How to Improve Your Lender Communications

Good?communications?with?a?company’s lender is always critical to?the?relationship.?But what exactly is “good lender?communications?”?Today’s newsletter answers that question and provides tips on how to do it well.

Lenders want to know three things about you and your business:

#1. Can your business pay back?the?loan??Most lenders rely on cash flow for payment. Back-up sources include collateral, accounts receivable, and fixed assets. Even asset-based lenders prefer to get paid by cash flow. So, lenders look at some variation of?the?fixed charge coverage ratio?and are also concerned about collateral.

#2. Are you financially on top of your business??That means from?a?financial perspective, you know where?the?business has been and where it is headed.

#3. Can you and your business?be trusted??That means doing what you say you will do, always taking?the?high road, and respecting your business partners (in this case,?the?lender).?

A?business’ lender?communications?should strive to answer those three questions.?Doing so requires remaining in financial control of your business.?Not only do lenders want to see this, but without financial control, it is hard to satisfy?the?lender’s other requirements.?

This means…

Have timely, accrual-based financials and review them monthly.?

“Timely” means no later than?the?second week after?the?fiscal month end.?Any later than that and you can’t react quickly enough each month to have an immediate impact.?

Many years ago, in my first controller assignment, financials were reported by noon of?the?third day after month end — and that was with?a?manual?general ledger and?the?company consolidated results arriving via telex! So, no excuses these days. Of course,?the?financials should be accurate. (Lenders know they are not when there are lots of month-to-month variances explained as “missed expenses.”)?

Have annual GAAP-compliant financial statements prepared that are reviewed — ideally audited — and (at?a?minimum) compiled by an outside CPA.?

Why? In one client situation,?the?senior?lending?officer told me he liked?the?company and?the?owners, but unless things changed,?the?loan needed to go. So I brought on?a?regional CPA firm to audit that year's balance sheet and?the?next year's financial statements.?That gave?the?lender confidence in my client's ability to meet its commitments and they agreed to stay in.?

Know where your business is headed from?a?financial perspective.?

That starts with?the?business knowing where it has been — good, timely financials are?the?starting point.?The?income statement, balance sheet, and cash flow should be projected periodically as well as any required covenants in?the?loan. Lenders will often require an?annual budget or projection?in?the?loan agreement. Don’t ignore?the?balance sheet; lenders look at it and it should matter to you, too.

Understand?your lender?and their position.?

Are they?a?regulated bank or?a?direct, non-bank lender??

Banks are highly regulated and restricted in what they can do?because most funds they lend are from deposits such as checking accounts and CDs. They fundamentally borrow short and lend long. As such, they are subject to bank runs, which means they don’t take?a?lot of credit risk and can’t lend very long.?So if your business heads south, banks will take actions quicker than?a?lender that can take more credit risk.

Non-bank lenders are funded by investors with?a?different time frame and risk appetite.?They can do different things, however their investors have different requirements. It is important to understand exactly what niche they want?the?lender to lend in — don’t expect them to stray from that.

Respect?the?relationship.?

If you have several lenders, understand?the?relationship among them.?Who has liens on what collateral and who gets paid first in case of default?

If several lenders are participating in one loan, one of them is typically designated as?the?agent and is responsible for administering?the?loan and communicating with?the?other loan participants. Rarely does it make sense to go around them.?The?agent has responsibilities to?the?loan participants and if they fail at those responsibilities, they can be on?the?hook to?the?other lenders.

Report bad news early.?

Waiting, particularly if?the?lender will soon find out, is?a?great way to undermine trust and damage your relationship with?the?lender.?

For example, one of my clients was scheduled to close?a?refinancing with?a?new lender on great terms. But on?the?Friday afternoon before?the?scheduled close, my client received?a?surprise notice from?the?IRS about?the?filing of?a?significant lien on all assets. Frankly, my client probably could have closed?the?loan before?the?lender learned of?the?lien. Instead, first thing Monday morning, we talked to?a?special tax accountant, determined it was?a?common IRS Covid snafu, and developed?a?plan of action. Then we called?the?lender.?A?minor change to?the?loan documents was made and?the?loan closed as scheduled. Not surprisingly, this action increased?the?lender’s trust in my client tremendously.

Read?the?loan agreement.?

Yes, it is long and boring. But?the?document contains things you agree to do (e.g., reporting deadlines) and agree not to do?(e.g., breaking financial covenants, making unauthorized distributions, acquisitions, not taking out new loans).?

Often,?the?agreement will require that certain services such as deposits, credit card processing, and so forth be done with?a?particular company or bank. You can’t do what you said you would do (a?key element of trust) if you don’t know what?the?company is supposed to do.?

Manage expectations.?

Lay out risks going forward, so if they materialize,?the?lender is not surprised. Be conservative with projections. If you are planning on major changes in your business, tell?the?lender?before?you make them so they are not alarmed when they occur.

Be as transparent as necessary, but no more.?

While I am?a?big advocate of transparency with lenders,?there is no need to give them?a?spotlight when?a?candle or flashlight will do.

Above all, remember that?a?loan is both?a?contractual agreement?and?a?relationship.?Understand, respect, and perform what your company agreed to do. But don’t forget that lenders are organizations of people, so it is important to build and maintain that relationship.

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Charlie Goodrich is Founder and Principal of?Goodrich & Associates, a management consulting firm that specializes in helping its business clients solve urgent liquidity problems. He 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.