The document discusses the importance for business owners with loans to understand their current financial compliance status and have a plan to communicate with lenders. Key points made: 1) Loan agreements require submitting financial statements and covenant compliance within 120 days of fiscal year end, often by April 30th. 2) Owners should understand their debt coverage, leverage, and other financial ratios to assess compliance. 3) Those out of compliance need a written short-term strategic plan and to communicate proactively with lenders to avoid renegotiation or issues.

1. The Chairman’s View: I’m Out of Compliance. Now What?
by R. Thomas Stocker
The potential for a larger financial storm able to meet the terms of your loan
than many private business owners are agreement, you must have a credible written
expecting may occur during the next several short-term strategic plan to discuss with
months if you are not proactive. And it your banker. There may be little they can do
could be personal. For those of you who for you if you don’t. But don’t wait for the
have business loans outstanding, end of year due date or for them to find out. You need to
financial statements and covenant talk with them as early as possible.
compliance certifications are generally due
So, what should you do to prepare? First,
to your lenders within 120 days after your
understand your current ratios and covenant
fiscal year end. For many of you that is
positions. If you don’t know much about
April 30. The current state of your
that part of the business, familiarize
company’s results and outlook is more
yourself. Understand where you are now.
important than ever. If you don’t plan now
Do the math (have your financial staff do it
you may need to be ready for significant
for you). If you are in compliance with all
change to your loan deal and in some cases
of your agreed ratios and covenants you are
banking relationship. Under most
fine. If not you need to start getting into
circumstances, most banks are not going to
compliance now. If you won’t be able to be
give waivers for missing their deadline for
in compliance by year end, your plan must
supplying financial statements and covenant
be in enough detail to get you there in a very
certifications.
short period of time. “Technical defaults”
Since October, there have been a significant are enough to get you in trouble. Address
number of seminars and panel discussions them.
around the subject of credit and lending. I
As a business advisor and member of the
would venture a guess it is the number one
Board of Directors of the RI EDC’s Small
topic for seminars right now, and rightly so.
Business Loan Fund Corp. I evaluate
It is very important for business owners to
companies’ credit-worthiness on a fairly
get started on understanding where you are
frequent basis. I’m not a banker, I’m an
right now if you haven’t done so already.
operating guy. A business owner. I do
Sponsors of these events are targeting their
review the ratios, historical income
customers and constituents who need to
statements, balance sheets and cash flow
know how to face this situation. The
statements. Once I have an idea of how
number one message from the speakers,
your company has operated and performed
bankers and panelists I heard was
historically, the most important part of my
“communicate, communicate,
review is to understand how you are going
communicate”. This is all well and good if
to spend the money and how it relates to
you have a positive relationship with your
where you plan to take your company. If
banker and you are in full compliance with
that is not clear, I’m not comfortable. If you
your agreements, but if not I say “hold on a
want your banker to help you there are
minute”. You need to do some work first. If
several things you must do now.
you are out of compliance and/or won’t be
10 Larkspur Road, East Greenwich, RI 02818 401-451-9799 www.boardroomadvisorygroup.com

2. standing, add significantly to risk
Lenders and investors hate surprises.
•
reduction and company credibility.
The horse is already out of the barn,
so now you must show tangible Make sure your financial team is
•
evidence you are being proactive. credible. Do you have a bookkeeper
You must show you have recognized when you need a controller? Make
you have a problem and are doing the change and make sure that
something about it. controller is good. I’ve seen many
owners call their bookkeepers
You must re-earn your credibility.
•
controllers. They are not the same.
That’s right, re-earn. Your plans
Your Chairman and CPA are both
must match your projections.
good advisors to use to help find that
Deviations must be explained
resource. You won’t regret it. This
completely and coherently. Be
step will take out risk, help make
confident in your understanding of
your banker more comfortable and
the numbers. By being up front with
will also help you as you grow.
your banker, you are adding to your
credibility. The best way back to As the leader and owner of your
•
credibility is to “under promise and company you should already be
over deliver”… always. cutting costs. If personal costs are in
your company, take them out first.
Your financial statements must be
•
Bankers don’t want to see your
timely. I’m talking about operating
personal mortgages, utility bills,
statements, the ones you should be
family car loans and tuition
using on a monthly basis to help
payments in your company’s
guide your company, not tax
expenses. After personal expenses,
statements. If you can’t get your
right-size the business. This point
operating financial statements to the
really hurts but is necessary.
bank on time, it will be an automatic
red flag, and potentially an Articulate your market, competitive
•
opportunity for the bank to position and marketing plan. Again,
renegotiate your agreement, or make sure the projections hang
worse. together with your financial
statements. Make sure any growth is
Any covenant violations should be
•
real.
addressed in detail. Reasons why
you are out of compliance, what you Highlight the tactics you are using to
•
have done to address it (and results) execute your plan. Especially the
so far and any additional action plans tactics already implemented and any
to be implemented. Although it is tangible results.
prudent to have intermediate and If you are trying to form a new
•
long term plans, the banks are only relationship, the reasons you are
interested in short term results right looking for a new bank need to be
now. disclosed.
Spotlight your management team,
•
Once you have a credible plan, it is time to
including key advisors and
talk to your banker. Let them know where
consultants. Next to history, bankers
you are as early as you can. They will be
(and investors) want to know who is
better able to provide assistance if you have
doing the work. Having people on
a plan than if you don’t. They most
board who they trust, have been in
certainly will be more willing to work with
this situation before and successfully
you. Many bankers are working hard right
brought a company back to good
now to reach out to their customers to

