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A CEOs Guide to Business Banking
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A CEOs Guide to Business Banking

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How banks make lending decisions... …

How banks make lending decisions...

How to manage the banking relationship...

Renewing your relationship...

Financial projections drive your banking
relationship...

Other lenders or sources of money...

Glossary of banking terms...

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  • 1. CONNECTIONS. STRENGTH.TRIUMPH.GLORY.ADVISE.ADVISORS.EXECUTIVE. CARING. CONNECT.LEADERS.DECISIONS.RESULTS.COACHING.JOIN.GROWTH. A CEO’s GuidE tO BusinEss BAnkinG BY VISTAGE SPEAKER MARVIN DAVIS SUCCESS. NETWORK.EXPERTISE.VISIONARY.LEADERSHIP.CONNECTIONS. TRENGTH. TRIUMPH.CHALLENGE.ADVISE.ADVISORS.EXECUTIVE.COMMUNITY. EADERS. DECISIONS.TRUST.STRATEGY.DECISIONS.JOIN.NETWORK. EXPERTISE. VISIONARY. LEADERSHIP.CONNECTIONS.STRENGTH.TRIUMPH.GLORY. ADVISE. The World’s Leading Chief Executive Organization DVISORS. EXECUTIVE.COACHING.COMMUNITY.CONNECT.LEADERS. DECISIONS. ESULTS. COACHING.JOIN.SUCCESS.GROWTH.NETWORK.EXPERTISE. TRIUMPH GLORY. ADVISE. ADVISORS.EXECUTIVE.COACHING COMMUNITY.CONNECT. A CEO’s Guide to Business Banking LEADERS.DECISIONS. RESULTS.COACHING. By Marvin Davis, Vistage Speaker Businesses need capital to build and grow, and for owners are very important to a bank, as is that they need loans from banks. Business banking stability in key positions. is a complicated subject, with plenty of pitfalls for the uninitiated. This article explains how banks • The collateral available for the loan. Banks decide on making a loan, common loan hazards want to see sufficient collateral in terms of to avoid, how and why to stay in compliance with receivables, inventories, and machinery and a loan, an explanation of banking terms, advice for equipment, so they can recover their loans CEOs on taking loans, and more. in the event of default. This is especially true of asset-based lenders which heavily rely on How banks make lending decisions this security. Again, the personal guarantee In most lending situations, bankers seek several provides another level of collateral to the lender. criteria before making the decision to lend money. The degree to which these criteria are satisfied • Communication. Last, lenders want affects the conditions of the loan, as well as the a schedule of reports and guaranteed interest rate. Criteria include: communication with the business, so they know what’s going on. • Viability of the business. This is determined by assessing the business’s historical track How to manage the banking relationship record from a P&L standpoint and its business There are several keys to taking control of your plan going forward. banking relationship and optimizing the conditions under which you borrow money: • Understanding the business concept. Bankers don’t invest in businesses they • Get to know your banker and acquaint him don’t understand and believe won’t stay in or her with the key personnel in the company existence for the term of the loan. This includes (CFO, COO, etc.). considering the competitive environment of the • Regularly review your company’s operations business. and your business plan with your banker. • Equity. Banks like equity investors who • Never lie to your banker. are prepared to step up with capital if the • Keep your banker informed of both favorable business gets in trouble; hence, the desire for and unfavorable events in the business—no personal guarantees, which eventually force surprises. further equity contributions. The day of highly leveraged transactions is essentially over, due • Always have an alternative banking source to regulatory constraints. available. • The character of management. The honesty and character of managers and
  • 2. A CEO’s GuidE tO BusinEss BAnkinG CONTINUED Continued... The last of these items is particularly important. • A forbearance fee (when a borrower has erred Your banker is a vendor. It’s foolish to have only or violated a covenant of the agreement, the source for a key component of your product. lender will forgive the borrower, but penalize Likewise, it’s foolish to have a single potential them with a fee). lender. The development of a relationship with a • An increase in the interest rate to what’s second bank achieves several things: called an “upset rate” (usually two to three points above the normal interest rate) • It helps keep your current lender honest and competitive with respect for rates and • Calling the loan (i.e., forcing immediate conditions of your loan. repayment) if the violation is severe enough • It gives you a place to go quickly if your current lending arrangement becomes compromised Renewing your relationship in any way. Each year, just as your bank reviews its relationship with your company, ask yourself the • It gives you negotiating power. following questions: The second bank relationship may involve Is the lender meeting my company’s needs occasional meetings with officers of the second in terms of services? This can include payroll institution or the presence of a minor account at services, clearing of deposits, letters of credit, the second bank. But all of us know what happens clearing of checks and resolution of disputes. if you’re forced to seek new lending in a short time frame. If you’re lucky enough to find a secondary Is my bank charging a competitive rate for my lender, the borrowing rates are significantly higher loans or can I get better terms elsewhere? and the conditions of the loan are much more Does the bank have overly onerous conditions in severe. the loan document? Can I get a loan elsewhere without a personal Financial projections drive your banking guarantee or with less collateral? relationship A key to managing your banking arrangement is the How easy is my banker to work with, and can he financial projections—what is