|Steps for decreasing lender worry.|
Many companies mistakenly alarm their lenders, either by their actions or lack thereof.
Today's newsletter outlines a number of things which cause lender worry, and offers suggestions for avoiding these.
Founder and Principal
Goodrich & Associates
Four Surefire Ways to Annoy Your Lender
There are (at least) four guaranteed ways to make your lenders antsy and/or angry:
- Make them worried that you can't pay back the loan.
- Make them worried the collateral that secures the loan is not worth the loan amount.
- Use a different lender or provider for certain services, rather than the lender or group of lenders that you agreed to in the loan documents. (The lender's profitability of your loan is based on your use of those services.)
The operative word in all four cases is worry.
- Destroy your integrity so the lender doesn't trust you. (This one is the biggest cause for concern.)
Although really bad things may not have happened yet, the lender has reason to believe they soon will. At the very least, the lender believes that the odds of such things are considerably higher now than when the loan was made. Today's newsletter is about avoiding the things which make a lender worry
(or make the lender worry way more than he/she should).
Some examples of what not
to do, all actual experiences I've encountered with past clients...
- Fudge the reporting to the bank (particularly the borrowing base).
Borrowers are often tempted to do this when their company "needs the money." Unfortunately, this amounts to fraud and once you are caught, your credibility is shot. And not just with the current lender - any future lender will likely find the misstatement as well during the due diligence process.
One former client of mine, for example, would "refresh" the invoice date of old, large invoices so they would be current and eligible to borrow on. Yes, doing so allowed them to live another day, but not many. I came in after the fraud was discovered, but the ramifications continued. The prospective "take out" lender found the fraud in its due diligence and walked away. Ultimately, the company was liquidated in bankruptcy.
In another case, the controller would provide the detail in an Excel spreadsheet for the borrowing base report to the CFO. The CFO would then manually manipulate the invoice dates. Once discovered, some of the banks (there were four participating in the loan) filed an involuntary bankruptcy petition and would not fund a full-fledged process to sell the company for maximum value to pay back the lender and other creditors. Today, the absentee owner is being chased personally by the PBGC, (the government agency that guarantees pensions) for the unfunded union pension liability.
Remember that once fraud is discovered, everyone in the company is suspect and trust is gone for all. As the last example shows, that makes it hard to fund a true sale process that maximizes recovery to creditors and minimizes personal liability of owners and officers.
- Provide late or questionable financial reports.
When lenders can't see the numbers, they don't know how your business is doing. Given their past experiences, they usually assume the worst. Moreover, they are concerned that you might not know where your business is headed either (a real problem). Delays in reporting usually mean the accounting function is understaffed, something which will make a lender assume there are weak controls in place.
A related issue is saying you will have your financial statements audited but then providing a review or, even worse, a compilation. Once promised an audit, the lender is counting on a strong form of assurance and will be unsatisfied with something substantially less. Moving from a public accounting firm the lender knows and trusts to a firm no one has ever heard of (perhaps the single-shingle CPA) also contributes to lender worry.
- Take on new debt.
This is a concern for a number of reasons. First, new debt means that there are fewer dollars to service the older debt. So default is more likely. Second, if the new debt is not subordinated, now the lender may have to share the proceeds with the new lender from any liquidation, reducing his recovery and further increasing the odds of default. Yes, debt service covenants may allow the additional debt, but that doesn't mean the lender's anxiety level won't rise.
- Use the loan proceeds for non-business purposes or purposes other than agreed to in the loan document.
One client of mine borrowed from the bank and took cash to buy antique cars (he was a collector). The buyer was in the scrap metal business and he called these purchase scrap. I have also seen companies buy equipment for other businesses and other interests, all outside what was agreed upon.
- Additional lender "worry-makers" include...
- Changing the corporate name or form without notifying the lender in advance. Why? If you default, their liens may be unenforceable and they will have a loan with the wrong party. Essentially, this concern is about the collateral.
- Missed forecasts. If you don't know where you are going, financially speaking, how can the lender be assured you can pay him/her back?
Here are a few suggestions to reduce anxiety on the lender side.
- Poor controls. These are always a concern. Financial surprises or, more likely, an exam or audit done by the lender will bring these to light.
- Guard your integrity. This means everything to your lender. Once lost you may never gain their trust again.
- Invest in your accounting function. Make sure you have adequate controls in place and are properly staffed to close the books and report in a timely fashion.
- Have your financial statements audited by a reputable firm. Unless your loan amount is tiny, this is critical. Make sure the firm you use is appropriate for your loan size. If the lenders are national (or simply lenders who are not local), a national name for the auditing firm helps. As you step up in loan size and complexity, one of the Big Four may be worth the money.
There are many ways to annoy and worry your lender. The four listed at the start of this article are not the only ones, just the most reliable in this regard.
Am I suggesting you do whatever is necessary to keep your lenders happy? No. But don't mistakenly alarm them either by your action or lack thereof. In today's aggressive lending market, some lenders will overlook these things - for now, but, not forever.
Please share with your colleagues
Heard on the Street
A humble economist should tell you he knows very little.
Not surprisingly, humble economists are rarely quoted in the press or politics. John Cochrane
, Senior Fellow of the Hoover Institution
at Stanford and former professor at the University of Chicago Booth School of Business
elaborates with the help of fellow Hoover Fellow, Russ Roberts
Goodrich & Associates is a management consulting firm. We specialize in helping our business clients solve urgent liquidity problems. Our Founder and Principal, Charlie Goodrich, holds an MBA in Finance from the University of Chicago and a Bachelor's Degree in Economics from the University of Virginia, and has over 30 years experience in this area.
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