Seek a Backup Source of Financing Now, Just in Case Your Bank Pulls the Plug
Is a credit squeeze in the offing for small and mid-size business borrowers? If so, what can you do to prepare for it?
The first question is harder to answer than the second. The National Federation of Independent Business, reporting on a monthly poll of its 600,000-plus members, says that in December only 4% of respondents found it harder to find debt financing than the last time they tried.
The percentages have remained below 10% for more than a year, according to the federation, and because they reached 10% to 12% during the last recession almost a decade ago, the recent showing is probably good news.
That does not mean, however, that good times lie ahead. Interest rates are down, but as noted in this space last week, they constitute only one factor governing the willingness of commercial banks to lend to small and mid-size businesses.
The smart thing is to start looking now for at least one other source of debt financing in case your bank pulls the plug on you in the coming months.
You start by asking yourself two basic questions:
* Is debt financing essential to your business?
* If you had more of it than you do now, could you increase your profit margin even as the economy slows?
If you answer “yes” to the first question and you now borrow from a bank, you may need an alternative lender soon, according to Russell Hindin, a partner in the Los Angeles investment banking firm Hindin/Owen/Engelke Inc., which arranges debt financing for small and mid-size businesses.
If you answer “probably” to the second, he says, you stand a good chance of finding an alternative lender and of weathering any squeeze that comes along.
He makes a good point about debt financing. In bad times, a reliable supply of debt can prove more important to the survival of a business than the cost of borrowing.
To be sure, for businesses with tight profit margins, interest becomes the primary consideration. But if you can use debt to prosper in difficult times, your worries about interest costs should probably go in second place.
Hindin counsels clients to follow what he calls the “12 commandments of smart corporate finance”:
1. Anticipate your financing needs.
2. Don’t assume that you can’t borrow even in a tight lending market.
3. Borrow as much as you can.
4. Don’t make interest rates your primary consideration.
5. Watch for watershed events in your company’s development, positive or negative, and keep your lender informed at all times.
6. Keep lines of communication open with several lenders.
7. Don’t think that just because one says no, the others will too.
8. Investigate financing sources other than banks, including commercial finance companies and institutional lenders such as insurers and pension funds.
9. When applying for a loan, ask when you can expect an answer to your loan application--and follow up.
10. Get all commitments in writing.
11. If you hire a professional loan consultant or investment banking firm, check references closely.
12. Pay for performance, not effort.
The lessons, Hindin says, come from the sorry experience of many business owners a decade ago.
“What did banks do in the last recession?” he asked. “They used covenant violations to get rid of loans they didn’t want, and they may do the same now if their auditors come down on them to tighten underwriting standards. The sooner you realize that this may cause you to need money, the sooner you can start looking for it.”
The covenants in any loan agreement set the conditions under which the lender offers the loan--and may call it.
Covenants may require the borrower, for example, to maintain financial ratios at specific minimums or report inventory or receivables in specific ways. Lenders want borrowers to adhere to covenants, of course, but don’t commonly call a loan for covenant violations alone--at least in good times.
“It’s important to anticipate your financing needs in hard and good times,” Hindin said, “and the reality is that most small businesses don’t.”
To do this, Hindin says, analyze cash flow over at least a year, projecting money as it comes in and out of your business, month by month, with as much precision as possible.
“If you do this realistically,” Hindin said, “you see whether you’ll be making enough money to support the debt you need and you can structure a loan to assure the availability of funds to cover any shortfalls.
“Then when you arrange a credit line, make sure your lender offers you all you’re entitled to, given the condition of your business. Banks aren’t going to offer leverage, because they are risk-averse and highly regulated. But if you can get a large loan with fewer covenants and a higher interest rate from an alternative lender, take it.”
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Recent Financing and Insurance columns are available at https://www.latimes.com/finin. Juan Hovey can be reached at (805) 492-7909 or at jhovey@gte.net.
