Manage your loan carefully or you may pay a terrible price.
Manage your loan carefully or you may pay a terrible price.
If you have a business, strong financials, and a good credit history, you probably nodded your head knowingly as you read Martin Mayer's January article, " A Borrower Be," about the sudden eagerness of banks to lend to small, growing companies. In all my years in business, I have never seen a banking environment like this one. I get an average of two calls a day from bankers trying to lend me money at terrific rates. It's wild. I doubt my situation is typical, however. Many readers, I suspect, read Mayer's article in wonderment and asked themselves, "What am I doing wrong?"
While it may be the best of times for some small-business borrowers, it's the worst of times for others. I personally know of three companies that have lost their banks in recent months. One company was dropped by a bank it had been doing business with for 50 years. Another company was asked to leave when its bank decided it would no longer do receivables financing. Yet another was given the bum's rush because its principal customer was considered a poor credit risk.
So why are banks falling over themselves to lend to some small companies and dropping others like hot potatoes? It's all about capital availability, credit standards, and the sluggish economy. For reasons Mayer explained in his article, banks have tons of money to invest and relatively few places to invest it productively. If your company is in good financial shape, lenders are eager to sign you up. The problem is, a lot of small companies are struggling these days. If your performance isn't up to par, you're out of luck. Meanwhile, loan defaults in the past year have led some banks to stop offering the kind of credit -- notably receivables financing -- that small companies typically need.
Of course, knowing that doesn't help you much if you're in danger of losing your bank. I've had my loans called twice in my career, and I wouldn't wish the experience on anyone. That said, one experience was much better than the other and helped me understand what you can do to protect yourself in times like these.
The first time I got dumped was in 1985, when I had a messenger business that was growing like crazy. I thought I had a good relationship with my bank until one day, without warning, it notified me by mail that I had 30 days to pay off my loans. I called my loan officer and said, "What the hell are you doing? Couldn't you at least call me?" He apologized and then essentially told me to get lost. The bank, he said, was getting out of receivables financing and didn't want my business anymore. Banks can do that if you're in violation of any part of your loan agreement, or if your credit line is coming up for its annual review.
The next experience, in 1995, was far more pleasant. Again, I had receivables financing from a bank that was changing its policy and getting into new lines of business. This time, however, my banker came to me and explained what was coming. "We're dividing our customers into three categories," he said. "The first group consists of those we definitely want to keep. They're good companies, and they fit into our new business plan. Second are the customers we should never have taken on in the first place. They have 30 days to get out. The third group is another story. It includes good customers like you who just don't belong here, given our new direction. We'll help you find a new bank, and there's no pressure. We'd just like to make the transition in the next six months, if possible."
His comments were a revelation to me. I suddenly understood what had happened the first time around: I'd landed in group two. Looking back, I realized that I could probably have talked my way into group three if only I'd kept my cool. As it was, my behavior no doubt confirmed the bank's decision to get rid of me as soon as possible. There are many entrepreneurs who make the same mistake.
In fact, I can think of seven mistakes that business owners make in dealing with their bank, often without realizing the damage they're doing to an important relationship. Avoiding those blunders can save you a lot of grief. Granted, your bank may still decide to drop you someday, for reasons beyond your control, but you'll have a much better chance of winding up in group three.
Mistake No. 1: Submitting financial statements late. To make sure a bank is following the rules, regulators check its records at least once a year, and internal examiners look at them quarterly, or even monthly. If you don't submit your financial statements when you're supposed to, your records will be incomplete, and you'll create problems for your banker, who gets rated on the accounts he or she is monitoring. That's a strike against you.
Mistake No. 2: Running on uncollected funds. To avoid drawing down their credit line, and paying interest on it, some companies will deposit checks they receive and immediately start spending the uncollected funds, which has the side effect of keeping bank balances low. A company may save a few bucks in the process, but it does so at the cost of alienating the bank, which is deprived of income it's entitled to. That's another strike.
Mistake No. 3: Being unresponsive. Bankers often have questions about your financial statements, and you may not know the answers. Some people get annoyed or defensive when asked to explain their financials. Instead of having an accountant provide the necessary information, they try to talk their way out of the situation, giving lame responses that don't add up. When the examiners come in, the banker is asked the same questions, can't offer satisfactory answers, and gets hammered as a result. Another strike.
Mistake No. 4: Neglecting the relationship. When you don't need anything from your bank, it's easy to ignore your banker. There are always plenty of pressing matters to focus on. But by the time you do need something, it's often too late. That's why it's important to meet regularly with your banker. My partners and I make a point of sitting down with our bankers at least once every three months.
Mistake No. 5: Failing to keep the bank adequately informed. Bankers don't like big, bad surprises any more than the rest of us do. They understand that unexpected things happen in business, but many problems can be anticipated, and bankers want to have as much advance warning as possible. Bankers also need some reassurance that you're in control of your business. If your projections are way off year after year, your banker will conclude that you don't know where your business is heading -- or, worse, that you're being dangerously optimistic.
Mistake No. 6: Ignoring the rules. When a bank lends you money, the loan comes with strings attached -- namely, the covenants contained in the loan agreement. A lot of people don't understand the covenants, or forget about them, or simply ignore them. I know one guy -- let's call him Marvin -- who decided, with his partners, to have their company give them a $500,000 bonus so that they could avoid having to pay taxes twice on the money (if they'd instead taken the money as a dividend, the company would first have had to declare the $500,000 as earnings and pay corporate taxes on it, in addition to the individual taxes that would then be owed). Unfortunately, they overlooked the effect that the payout would have on their debt-to-equity ratio. By reducing their equity in the company, the bonus caused the ratio to soar way beyond the limits allowed by the bank. When their banker told them the company was out of ratio and they had to correct the problem, they were outraged. The bank, they said, had no right to tell them what to do.
That was also an example of...
Mistake No. 7: Arguing when you're wrong. A lot of businesspeople think they're entitled to the money they borrow from a bank -- especially if they've been good customers for a long period of time. But banks have the right to get their money back when borrowers violate their loan covenants. After all, those covenants are there for a reason. A bank is also required to follow certain rules. If its loans don't measure up to federal standards, it could wind up with serious regulatory problems.
Nor does it help to protest when a bank changes its lending policies, as happened in my case. Arguing won't bring the old policy back, any more than outrage will make a bank forgive you for violating your particular loan covenants. On the contrary, by becoming a pain in the neck, you give the bank another reason to throw you out. That's exactly what happened to Marvin.
Understand, none of the mistakes that I've mentioned is fatal by itself. Even Marvin could have salvaged his banking relationship if he'd stayed calm and come up with a plan for getting his company back in ratio. Just as it takes time to build a relationship, it also takes time to break one up. One mistake compounds another. The damage is cumulative, and it is often invisible. You may not know exactly where you stand until a letter arrives one day, or the banker calls, and you find out you're in group two or group three.
Perhaps you'll never get that letter or call, but if you do, let's hope you land in group three. In business, as elsewhere, it's a lot nicer to be shown gently to the door than to be given the boot unceremoniously.
Norm Brodsky welcomes your comments and questions. He is a veteran entrepreneur whose six businesses include a three-time Inc 500 company. This column was coauthored by Bo Burlingham. Previous Street Smarts columns are available online at www.inc.com/keyword/streetsmarts.
Please E-mail your comments to email@example.com.