Good communications with lenders, particularly senior secured lenders, is always a smart idea. But it’s even more critical when your business is in default of the terms of the loan and/or in financial distress.
At that point, the three golden rules of lender communication become paramount:
#1. Communicate early. This demonstrates that your company is capable of seeing ahead financially. Lender confidence in your business declines if they are surprised by bad news after the event has happened.
#2. Get in front of the problem. Lenders will want to know how your business will address the situation. Make sure you have a solution in hand before talking to them.
#3. Be honest. Once lenders catch you in a lie, they will rarely trust you again — and would rather not do business with you.
With those fundamental rules in mind, here is how to proceed…
Understand the Situation
The first step is to get clear on where things are headed
, hopefully before a crisis occurs. Begin by developing a 13-week cash flow projection
that also projects critical collateral, accounts receivables (usually), and inventory (sometimes).
Next, dig into the accounts receivables. Who is current and who is not? Make sure payments and credits are applied. As for inventory, is it accurate? Are there issues with slow moving items or items whose sell-by date has passed? Secured lenders will want to know how clean their collateral is.
Read the loan agreement
Are there any compliance issues you have forgotten about, such as unauthorized distributions to owners, new debt, reporting, and so forth. You’ll be surprised at what you may find.
For example, while working with a client that I was called in to liquidate, after an effort to sell the assets had failed, I had an upcoming meeting with its lender. The lender had called a default and I asked my client for a copy of the loan documents so I could read them prior to the meeting. My quick review of these found that the only way to default was to not issue timely financial reports, liquidate, or close on a sale of the business or assets.
So, when we met the lender, I told them my client was not liquidating and was going to continue operating while they undertook an expanded sales effort for their assets. They would continue to do so until they ran out of cash. Now, there was no default. (I could tell by the lenders' faces that they had been afraid someone might actually read the loan agreement!)
Get Your Ducks in a Row
Figure out what you are going to do differently. For example, if cash flow is tight, but just for a limited period of time, which payments can be deferred? If the business needs to change to restore profitability, etc., what will you do? Is additional funding needed, whether from owners, a new junior lender, or elsewhere?
Get a plan in place to do what’s necessary.
Think Through the Lender’s Position
Start by assessing the lender’s situation with respect to your company. Have you surprised them frequently in the past? What is the risk that your business can’t make principal and interest payments? Have you given the lender timely financials they can have confidence in, or are they concerned by a lack of financial transparency? Is your loan already being managed by the “managed assets” or “special assets” group (fancy names for the bad loan department)?
In other words, and from the lender’s perspective, how much inherent risk is there in your company’s plan to cure the default?
Then, think through what the lender’s options are. A simple waiver of default may be all that is needed (this is likely if the lender is well secured and notified well in advance). If financials are late and murky, your call will be another surprise, making the lender more likely to force your company to either refinance with another lender or sell the company and pay off the loan with the proceeds.
With these preliminary steps in place, now you can talk to your lender.
A few more tips…
Shed no more light than necessary. While it is important to always be honest, sometimes it makes sense to not share more than is needed. For example, if the lender is grabbing funds, there is no need to tell them of unusual cash coming in — cash that can be used for other purposes, such as paying down debt made with personal guarantees, paying vendors to stay afloat, etc.
Have an end game. What is realistic/feasible? Is it refinancing with a different lender? Getting through a short-term blip to live another day? Sell the business to maximize value? For smaller business owners, minimizing loss on personal guarantees is often a goal. For larger companies, minimizing loss on guarantees from other parts of the business might be the priority.
Maintain transparency. Lenders get nervous when they can’t tell what’s happening. Ensure that financial reporting is timely, accurate, and GAAP compliant. Don’t let audits or reviews from public accountants drag out. In one client situation, the senior lending officer told me he liked the company and liked the owners, but unless things changed, the loan needed to go. So I brought on a regional CPA firm that was engaged to audit this year's balance sheet and all of next year's financial statements. In short, because a detailed plan was laid out that was backed up with the credibility of an outside firm, the lender had confidence in my client's ability to meet its commitments.
Usually, that means not shooting too high
; project a somewhat lower hurdle that can be easily cleared. Lay out upsides and downsides to any financial commitment made. This way, most variances won’t be surprises — they will be fluctuations within expectations.
This helps the lender understand the risks involved, as well as isolating future performance variations between uncontrollable factors and management execution.
Multiple lenders. Things get more complicated in this situation, but the basics remain the same. If the loan or loans are agented, communicate with the agent and let the agent communicate with the other lenders.
Every business has its share of ups and downs. When the downs create financial distress or threaten your business with a loan default, lender communication will necessarily come into play.
Those businesses that stay proactive, open, and honest with their lenders, are well positioned to survive — and even thrive — during hard times.