normally called your meet my borrowing needs as the company grows? budget. The budget document and its updates are the financial document that drives your relationship. Many companies stay in less-than-optimum loans Here’s why: because of “comfort” with the current lender. You should annually review your relationship with your • Your performance is measured against it. lender, especially if the company has had a very good year and, as a result, represents a lower level • Your loan covenants are based on the of risk to the bank. numbers you project. The personal guarantee Most businesses have seasonal ups and downs, or The biggest problem for privately held or closely if they’re growing, may have cash needs beyond held companies is the personal guarantee. This that of a steady-state business. The projection you typically guarantees all the assets of the owners give the bank should be conservative in nature and or senior managers of a company as security for a reflect a less cheery projection that what you use loan. for your sales force or board of directors. It should provide a realistic picture of your cash needs and These types of guarantees are problematic for a allow for contingencies. turnaround person because they add the burden of repayment of the loan to the individual as well 221_1665 C There are, of course, penalties for breaking your as the company. The temptation to get out of the loan covenant. These may include:
  • 3. A CEO’s GuidE tO BusinEss BAnkinG CONTINUED Continued... loan by declaring bankruptcy is diminished by the revenue bonds) for factories and other fact that personal bankruptcy also has to occur. facilities. Unfortunately, many loans to small and medium- • Venture Capital and Private Equity Funds— sized companies require personal guarantees. Here There are venture capital companies or private are some rules regarding pledging personal assets: equity funds that provide cash in return for equity or will lend money themselves. They • Avoid them if you can trade other concessions often expect to “cash out” in three to five such as rate or term in place of a personal years. Usually these funds want control of the guarantee. business (over 50 percent) when they make equity investments. • Limit the personal guarantee to a specific amount you can afford. It may represent only a • Private Investors—This is similar to venture portion of your assets. capital but represents fewer investors, either as a loan, an equity infusion, or both. • Set conditions for the personal guarantee to be reduced or eliminated based on the • Suppliers—Often good suppliers provide performance of the loan. For example, if the funding if they wish to own part of the company meets its budgeted profit goals business or are willing to make loans to the for three years in a row, the guarantee is company. eliminated or reduced by one-fifth for each year the loan is in place. • Government Sources—A variety of government entities provides loans or grants • Identify specific personal assets that back to companies, such as the Small Business the guarantee and allow substitution of new Administration. assets for old. • Secondary Lenders—Some lenders specialize Lenders will also want your spouse to sign a in specific industries, distressed companies or personal guarantee since most states have joint- other categories. The interest rates on loans ownership laws. Try to avoid this as well. from these specialty commercial lenders tend to be much higher than on commercial bank Other lenders or sources of money loans. There is an almost infinite variety of ways to obtain cash for running a business. Turnaround experts The workout are trained to seek the best of these alternatives for How does a company deal with lenders if the their clients, while keeping in mind that the lowest- loan is in distress? The lender dispatches a price loan or source may not be the best answer, team to discuss the situation and sends a formal depending on the loan conditions described here. default letter to start the clock on the cure period. Some of these alternative sources are: The company may find itself dealing with the “special assets” section of the bank if it has an • ABL Lenders—they don’t rely on a company’s underperforming loan. traditional performance but rather the salability of its assets. No company is normally equipped to handle this • Bonds and Commercial Papers—Issuing situation. The key is to get help immediately. You bonds as a method of raising cash is a form need a very good lawyer, plus a turnaround crisis of borrowing from the general public. Smaller manager, to act on your behalf. There tend to be companies often use bonds to raise funds for emotional issues as well as economic issues in real estate purchases (industrial development tackling this problem, and it’s best to use third 221_1665 C
  • 4. A CEO’s GuidE tO BusinEss BAnkinG CONTINUED Continued... parties that will negotiate on your behalf. When Rate. The interest rate charged by the lender can companies try to handle this themselves, it often be fixed for the term of the loan or vary according proves to be a fatal mistake. to an index such as the prime rate or the London Inter-Bank Offered Rate (LIBOR). This rate can Finally, suppose the workout is successful and the be negotiated. Rates for excellent companies are company is able to recover from its problems. Then sometimes below prime, but risky loans may carry it’s time to get another bank or lender, because rates as high as prime plus four or five percent. your original bank relationship is spoiled. The memories of the company’s failure to perform When a company has been doing well, it can properly will linger, so it’s better to start afresh with sometimes go back to the lender and get a lower a new lender. rate. Loan documents—taking control Term. The term or amortization period of the The lesson that all turnaround people know is loan is also negotiable. Quite often, turnaround that language