The pillar of a solid relationship with a lender is honest communication on the part of the small business owner. Whether your business is struggling, or making money hand over fist, it's important that both situations be communicated to a lender.
Recently, I surveyed about a dozen senior, experienced lenders located in Massachusetts, New York, California, Texas, Florida, and Ohio1, on the importance of being honest with a lender in good times and bad. All lenders responded that it is very important to keep lenders apprised of your company's financial health, particularly when it is experiencing -- or is likely to face -- financial problems. Respondents felt that a lender's direct involvement can help a company overcome financial challenges; however, when a business owner conceals the truth, lenders felt they would be less inclined to cooperate -- and more apt to act adversely.
When your company is performing well financially, when it generates sufficient profits and cash flow, and when loan repayment is not threatened, you certainly can get away with some things without jeopardizing your loan relationship. A loan officer will note your behavior for future reference, but he or she most likely will not end the relationship because of it, especially if things have been going smoothly.
Several situations2, however, will raise red flags with your lender, and could cause him or her to re-evaluate your relationship with the bank. These include:
- Purposefully delaying submission of financial statements to conceal that the company has been losing money.
- Borrowing money for one reason but spending it on something else, particularly unrelated to your business.
- Changing ownership in your company without permission of your lender, when your loan agreement stipulates that you have to secure such permission.
- Borrowing more money from other lenders without notifying your existing ones, when your loan agreement prohibits it.
- Cleaning the company's cash to satisfy your personal spending habits and then borrowing money to fund your company's operations.
- Not disclosing potentially damaging situations that lenders can eventually discover on their own. This includes loss of a significant customer or supplier that can adversely impact your company's revenue and profitability; an impending lawsuit that could have a negative effect on your company's financial health; potentially damaging developments in your industry; and personal situations that are likely to hurt your business's financial health.
Any of the above behavior could warrant more aggressive action on the lender's part, including asking you to take your business elsewhere. However, many lenders can be assuaged if you're honest with them, thereby actively enlisting their help in resolving situations before they harm your business and your banking relationship.
Of course, being honest has its risks, but generally, its benefits can be far more helpful to your company.
Risks of being honest with lenders:
- Lenders may limit their desire to give you money in the future if they know that their existing loan repayment is already in jeopardy.
- Lenders may begin to look for additional collateral if they feel that the existing collateral is not adequate.
- Lenders may request additional financial information and request to meet to discuss an already unpleasant topic, bringing more attention to your loan relationship and putting pressure on you to come up with a strategy to resolve the situation.
- If your company is already in financial trouble but not yet defaulting on its loans, some lenders may take it a step further and ask you to take your business elsewhere.
Benefits of being honest with lenders:
- Lenders may exhibit a willingness to be patient and work with you when your company is going through difficult times.
- Lenders may offer alternatives that are often mutually beneficial and allow you to maintain your loan relationship (e.g. restructure your loan term and payment amount).
- Honesty provides additional confidence to the lender that your character and integrity will help ensure a successful loan repayment.
- Honesty also frequently gives you the necessary time to improve the situation and to avoid some of the worst outcomes related to borrowing money, such as bankruptcy and sale of your business assets.
Yes, the risks involved with being honest could result in your damaging the relationship; however, the benefits of being honest could strengthen and establish a lending relationship that thrives today and finances your business's future.
1 The survey is confidential and does not disclose names of lenders or their companies as a condition of participation.
2 In certain situations, particularly such as possible bankruptcy or grave financial problems, I also suggest contacting a lawyer and a financial adviser to develop a strategy that suits you and your company.