Are you bankable? If so, what amount can you afford to borrow? And at what rate, terms and collateral? Also, which bank(s) do this type of loan? Business owners don't understand the variables or the metrics. It takes a guide.
Within the last two weeks, I've talked to a doctor wanting to do a debt consolidation loan for his practice, a pastor about how much his church can borrow to build a building, and a restauranteur that is being offered the real estate that his restaurant sits on. All these questions come up and business owners really don't understand their options.
So, what are the 5 tips that make your deal bankable or not? Here we go:
1. Do you have skin in the game? The days of banks doing 100% financing (if they ever did) are gone. For real estate 20-25% equity is a rule of thumb, there are exceptions. The same is true with equipment and the same with buying a business.
2. Do you have the cash flow to repay the loan with ample cushion? Banks are looking for your historical cash flow to repay the loan with a 20-30% cushion. Cash flow can be defined from the business only or from the business and the owner combined.
3. Does the collateral you're providing (when margined) cover the full loan amount? Banks are willing to loan 75-80% of real estate, equipment and accounts receivable; less on inventory, but more on cash value life insurance or some listed securities.
4. Does your company have a well proportioned balance sheet and a history of profits? What does well proportioned mean? A fair amount of liquidity (5-7 days sales in cash for example) and less than $4 of debt for every $1 of equity. The last year should be profitable, preferably the last three, in order to obtain financing.
5. What are the prevailing economic conditions in your industry? During the Great Recession, residential and commercial contractors really struggled, many went out of business. Now, these industries are really doing quite well. Is your industry cyclical? Where are we in the cycle and is it expanding or contracting?
Once you've answered these questions, you're halfway home. The next step is to find a bank(s) that is doing the type of lending that you're looking for. Stay tuned for part 2, finding the right bank for your loan.
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Recently, I’ve had several churches that are either looking for a building to purchase or refinancing an existing loan to improve and free up dollars for ministry. It occurred to me that most of my tips and advice are intended for profit companies, but what about the non-profits? If you are one, this article is for you. Here's the top 3 tips non-profits need to know about borrowing money.
1) It’s hard to borrow for operating expenses from a bank. Since the nature of your business is to collect donations from individual and corporate donors, most banks will not loan you money for operating expenses because their repayment will come from the same donations that are employed for your operating budget.
Banks will loan money for buildings or equipment where there is money earmarked in the budget to repay the mortgage or loan whether from excess funds or from a capital campaign of some type.
2) A bank will want to spread the risk of the loan over as many members as possible. The rule of thumb for most banks is they will not finance a building to a church with less than 100 members. Depending on the size of the loan, a rule of thumb for many banks is no one donor makes up more than $50/month of debt service and no one donor contributes more than $2,000 of annual budget. Also, banks look for the total debt to be less than $3,000 per donor.
3) Due to the ministry aspect of your non-profit, most banks will not lend you more than 2.5 to 4 times your annual budget for a building mortgage. They also want to be sure that less than 30% of your annual budget goes toward the mortgage leaving 70% to go toward your ministry budget.
Applying these metrics will go a long way toward helping you be successful on how much a bank would be willing to loan your church and how much you can afford to repay from the bank’s point of view.
Your bank loans have matured and you might be facing a bank forbearance agreement with your bank. You've decided that your existing bank won't provide a long term relationship and you've decided to look in to changing banks.
Probably the first thing you did was to obtain some banking advice on where to find financing and who to talk to. You may have even considered hiring a business banking consultant. The next thing you did was to put together a loan package and make bank presentations to bankers who are likely to approve your loan request. Congratulations your line of credit and mortgage loan have been approved! So, when your line of credit has matured, you have a place to move it to. Your mortgage loan was approved as an SBA loan which has a 90% guarantee with no SBA fees. SBA loans are now an excellent vehicle for refinancing owner occupied real estate loans.
The best place to start when you're changing banks is with the commitment letter provided by the lender. This should give you all the items needed to close your loan. Many times the loan(s) are closed by an attorney, but not always. The most common items you'll need are the following:
- Name, address and tax id number of all borrowers and guarantors.
- Legal description of the real estate taken or any other items taken as collateral, accounts receivable, inventory and equipment. The address where these items are located will be required.
- You'll need a property insurance binder showing the bank as mortgagee on real estate and loss payee on any other collateral take like inventory and equipment.
