These days, even some companies with healthy balance sheets are facing increased pressure from their bank. Here’s our prescription for navigating your bank’s increased demands.
Many businesses have experienced tightening credit markets first hand. Over the past 18 months or so, many borrowers have seen changes in their bank agreements, from more frequent reporting, higher interest rates and fees, and lower caps on lines of credit to tighter loan covenants, demands for collateral enhancement and/or personal guarantees, and pressure to find financing elsewhere.
How should a business respond? Understand that during the past two years, there have been marketwide changes in lending. Banks are under substantial pressure from their regulators to reduce lending risks; that pressure gets passed along to borrowers in the form of tighter lending practices and higher costs. These marketwide changes are no more the doings of your individual loan officer than the price of gasoline is set by the local gas station owner.
In today’s market, even companies with healthy balance sheets and consistent profitability can expect the following upon renewal of their bank agreements:
- Moderately higher interest rates spreads (vs. prime or libor)
- Line of credit caps reduced to match the company’s expected borrowing
- Covenants requiring adequate cash flow to pay debt service
- Some tightening of details, such as more frequent reporting or additional exclusions to their borrowing base calculation
Companies with moderate balance sheets, especially those that haven’t turned around their monthly results, can expect some or all of the following:
- Meaningfully higher interest rates and/or fees
- Collateral enhancements if the existing loans are inadequately collateralized (typically due to falling equipment and real estate forced liquidation values)
- Covenants that require improvement in the company’s financial condition
- Tighter reporting, more collateral audits, and tighter borrowing base calculations
- Enhancements to personal guarantees
- Additional restrictions on owner distributions, intercompany transfers, capital investment, etc.
Higher risk credits (weak balance sheets, current losses, and/or inadequate collateral) can expect harsher versions of the above. They may also be forced to find another lender. If there are covenant or other defaults, they may even be forced to liquidate.
It is also common for the lender to encourage or even force underperforming borrowers to hire a turnaround consultant.
It can be difficult to accept the bank’s aggressive demands, but for many underperforming and distressed businesses in today’s market, the best borrowing option remains their current bank. It’s likely that other lenders (banks or finance companies) will charge even more and may offer less availability than their current lender. Often, the best approach is to do whatever it takes to get back on solid footing with the existing bank while the turnaround plan works its magic and the company’s financial condition improves. Once the company has a positive track record and a decent balance sheet, it can either stay at the existing bank or seek out another lender from a position of strength, not weakness.
Finally, if you have any inkling that your existing bank doesn’t want your business for the long haul, it would be prudent to develop a relationship with one or more potential future lender(s). Lenders like to get to know companies and their owners and management teams thoroughly before making a loan, so establishing that backup relationship now will give you a head start if there comes a time that you need to seek out a new lender. This lender should be one that’s interested in lending to companies of your size, in your industry, and at your risk level; don’t waste your time with a lender whose lending profile doesn’t match your company.
It’s been a rough year and a half for many companies and their lenders. While things will remain challenging for the foreseeable future, your best bank is often your current bank. Yes, their demands may be more aggressive than they were, but the lender you know is often better and more willing to work with you than the one you don’t.
The Role of a Turnaround Consultant
Why do banks encourage or even force distressed clients to hire turnaround consultants? Because a turnaround consultant has the knowledge and experience to help troubled companies determine the best way out of their current predicaments and implement solutions. The involvement of a turnaround consultant often gives the bank the confidence to persevere with a borrower while the company determines and implements their plan. On the other hand, if a situation has progressed to the point that a lender will no longer work with a company, turnaround consultants often help that company obtain new financing.
The turnaround consultant’s purpose is to help the company achieve the best possible outcome. Most of the time, that means cost reductions, better working capital management, and process improvements. Sometimes it can mean cutting products, closing locations, and slaughtering sacred cows. In severe cases, preserving the owner’s personal wealth while maximizing a return to creditors may mean a sale or even liquidation.
For distressed companies, hiring a turnaround consultant is like a trip to the E.R. The turnaround consultant assesses the patient, stops the bleeding, stabilizes the company, calls in specialists if needed, and prescribes next steps (the turnaround plan). The turnaround plan may include emergency surgery (rapid action to improve finances), additional tests (detailed financial analysis), admission to the hospital for extended care (continued consulting involvement to implement the turnaround plan), and/or a transfusion (cash from a new source).
For a company that’s merely underperforming, hiring a turnaround consultant is more like a trip to the primary care physician’s office. Just like in health care, the costs are much lower and the treatment less severe if the company gets help before there’s an emergency.
No underperforming company has ever hired a turnaround consultant too soon. On the contrary, too many business owners put off obtaining the help they need until they’re desperate. The facts are these: the earlier you make this decision, the more treatment options are available for your company. Wait too long, and the patient may be dead on arrival.