Banking on Business Loans : Corporate Adviser Offers Tips for Winning Approval : GARY C. NAUMANN

It’s not easy borrowing money these days, especially for the little guys.

Small businesses don’t have to be told that banks and other lending institutions are tightening their purse strings as higher energy cost fuel fears of a possible recession and as loan defaults increase. Economic factors and the savings and loan crisis have combined to create a credit crunch.

As a result, many companies are putting some ambitious business plans on hold for lack of financing. But this need not happen if business owners show lenders that they are running solid, stable companies, financial advisers say.

Understanding and knowing how the credit market works and what lenders want to know about companies are keys to a successful loan transaction, they say. Among other things, companies requesting loans need to provide the lending institutions a detailed history of financial transactions and provide financial statements that make sense.

But for many owners of small- and medium-size companies, putting together a loan proposal can be daunting. And that’s when financial advisers come in.

As director of the capital services group for the Deloitte & Touche accounting firm’s Orange County office, Gary Naumann counsels companies on corporate financing and guides them through putting together loan proposals.

“We’re the coach,” he said. “We’re the catalyst to getting things done.”

But the original business plans must come from the companies, he said. On many occasions, financial advisers play the devil’s advocate by making company owners think of other issues that could affect their companies.

Naumann recently spoke with Times staff writer Cristina Lee about how companies can skirt the credit crunch.

Q. What do lending institutions look for in companies requesting financing?

A. In real estate, clearly it’s location, location, location. But generally, we’re talking about management. We want to make sure that they are people with high integrity, who we feel comfortable representing and who really know their business.

Companies must have good collaterals. The collateral that supports the loan is generally a combination of accounts receivable, inventory and equipment. A further consideration is that the lender will want to make sure that the company has sufficient cash to meet its financial obligations. And that’s really the way to see the strength of a business.

Q. What’s going on in the market right now that small and mid-size businesses should watch out for?

A. There really is a financing crunch in the marketplace. It’s a lot tougher now to get your financing in place across the board because of the general skittishness in the economy. It doesn’t mean it’s impossible or that there’s no financing available out there. It just means you have to work a lot harder to get things done today than you might have a year ago.

For instance, what banks are doing across the board is taking a closer look at how a company’s going to pay back the loans. As they do that, they take a look at each of the items they loan against, such as accounts receivable, inventory and equipment. No bank now wants to put a loan on its books that could be criticized by (banking) regulators. Banks will look at loans the same way the regulators are looking at them.

It’s a two-tier market now. There’s a group of companies that all the banks would love to do business with, and the banks will fight very hard to get into the doors of these companies. A typical company would be one with good net worth, strong operating revenues for the last five years and substantial collateral.

The second tier are those companies heading for trouble either because their market has changed or the economy has just dealt them a blow and they’re all out looking for a new bank to finance their operations. Those are the companies that generally need our help the most and the ones that banks take a lot closer look to see if they’re going to extend any credit.

Q. What role does sales have on a company’s ability to get credit from a lending institution?

A. It’s not sales that would drive a lender to extend or not to extend credit to a company. It’s the underlying cash flow of the business, the strength of a borrower’s collateral and how they think the company’s going to be able to repay the loan. If, for example, the company’s going through declining sales, and sales have gone from $12 million to $10 million to $8 million, and it looks like an irreversible downward spiral in sales, the lender’s going to be very reluctant to extend credit.

So sales isn’t really the issue as much as the underlying strength of the company--its ability to generate cash flow to repay the loans.

Q. In times of increasing inflation, what should small and medium-size companies do?

A. When a company is putting together its financial plans for the coming year, it is far better to focus on the specifics of its business versus the overall inflation rate. In particular, what price increases can be passed along to customers and what specific increases are expected in the goods and services that the company purchases.

A number of our clients have come to us and asked how can they plan in such volatile times. And we always shoot back with the question: How can you afford not to plan? If it’s going to be tough enough with a plan, imagine trying to guide your company without one.

So what we encourage them to do--since we can’t write their plans for them--is write a business plan for the next year. We advise companies to focus first on their goals for the year. This, in turn, will determine the amount of financing the company will need to achieve those objectives.

Once the company has determined its financing needs, it must reconcile that with the company’s capacity to raise financing, which is based on a combination of the company’s historical financial performance and projected performance.

Oftentimes, what the company needs and what lenders are willing to provide are different amounts. The company must either adjust its financing request downward to reconcile this difference or bring additional capital into the company. This additional capital may come from existing shareholders or from outside investors.

Q. How can a company size up a lender’s financial health?

A. They should specifically ask the bank how clean its loan portfolio is and how it’s doing in the eyes of banking regulators. Has it been forced to reduce its portfolio of loans because of problems in some loan payments? Does it have clients with a similar business? How does the bank perceive the company’s market as a whole? You can also ask if the bank has expertise in the company’s market. Companies can easily find out if the bank is making or losing money by asking for copies of its quarterly and annual reports.

A lot of people are sometimes afraid to ask those questions because they may not seem appropriate. What a business doesn’t want to do is put itself in a position where it has been granted a loan by a bank and then finds itself having to seek another source of financing because of financial difficulties that bank may have later on.