- Some banks will require the owner to take out or assign a key man life insurance policy with the bank as beneficiary.
- Appraisals on real estate or equipment can be required.
- Sometimes an environmental assessment can be required on any commercial real estate.
There are other items required, but this will cover the majority.
The next thing needed is to cover moving your deposit accounts also. Same company name, address and tax id number are required along with signers' names and social security numbers. If your bank has a separate treasury management person, they will help you with any online banking set up, ACH and/or payroll services. It is suggested that you establish a cut off of your old bank account after you have set up your new account. You may run parallel accounts for a brief time while all of the activity clears your old account.
Changing banks is a pain for most businesses, but with the help of your bank and bankers they can minimize the amount of headache and hassle it can create.
I'm going to talk about a four letter word that makes some squirm, especially when you have to apply for it. Debt. So how much debt is enough and how much is too much? How do you restructure it and under what circumstances is the bank willing?
I have a client with a mortgage on his building at a failed bank. He used his line of credit to get through the economic downturn and needed additional working capital to fund his growth after the recession. We were able to restructure his mortgage, fold the line of credit in to the balance and obtain additional working capital to finance his sales growth. The bank got a good loan and he got the working capital he needed, placed his mortgage with a well capitalized bank and reduced his payments in the process.
Bankers want to be sure you have skin in the game before they loan you money. A good rule of thumb is 25% you, 75% bank and other liabilities. So, if you have $1 million in assets, the liabilities should not be more than $750,000 and your equity should be at least $250,000.
Watch out for intangible assets (goodwill) or shareholder notes or receivables. Depending on the situation, those could be subtracted from your equity which changes the percentages.
There needs to be a good reason to restructure debt. A lower interest rate or payments or obtaining additional credit that wouldn't be available otherwise are all good reasons to restructure. Recently, many banks have not granted credit based on their financial health. So, relocating to a healthy bank to have access to debt would also be a good reason.
Are there any other debt stories out there that may have been a little sticky, but had a happy ending? If so, please share them.
Do you read the fine print in your line of credit documents with the bank? You’ve heard the old expression “the devil is in the details.” That’s certainly true in loan agreements.
I have a client that is renewing his line of credit with the bank. He’s had a hard year and he lost money last year. That loss also hit his retained earnings leaving the company with less equity and the same amount of debt. His leverage (debt/worth) increased. He’s trying to come up with the money needed to bring his payments current and renew his line, $58,000. He has plenty of receivables, but no cash. He’s got some cash coming in, over $100,000, but the timing of that cash is unknown at the moment. He broke several of his loan covenants. Despite that, the bank is willing to renew his line under tighter restrictions.
Banks usually have at least three covenants in your loan agreement. Here’s what they are so you can look for them. Two are related to your financials, one is related to your management and ownership of the company.
- Cash flow covenant: Banks are usually looking for you to have the ability to repay your loans and still have a 20-30% cushion. This is expressed in a term called cash flow coverage or 1.2-1.3x. Be sure you understand how cash flow is defined. Most often it includes profit, depreciation and any other non-cash charges to earnings. Some banks include taxes, some take them out. Same thing with owners withdrawals or distributions. On lines of credit, most banks will define the coverage with the line fully extended, not just the usage. For a term loan or mortgage loan, it's 12 payments of principal and interest. Most banks define this term in their commitment letter, but if they don't it's important to ask. No surprises here!
- Debt to worth covenant: Most banks care about how leveraged your company is. High leverage spells high risk to banks. Leverage is defined as the amount of debt (total liabilities) to the amount of equity (net worth). Most banks like to see about 75% debt to 25% equity.
- No ownership or management change: No change of ownership or management without discussing it with the bank first. The reason for this is the bank may not feel the same way about extending credit if you sell the company or choose someone else to run it for you.
The number of covenants can vary depending on the financial condition of the company, the size of the credit and the bank, but you should see these three in almost every line of credit with any bank.
What other covenants have you seen in your line of credit documents?
Is there anything more important than cash flow right now? I have a client who is merging his business with another firm. He's considering a line of credit to help fund his cash flow, payroll or other expenses. However, there are 5 really good options if you're struggling with cash flow.
