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Picking a bank is an often overlooked business decision.
To be clear, I am talking about the bank or banks that will provide a senior credit line and treasury services to your organization. Making a strong choice matters because when your situation changes, be it the business softens or growth opportunities appear, you don’t want to have to change lenders. Switching banks is cumbersome and time consuming, so it’s in your best interest to make a wise and appropriate selection from the start.
Some things to consider…
Financial Strength
The recent demise of Silicon Valley Bank and a few others is a reminder that the financial strength of the bank is just as important as rates, fees, and credit terms. There are two items to think about.
The most obvious is collapse.
Besides losing the cash on deposits, when the FDIC takes over a failed bank,
all
lending stops — even for existing credit lines. For those companies that rely on a credit line for liquidity, that can be an existential problem.
Collapse aside, the other important item related to financial strength is
the bank’s ability to continue lending.
Currently, many lenders have told me that as a practical matter, they have paused lending. Why? These banks lost deposits when interest rates rose and those deposits funded loans. They had to sell government bonds at a steep loss to fund paying the deposits and so they now have insufficient capital to support new loans.
(As for how to evaluate a lender's financial strength, that is beyond the scope of today's topic.)
Treasury and Cash Management Services
Here,
what is important is the sophistication of tools
to make payments, move money, etc., as your needs require, not to mention associated fees and expenses.
For example, a company that makes payments in foreign currencies should consider not only the fee to make the transaction but the fee hidden within the dollar-to-foreign-currency conversion. For other companies, the fees and services to process credit card and ACH payments are most important.
Before moving forward,
make sure you align your particular needs with a bank’s strengths and costs in this area.
Credit Lines
These are loans that can fund the business on a daily, seasonal, or “just in case” basis. They come with all sorts of restrictions and often require guaranties from owners or other related entities.
These loans fall into three basic types based on how much the lender relies on collateral versus cash flow to get repaid.
At one end, the lender is relying solely on the cash generated from the business. If cash flow declines too much, the lender is at risk. At the other extreme are asset-based loans in which the lender is relying primarily on the liquidation value of accounts receivables and sometimes inventory. In between are Commercial and Industrial (C&I) loans which are secured by assets in case of default, but depend on cash flow to repay the loan.
How to Choose
As a first step, evaluate your own financial and business circumstances:
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Assess your borrowing and treasury needs
, taking into account your need for term loans and junior debt. Depending on the situation, the lender that provides the credit line may be willing to provide term loans as well. If not, your business will need to find a lender that will work with other lenders.
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Look at your financial history and future
, particularly the
Fixed Charge Coverage Ratio
(FCRR). This will help you decide the structure of the loans needed. Credit lines are interest only and that helps the FCCR. Conversely, term loans typically amortize and that debt service strains the FCCR. Most important, this analysis will help determine if you will be best served by an asset-based, C&I, or cash flow lender.
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Consider your company and borrowing size.
Large banks can lend more than small banks and only large and regional banks can put together a multi-lender syndicate for large loans. But large banks often struggle with small business lending; they just can’t do it efficiently. When approaching regional and very large banks, make sure you are working with a person whose group lends to your size company.
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Think about your industry.
For example, some lenders specialize in a particular industry (or have an internal group that does so), such as government contracting or agriculture. They understand these industries and their collateral.
Next,
put together a financial package
that summarizes your banking needs; provides an overview and history of the company, markets, and competition; and includes about five years of summary financials. I include an appendix with an overview of accounts receivables and all other potential collateral and summary financials by quarter for the current year and next year (includes a summary balance sheet).
Now, you are ready to contact potential lenders and ask for a proposal.
Give a due date and ask for term sheets; get clarity and then cull the herd. It’s a good idea to contact more lenders than you think you need, as in my experience, most will drop out for a variety of reasons. Your loan may be too big or too small; the lender’s credit department may have had a bad experience with companies in your industry; the lender may have too much exposure in your industry or collateral types.
At last, it’s time to
negotiate with a handful of lenders, with the goal of signing a term sheet from the best offer.
Give notice to your attorney as to your financing plans, as they should review any documents you sign and will negotiate the legalese of loan documents.
Dig into the details of the proposals:
- Look into the financial covenants. How constraining will they likely be?
- How are funds made available on the credit line? For example, one client of mine had no limitations other than dollar amount. However, the maximum line was a fraction of the value of the accounts receivables and inventory. Most credit lines will lend up to an amount based on a formula that in turn is based on collateral values. The catch can be reserves the bank charges that reduce the amount that can be borrowed.
- Now is also the time to review the lender’s treasury and other services you need.
Finally, pick the winner and close the loan.
(There are many important details to closing and documenting a loan; they are beyond the scope of this newsletter.)
Final Thoughts
As in many areas of business, experience counts, so
use a lawyer who is well-versed in negotiating the documents for your type of loan.
Get outside financial help if needed. This can be someone that takes you through the entire process or just develops financial projections to show the lender.
Above all, remember that picking a lender is an important business decision.
It’s a winnowing process, so give yourself ample time to complete it thoroughly.
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