in the loan documents affects your personnel attempt to reduce the company’s cash relationship with your lender. The more liberal your strain by renegotiating the term in order to extend bank document, the easier it is to come to an out principal payments or move some payments equitable arrangement with the lender when things to the end of the loan (balloon). Also, it’s best not go awry. to incur a prepayment penalty if the company wishes to extract itself from the loan early. Let’s examine the types and elements of loan documents that you should be aware of: Advance rate. In an ABL loan, negotiations focus on the advance rates offered against assets. For • Fixed-term loans. A loan for a fixed period of example, an 80 percent advance rate against time with a specific payment schedule receivables less than 60 days is typical. You can negotiate this rate up to as much as 90-95 • Revolver. A loan of a fixed maximum amount percent depending on the quality of the receivable. that may be drawn down at the borrower’s discretion and remains in place for a Certain receivables, such as government determined period of time receivables, are typically disqualified (there are other lenders for government receivables). The • Asset-based Loan (ABL). This loan relies same idea applies to inventories (typically, 50-70 on inventories, receivables and other assets percent for finished goods, 70-80 percent for for its securitization. The loan size is normally current raw material, and 0-10 percent for work in a percentage of the value of the assets, progress) and plant and equipment. Each of these called the “advance rate.” If lending is just categories can be negotiated to optimum levels. against receivables, the common term used is The methods for valuing the inventory become very “factoring.” important as part of the negotiations as well. The contractual conditions for most businesses Default sections. This refers to parts of the loan vary. Every condition in a loan document can agreement that name the conditions the borrower be negotiated depending on the strength of the must maintain in order to avoid a default. This company and competitive market conditions. can be a debt-to-equity ratio, a minimum cash requirement, a maximum negative cumulative Glossary of banking terms cash flow, etc., plus the requirement for timely Here are some simple explanations of common payment of interest and principal. If a company banking terms. violates a covenant, it may be subject to a series of punishments. Another area of negotiation is 221_1665 C
  • 5. A CEO’s GuidE tO BusinEss BAnkinG CONTINUED Continued... the “cure period” to fix the problem, normally 30- Cross-Collateralization/Cross-Defaults. Often 60 days and also negotiable. If a default occurs, the bank gains additional security in a loan by the bank usually charges an upset rate so that asking for cross-collateralization or cross-defaults your woes multiply by having to pay even greater against other companies or assets owned by the interest. The condition of imposition of this rate parent company. Non-payment or default ton a (plus the conditions for its removal) is an important different corporate loan can trigger a default on part of the loan document. the one you’re seeking. This obviously should be avoided. Right of offset. Banks like to have the right of offset, meaning if you default they can reduce your Change of control. Most loans carry a change- debt by seizing cash in the accounts you have with of-control provision allowing a bank to force the lender. This is a good reason to have small immediate repayment of the loan if more than accounts at other lenders. 50 percent (or a number to be negotiated) of ownership changes and key operating personnel Deemed insecure. This omnibus provision change. If the provision is broad enough, this is allows the lender to terminate the loan if you are seldom a problem, except at the time of sale. “deemed insecure.” If your industry begins to tank, even though you’ve met all your other contractual To ensure that your interests are served, it’s obligations, the bank can exit the loan with notice important to enlist a good attorney to assist in the to the borrower. It’s a back door for the bank to drafting of loan documents. Many small-company get out of a loan. The bank usually does this by borrowers are blissfully unaware of that they’re informing you that it wants you to pay off the loan agreeing to. within a given period of time (90-120 days) and to seek another source of funds. It may also begin This article is based on the banking dropping its advance rates on accounts receivable chapter from the book Take No Prisoners and inventory. by Vistage speaker Marvin Davis. Davis is turn-around expert who presents real solutions for companies that are facing Fees. There are all sorts of additional fees that tough times and challenging problems. He banks can—and do—charge beyond interest for can be reached at mdavis2866@aol.com or by phone their services. Audit fees, interest on the unused at (404) 441-3970. portion of the revolver, transaction fees, as well as legal fees, are some of these. In your negotiations, you can place limitations on or eliminate some of these fees. Why Join Vistage? Sixteen chief executives. Zero blind spots. Vistage delivers the vital perspective chief executives need to see the big picture, test ideas, overcome obstacles and seize opportunities. The Vistage Chief Executive Program includes: • Monthly, full-day problem solving meetings • Up to eight workshops per year led by a with up 16 chief executives, presidents, or Vistage expert resource speaker. business owners, professionally facilitated by a Vistage Chair. • Online best practices library; local and regional member events; and access to a • Monthly, two-hour personal coaching global network of 14,500 business leaders. sessions with a seasoned business advisor (the Vistage Chair). 221_1665 C Click here for more information on Vistage.