Here are the top five ways to improve your cash flow:
- Collect faster. If you have a cash business you can't improve that, but billing more frequently, offerring discounts (2%/10 days) or accepting credit cards could improve your cash flow dramatically. For example, in a $1 million revenue company, collecting your AR one day faster means having $2,777 more in the bank daily.
- Pay slower. If you buy most of your materials on credit and your vendors offer net 30 day terms, take the time. Paying them sooner doesn't gain you anything unless you're on the other side of the discount. If you can take 2% per month that's 24% annually. Every day you can keep money in your bank account vs. your vendor's account helps you.
- Got any excess assets you're not using? Stale inventory can be liquidated and unused fixed assets can be sold to some else. If there's furniture or equipment sitting around collecting dust, you want to turn it into cash.
- Get a line of credit. Up to this point most of the suggestions focus on internal sources. The most common way most businesses improve cash flow is by obtaining a line of credit from a bank. If you have timing differences between income and expenses, a line of credit is good way to go. The best time to get a line of credit is when you don't need it.
- Get a partner. Let's say you've used all these sources and still need cash. If you're tapped out personally because of the last recession, you may want to consider a partner. There are pluses and minuses to having a partner, but it is an alternative when you've exhausted all other options.
How do you improve cash flow for your business?
Just like real estate is about location, location location, business success is all about management, management, management. Today we're going to talk about the importance of a company having a good balance of sales management, operations management and financial management.
I have two clients. Both want to grow. The first had a good operations manager, the finance manager is close to retirement and sales management was left to the CEO. The CEO was more of a visionary and sales management was not his strength. There were trends going on in the business which were missed by the finance manager and the operations manager tried to fill the gaps of sales and finance manager. This is not a good recipe for success.
My second client had a good finance manager. But, she wanted to work part time. Sales management and operations management were left to the CEO and it was a challenge to handle both of these with CEO duties. The company seemed to stall out in sales growth until a full time finance manager and sales manager were hired. It appears that 2014 is going to be a break out for this client.
Does your company have a balanced approach to sales, operations and financial management?
Here's a few questions to ask yourself:
- Who runs sales for my organization?
- Do we have clear goals and a clear differentiation strategy?
- Is our sales model delivering optimum results?
- Do we track sales against goals, weekly or monthly?
- Who's accountable for operational services?
- Is our delivery process achieving high results and client satisfaction?
- If process or systems require change, who handles that?
- Who evaluates industry best practices against yours?
- Do we have a budget?
- Who is responsible for managing results against budget and same month last year?
- Who reviews working capital and cash flow against requirements?
- Who manages all budget plan/reporting plan requirements to insure they're being met?
If there is one of these three that seems to consistently plague business owners most, it's financial management. Be sure you have all 3 M's addressed to insure business success.
Access to capital for business owners is the number one deterrent to hiring people which will reduce unemployment and improve our economy according to the most recent survey by the National Small Business Association (NSBA).
Dating back to 1993, the NSBA provides consistent data that shows a clear correlation to a business's ability to obtain financing with their ability to hire.
Over the last four years, this correlation has been exacerbated because almost half of the survey respondents failed to find access to capital whether its bank financing, credit cards or investors.
The consequences of this are dramatic when you look at the hopes of an economic recovery. Here's why:
The findings of the survey show...
- Hiring remains stagnant. The number of small business owners who project employee downsizing is up to 16%.
- While lending appears to be thawing, one in 4 businesses lack the capital needed to run their business.
- Economic uncertainty is the number one challenge for business owners, followed by regulatory burdens and health care costs.
"These items combined with the failure of Congress to adequately address the deficit and widespread confusion over ObamaCare, there are very few incentives to start or grow a small company," said NSBA chair, David Ickert.
So, how do we get business owners the capital they need to hire and run their businesses?
- First consumers have to start spending again. That won't happen until you reduce taxes and government spending. It doesn't matter what party you're affiliated with. Reagan did it in the '80s and JFK did it in the '60s. It's time for a change again.
- As consumers begin to spend again, businesses will hire to meet demand and unemployment will fall.
- With increased demand businesses will be expanding again, with more profits and will become more bankable.
- Banks will see healthier financials with decreased risk and be able to lend to meet the needs of expanding businesses.
- Banks have more government oversight than ever before with the Dodd Frank legislation. Less government intervention would certainly help the free market forces at work within the economy and make the lending and business climates more favorable.
Those are my thoughts. I would welcome yours.