How to Get a Loan for Your Company
The reasons for the need for new financing were mixed and involved companies ranging from small family owned businesses to those with institutional backing.
Despite the difficulties that had been encountered by the various borrowers, we were successful in obtaining new loans for all of them.
What constitutes a small or a mid-market business? The answers are a varied as the answers, but Gartner Research categorizes a small business as having up to $50 million in annual revenue, and a mid-market business as having up to $500 million in revenue.
Definitions Are Important …
The definitions are important because matching the loan request to the lender and their characteristics is the beginning of a successful loan presentation.
In almost every case, a business has a banking relationship. At the simplest it represents what are known as treasury services; checking, payroll, and other money transaction services. And the bank that provides those services is often the first place a company goes for a loan. And if the company is healthy enough, and the loan is of a size to be interesting to the bank, then everything runs smoothly. Until something goes wrong.
We Found Some Commonalities …
In looking at the companies we worked with that needed new lending facilities, we found some commonalities. Most were in violation of one or more covenants of their loans. The covenant(s) may or may not have been appropriate for the company, but the company had agreed to it.
All were either unprofitable or at best, marginally profitable. Most, but not all, were family owned.
And Without Exception, All Were …
And, without exception, despite their perceived and real problems, they were all credit worthy. Also, without exception, they presented their loan requests ineffectively.
Making an effective loan presentation to a lender is one of the least understood concepts in the small and lower mid-market. The borrower is often told to “create a Business Plan” and to include various required documents. This generic approach is more often than not going to end up in a rejection.
Lenders want to be assured that; a) your business will repay the proposed loan and
b) that there are sufficient assets to pay off the principal should the loan go into default.
In small or family owned mid-market businesses, the lender wants assurances that the owners will pay the loan if the business fails to.
It is your job to provide the lender with these two assurances in a clear and concise format. Lenders reject loans when they do not understand the risk or the risk is greater than acceptable to the lender.
Before You Apply …
Before you apply, know the lender you are talking with. There are lenders that provide; cash flow loans, asset based loans, factoring, subordinated and mezzanine loans, and second lien loans. A presentation to each type of lender would emphasize different factors and strengths within your company. Looking at some key differences…….
A Cash Flow Loan …
A Cash Flow loan is made to a company on the basis of their expected cash flows. These loans often involve minimum loan thresholds or lending commitments that are not specifically tied to a borrowing base or the value of specific collateral that secures the loan. While most middle market cash flow loans are secured, the lender relies on the borrower’s ability to operate their business in a cash positive manner. These loans often have financial maintenance covenants such as minimum EBITDA requirements, fixed charge coverage ratios and leverage restrictions. A pure cash flow loan is generally offered to a very healthy company, mostly at the mid to upper end of the mid-market.
An Asset Based Loan …
An ABL or Asset Based Loan in its simplest form is a loan sized as a percentage of and secured by certain assets of the borrower. These assets are typically accounts receivable (A/R), inventory, and in some cases property, plant and equipment (PP&E). Depending on the borrower and industry, lendable assets may also include items like intellectual property and other assets. Borrowing availability and capacity is limited to a percentage of the realizable value of these assets that meet defined eligibility criteria of the lender. ABL structures may offer significant advantages in difficult financial situations. Most notably, they require fewer and less onerous financial covenants including “covenant lite” structures. One disadvantage of an ABL structure is that lenders require frequent and detailed collateral reporting including borrowing base certificates, A/R aging reports, field exams, etc. in addition to the usual financial reporting associated with cash flow loans. This obviously creates additional cost to the borrower.
Most Loans Are Established As A …
Most Cash flow and ABL loans are established as a revolving facility. A revolving facility provides the borrower with a maximum amount that may be borrowed, paid back and re-borrowed over a specific amount of time, typically 3 -5 years. The borrower usually pays a commitment fee that is substantially less than the interest rate on the unused portion of the revolving commitment.
It is important to note that a lender may refuse to fund under a revolving facility if certain conditions are not met. These include an event of default, a borrowing base that does not meet or exceed the outstanding amount borrowed (overdraft) or a material change in representations and warranties.
Unlike a secured lender where the lender takes a lien on the assets of the borrower to secure repayment, a factor actually purchases A/R from the borrower, sometimes taking the risk of loss on the receivable; other times with full recourse. The sale of the A/R is priced at a discount which is usually higher than the comparable rate of interest on a secured loan. This higher cost factoring is primarily used by borrowers that do not have access to less expensive financing options. Factoring is sometimes characterized as “lending of last resort” and in some cases may carry the stigma that the borrower is financially unstable. However, for companies with no other options, factoring provides a solution to speed up cash flows and provides financing to continue operations.
The Following Rules Apply …
To get the loan that fits your business, the following rules apply:
- Know your banker before you apply. Determine how they will underwrite your loan and make certain that your financial statements comply with that particular banks underwriting criteria. Always add comments where you can focus on items that exceed their criteria.
- Some underwriting conditions are flexible. If you have issues, don’t just submit your loan request, but work with your banker.
- Be flexible. Often a loan will underwrite by changing the deal. Typical changes include reducing the loan amount, raising more equity, or offering addition or personal collateral.
As we have experienced with our recent clients, there is an appropriate lender for almost every company. It’s knowing the right lender, the right criteria and the right presentation before you ask for the loan.