Q. How should companies go about shopping for the right lender?

A. Again, it’s for the company to evaluate the bank. Companies should be asking the banks the following questions: Does the bank have similar companies in its portfolio? How important will my loan be to the bank? Who will my loan officer be? What is the decision-making process within the bank? And finally, who are the decision makers?

We find some companies that shop their loan all over town. This means putting together 50 to 60 pages of information about the company, making 30 copies of it and sending them to 30 banks. That is about the worst thing a company can do.

It’s not a good idea because the financial community is very close-knit, and it generally becomes known if a company is shopping all over town for financing. Instead, companies should very selectively target those banks that they think might be the best candidate for their particular type of credit. And companies should go to them and make their presentation rather than just corresponding with the banks.

We advise companies to perhaps shop with six banks but not to go for a full-blown presentation with each of them. They should really prescreen those six lenders and determine which of those really make sense to talk to. From there, they can pick three or four institutions to go visit and talk to. They can choose perhaps two or three to make their loan presentation and then proceed to negotiate for the best loan arrangement they can make for their company. The purpose is not to play one institution off the other, but to try and find out who’s the best lender in their particular situation.

Q. Should companies shop around for the lowest interest rate they can get from a loan?

A. In today’s market, we think that interest rate is not as critical as the availability of financing and its terms and conditions. Companies should not be jumping around from one lender to another for small differences in interest rate. For example, if we take 0.5% difference in interest rate on a $2-million loan, it amounts to $10,000 in interest savings over the period of a year. Considering the time spent searching for new financing, the savings does not justify changing lenders. We would probably counsel them away from moving to another bank if that was the only factor.

The second thing we’d advise companies is to make their existing lender their ally. The loan officer is probably a company’s strongest advocate for obtaining credit. As much as possible, keep the loan officer informed. Make sure the officer is fully aware of any problem in the company and (that there is a) management program to address those problems. Give the officer all the ammunition to make the best presentation before the committee.

Casual presentations and generalizations won’t suffice for major increases in financing. It will take a well-articulated and supported financing request.

Q. What’s the next step if a company’s bank turns down its loan request?

A. If a company’s loan request has been turned down by their existing bank, they need to test the waters and talk to other banks. One bank may be receptive to a company’s financing request, another bank may not. Again, a company may not want to approach a large number of other banks. Three or four banks will suffice.

If bank financing proves unattainable, then a company should consider a commercial finance company. These lenders are generally more tolerant of losses and leverage; that is, the ratio of total liabilities to their net worth is much higher than what regular banks would accept.

As a general rule, a commercial finance company is tougher on deals. They will monitor transactions more closely. They will audit more closely a company’s receivables. They will sometimes require higher interest rates for the financing. While there are a number of commercial finance companies willing to consider financing in excess of $2 million, there are only a handful of lenders eager to look at financing below this level.

Given the volatility of the markets, a company’s best bet is to check with its accountant or other financial adviser to determine the best fit for a company’s particular situation.

Q. What makes financial advisers different from loan officers in a bank?

A. Given that I’ve been a lender, a borrower and a financial adviser, I can understand issues facing each party. What I try to bring to clients is an understanding and a perspective as to what’s achievable, what’s not achievable and where their time is best spent.

Banks have to maintain a separation between the lenders and the companies they are lending to. So they cannot get directly involved in the management of a company like we can. Any good loan officer of a bank will try to be as helpful as possible, but they can only go so far. They have to spend their time monitoring a company’s portfolio and watching other deals. So there really is a need for firms like ours who have specialists in particular areas to devote attention to a company’s problems.

Q. When should companies turn to venture capitalists?

A. Companies should not turn to venture capitalists when the wolves are at the door. Bad timing. If a company’s proposition to a venture capitalist requires an infusion of funds to cure past problems such as debt reduction or reducing past due accounts payable, it’s likely to get a cold reception.

Most venture firms look to invest in companies with significant growth potential.

Q. How best can a company increase its value over the long run?

A. One of the most important considerations is to build a competent management team, and, depending upon the size of the company, the owner may consider appointing either a chief financial officer and/or a chief operating officer. The more the company depends solely on the founder, the more difficult it is to increase the long-term value of a company. A competent management team must be in place for a company to build its value in the long run. The management team should be people that a business owner can rely on to build confidence among the company’s investors and lenders so that they know the company is not a one-man show.

Consistent sustainable earnings makes the best argument for maximum evaluation of a company.

A company can also increase its value by erecting barriers to entry in key phases of its business, such as patents, exclusive distribution channels, licensing agreements, etc.

Another way a company can build value is to understand its market. Many small- to medium-size companies don’t really focus on what their competitors are doing. They just pursue their own plan and hope that it works out.

Q. How important is the reputation of a business owner?

A. The reputation of the owner is really critical because in most small- and medium-size companies, the president and founder is a 100% owner of the company. And the lenders are going to be focusing very closely on him or her. They want to know what type of person they’re dealing with--their reputation, integrity, etc.

A business owner’s previous financing relationships with institutions and track record counts a lot. As long as the owners conduct themselves with absolute candor with respect to both business problems and opportunities, that’s the best assurance that their reputation will be sound in the market. Even if they’re leaving a bank that has asked them to leave, they have to make it as smooth as possible because those bankers may show up again.