3. prepare and to try to get an early warning if During my discussions with bankers, owner
there are problems they aren’t aware of. distributions were a frequent topic of
Even if you are in compliance, talk with concern. Many owners take out funds from
your banker early. They don’t want to have the company as a matter of course. S Corps
to concentrate on you right now (actually were cited the most in examples. These
they would rather concentrate on helping distributions are really not unlike public or
you be successful). What I mean is they private equity “professionally run”
don’t want to worry you may be a problem. companies giving themselves excessive
A key to remember here is you can’t hide bonuses or “special dividends”. The net
from your banker. They will find out the result is higher risk for the lenders, investors
truth. or bond-holders. In the current
environment, banks are in a position to take
Keep in mind that any violations to on a more aggressive stance. As a small or
covenants or unacceptable ratios may trigger mid-market business, you will now be
your bank to renegotiate your deal, or worse. expected to live by a higher standard to meet
So be prepared. I can assure you your the measures you signed up for when you
relationship manager does not want to have agreed to borrow funds. Distributions
that discussion with you but is obligated, in higher than the annual profit of the entity
many cases by regulation. Only a few short will raise a red flag. Banks are expecting
years ago banks were very aggressive in owners to leave more cash in the business
their lending practices. Many didn’t price in for growth, investment and emergencies. It
risk and the spreads on many current deals may be safe to assume your banker won’t
don’t make sense in the current have much sympathy on your company if
environment. Some are still more they deem those owner distributions
aggressive than others, but very few are excessive. Keep your ratio above 1.2:1.
offering deals anywhere near as aggressive.
Another ratio several banks use as a major
So, what are the current requirements indicator is the Leverage Ratio, a Balance
bankers are looking at to assess risk? Sheet measure. It is calculated by dividing
Although risk factors are industry specific, total debt by tangible net worth. Tangible
the number one ratio criteria I heard for net worth is reduced by officer and owner
deciding a business’s credit-worthiness is loans and other intangibles. Bank consensus
debt coverage. Nothing new there, but was that a 3x ratio was generally the max
perhaps the ratio is a bit tighter. All the acceptable. As this ratio rises, additional
banks I talked to require at least a 1.2:1 covenants and guarantees are introduced.
ratio, and several require 1.25:1 ratio.
Generally, this ratio is calculated by Almost everyone I talked to suggested
dividing EBITDA less owner distributions owner personal guarantees are part of most
divided by the current portion of long term deals and always have been. All deals start
debt plus interest. From the bank’s point of with them in but are sometimes removed
view, the higher the ratio, the less risk of through negotiation, if the company has
default. Many banks will pass on lending to significant liquidity and low risk. Most
a company if that ratio is below the 1.2:1. articulated that the owner needed skin in the
Some high-risk industries such as game and saw no reason to remove that
construction, fishing, retail, consumer goods dynamic. Likewise, the personal credit
and auto dealerships may require history of owners is always taken into
significantly higher coverage ratios. consideration. Because of the dynamic
between owners and their businesses,

4. historically both have been found to be industries or factors specific to your
closely correlated. situation, you should have a sense of what
you may be looking at from a generic sense.
In many cases you probably use one bank I didn’t discuss size of banks and specific
for all of your “go to” needs; deposits, requirements because there are just too
checking, savings, credit line etc. Pattern many and in some cases personal bias
changes such as running balances down toward specific types of deals. Bottom line,
significantly can be another red flag to the communicate with your banker early and
bank that all is not well. However, having often, try very hard to keep your end of the
all of your business with one bank is a deal and have a plan you can share to show
positive and shows you have a commitment short term improvements when you are
to your bank. unable to achieve acceptable ratios or
covenant certifications. And most
Although this article does not cover all of importantly, be prepared to have those
the variables in dealing with your banker, discussions soon.
types of loans, credit lines, specific
To comment on this or other topics important to private business owners, access my blog at
www.boardroomadvisorygroup.com.
About the author; Tom is a Principal of Boardroom Advisory Group, LLC, an owner advisory and consulting firm. Tom serves on the Board of
Directors for the RI Economic Development Corp’s Small Business Loan Fund Corporation (SBLFC), the finance arm of the RI EDC. He writes
a monthly article for the RI EDC’s Every Company Counts initiative. His articles focus on areas that can add significant value for business
owners. Contact Tom directly at 401-451-9799 or tstocker@boardroomadvisorygroup.com.
Boardroom Advisory Group, LLC is a business advisory and consulting firm specializing in helping both growing and underperforming small to
mid-market private companies resolve day-to-day systemic issues that interfere with cash flow and profitability attainment. The firm’s team of
hands-on professionals find and implement solutions to improve top-line and bottom-line growth, cost reduction, cash flow, process and structure
improvements, and owner transition strategies. The firm also has experience doing business restructures and workouts. Boardroom Advisory
Group’s core focus on developing strategies to drive and measure performance has resulted in a history of sustainable top and bottom line growth,
healthy cash flow and meaningful company value for their clients. For more information about how we can help you build a more valuable
business visit our website at www.boardroomadvisorygroup.com .
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of the author. All registered trademarks mentioned in this document are the property of their respective owners.
Additional articles written by Mr. Stocker include:
Start Forecasting Now! Do You Have Contingency Plans?
I’m Out of Compliance. Now What? Have You Thought About Your Future Lately?
Are you in a Foxhole? Metrics Should Be Everywhere (Part I)
Are You an Octopus? Metrics Should Be Everywhere (Part II)
What is Value? It’s All About Growth
These articles can be accessed at www.boardroomadvisorygroup.com/pages/pubs.php. You can also request to be added to his email list to
receive his latest articles on a monthly basis on the Company website. Contact Tom at tstocker@boardroomadvisorygroup.com.