISC behavioral style assessments and then charting the players by their behavior types, new insights jump out such as:

• What behaviors are missing?  If a quadrant is empty or light, a key perspective could be missing.  For example, if you don’t have an Influencer, you may not be getting new ideas and be out of touch with the outside world.  

• What people are opposite (kitty-corner) each other?  Directors vs. Stabilizers, Influencers vs. Calculators.  These can be biggest conflicts, but can be turned into strengths by recognizing and learning to work together.  For example, a Stabilizer needs a Director to set a path, while the Director needs a Stabilizer to provide structure and help implement their strategy.

• What people are together in the same quadrant?  While this can appear to be a good thing, too much of the same can get you stuck.  For example, a couple Calculators can give you great analysis, but may always want to crunch more numbers and never move to take action.

• What people are across from each other?  In some ways they will agree, but in other ways they will disagree.  A Director and an Influencer can both drive change, but the Director could come across as cold to the Influencer while the Influencer may seem flip and not as well thought out to the Director.

No one behavior is correct.  A company where everyone acts the same would be a disaster.  What’s needed is balance.  Opposites can attract and build on each other as long as they recognize and respect their differences.  

Nor does one mix fix every situation.  You want to assess how it fits your company life cycle, your industry and your strategy.

The CEO of a business services company wanted to get new ideas into the company.  They had survived tough changes with a few major customers and stabilized the business.  It was time to grow revenues more and improve profits.  The organization chart looked solid with good people.  However, the DISC chart showed a hole.  There was only one key person in the Influencer quadrant and his role was better suited for a Calculator/Stabilizer.  

When they were in survival mode, the Stabilizers and Calculators helped them pull through and determine what customers to keep.  But times had changed and the CEO brought in an outsider who was a strong Influencer.  In addition, an inside person was moved to a role that used more Influencer behavior.  While the company did not use a DISC mapping as we described, the CEO’s instincts were correct.  The Influencers brought in more ideas.  With the CEO’s direction, analysis by Calculators, and processes put in place by Stabilizers, the company made many exciting, proactive changes.  They stayed profitable despite a tough economy where other competitors did not fare as well.  

As we come off a difficult year in 2009 and look ahead to the next decade, you may face challenges like growing revenues or cutting costs.  Use this chart to predict how well teams will react and their inherent biases that could hold them back.

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.