How to get your banker thinking about something other than short-term debt
Arranging the wrong kind of loan for your company can make life a terrible hassle. While short-term loans fit a banker's normal way of thinking -- "keep debts short' -- they're not always in your company's best interest. The fact is, many good reasons for borrowing can be the result of situations that dictate intermediate- or long-term repayment plans.
Despite the bias most bankers have toward short-term debt, if you are clear about why you need the money, you can often negotiate other terms. To help you think through your own borrowing needs, let's look at some common reasons for requesting a loan, and the terms that are appropriate for each.
* Rapid growth in sales. Frequently, sales rise faster than profits and/or retained earnings, causing inventory and/or accounts receivable to be higher than the cash available to carry them. If your sales spurt is temporary -- because of seasonal demands, for instance -- then a short-term loan will fit your needs. If the rapid growth is expected to continue for a long time, however, you really need to consider a continuously expanding line of credit based on some ratio of increasing sales, accounts receivable, and/or inventory.
* Expansion into new markets. Normally, a move into new markets does not yield short-term repayments. Bankers usually evaluate your current profits to see how long it would take to pay off an unsuccessful venture. You may be able to negotiate an intermediate-term loan, say from two to seven years, on that basis.
* New product line. Much like an expansion into a new market, a new product is not likely to yield a short-term payback. You ought to structure your repayment -- usually an intermediate-term credit -- based on the profitability of existing lines and marginal gains on the new offering.
* New equipment. If the new equipment will reduce current overhead, then tie your repayment to current profits plus projected reductions in overhead. If the purchase will enable you to expand into other markets or offer new products, see the above suggestions. Your banker will limit the term of the loan to just less than the expected life of the equipment. The answer is to match the repayment to the change you anticipate in your cash flow.
* New plant. Even though you will probably be able to arrange a long-term loan -- over seven years -- based on the long-term value of real estate and buildings, that is not necessarily a good reason for borrowing long term. If you're growing fast, it may not be wise to tie up your cash in a building that you may soon outgrow. Long-term loans should be for stable, mature companies, with steady earnings, that are not likely to expand again in the near future. Otherwise, you may be better off leasing space, with an option to expand or move, and keeping your cash for growing inventory and accounts receivable.
* Completing an unusually large contract. Borrowing to complete a contract can be tricky. Bankers always say something like, "If you fail to complete the contract, how will I complete it?" It is unlikely that the bank will want to finance the whole project and wait for payment until the end. For a large contract, tie the repayment to fulfillment of specific parts, such as the purchase and delivery of equipment. Once you deliver the equipment, you should receive a partial payment and repay the bank. For advances to pay labor, you should also arrange for payment tied to completion of various milestones in the contract -- which will also allow you to repay the bank.
As a rule, bankers do not like to loan new money to a company in trouble. However, if you already owe them money, they may be receptive to providing more, so long as you know what the problem is and what you're going to do about it. If you can provide a good explanation, even a new banker might consider loaning you money. Following are some common "negative" reasons for borrowing, and probable repayment plans.
* Losing money. It's amazing to me how few people come to the bank and start out with the truth: "I'm losing money." The ideal borrower would say, "This is what happened, this is what I'm doing about it, and this is how long it will take my new plan to work." Your loan will likely be short term, matching your action plan. It is possible that your short-term loan will not be fully paid at the end of your action plan, for such positive reasons as a successful sales season resulting in higher accounts receivable. As you describe how you will become profitable again, you can describe the conversion of the unpaid balance into a monthly payout at the end of your successful turnaround. The payout should not extend longer than five years. You should expect any new advances to be very well secured.
* Slow-paying accounts receivable. Often, people who think they are making money really aren't, because they're failing to collect their accounts receivable. Again, your best bet is a short-term action plan, and a payout tied either to collection of specific receivables or monthly payments from ongoing profits, or both.
* Stale inventory. This is very similar to slow-paying accounts receivable. You have to come up with a plan to dump the stale inventory and then repay the remaining debt from ongoing profits.
* Declining sales or narrowing margins. It is possible to be making some money but not enough to service debt that was incurred when sales or margins were higher. Here a new loan may not be the answer. You may need an extension on your existing debt, but only until you can sell enough assets to reduce your debt to a level that can be supported by current profits.
The bottom line in putting together realistic loans with your banker is that you have to go into the bank with more information than the fact that you need cash. You have to be able to explain why you need it as well. Your reason for borrowing will then dictate a realistic repayment plan.
Thomas E. Bennett Jr. is executive vice-president of Stillwater National Bank & Trust Co., and manager of its Tulsa office.
Questions your banker is bound to ask
The first question is whether you're borrowing to pursue a growth opportunity, such as market expansion, or because of a problem.
If the answer is a growth opportunity, think through the following:
* What exactly is your opportunity?
* How much will it cost to realize it?
* If you are successful, how will it affect your balance sheet?
* How much money or other resources are you committing? How much will suppliers provide, and how much do you need from the bank?
* If you are unsuccessful, what are the downside risks?
* How will you absorb those costs?
If you are headed to the bank because of a problem, be prepared to answer these questions:
* What exactly is your problem?
* What caused your problem?
* What are you doing to resolve it?
* How much will it cost to fix it?
* What will be the result of the successful implementation of your plan?
* What are the alternatives if your plan does not work?
* How can you assure the bank of repayment even if your plan and proposed alternatives are unsuccessful?