Lender Relations (#124)
/In this podcast episode, we discuss the best way to handle a long-term relationship with a lender. Key points made are noted below.
Set Expectations
The first point with lenders is setting the proper expectations, and that starts with the initial meeting when you’re trying to set up a relationship. When you first describe your company to a lender, try not to be too optimistic about the company’s prospects. The problem is, that if you convince the lender that you’re going to take over the market and be bigger than IBM within three years, then that’s what they’ll expect you to do. And that means that every time you send them a financial report, it’ll be below their expectations, no matter how good the performance actually was.
This is not a minor point. I’ve worked for a couple of CEOs who gave some overwhelmingly optimistic presentations, and then I had to spend time talking these excited lenders down to a more realistic set of expectations. This doesn’t mean that you’re always cleaning up after the CEO. It’s worth your time to explain matters to the CEO in advance, and try to get him to understand that setting reasonable expectations is better for the long-term relationship.
Now, a part of those initial meetings with lenders will be a discussion of the company’s business plan, or budget. The same problem arises here. If you hand over a budget that shows a massive increase in sales and profits, then not only does the lender get very excited, but he’s also going to assume that your borrowing needs are going to be astronomical, since fast growth implies the need for a lot of cash.
So – first point - be prudent in setting expectations.
Limit Lender Covenants
My next point about lender relations is to fight back on loan covenants. This is the part of the loan agreement that says the lender can call the loan if certain things happen, like falling below a certain current ratio. If the lender sets the loan covenants anywhere near where your metrics currently are, then there’s a really good chance that you’ll blow through a covenant, and then you’ll have either an unhappy lender or a lender who wants to revise the terms of the loan. If you can’t avoid the covenants entirely, then this is a good time to negotiate the most liberal covenants you can get, so you have some breathing room on the numbers.
Limit Lender Reporting
And another thing you want to set is the minimum possible amount of financial reporting to the lender. The intent here is not to keep financial information away from the lender. Instead, the point is that the average business is going to have a bad month every now and then, and that’s just the way it is. But if you send out quarterly financials, the chances are pretty good that the bad months and good months will have evened out during the quarter, so you have better odds of reporting three months-worth of decent results. And that means no surprises for the lender.
Communicate Regularly
So, once the relationship is in place, what can you do to maintain relations? Well, a key issue is constant communications, which can come in a lot of forms. For example, if you send over the quarterly financial statements, it helps to do a follow-up call to ask if you can clarify the information. Or, do a scheduled quarterly or semi-annual lunch to discuss the business in general. Or, call every now and then to inquire about purchasing some additional services.
So, to clarify what I’ve said so far, lender relations is kind of like a speech. You use a conservative forecast to tell the lender how the company is going to perform, and then you report back that you did just what you said you were going to do. If you can do that consistently, lender relations will be good.
How to Deal With Poor Results
So what about when things go wrong? Well, you still have to look at the relationship as a long-term relationship, and that means you have to talk to the lender about the problems you’re having, and as soon as possible. The worst thing you can do is use some accounting trickery to push the problems out into the future, because all that means is that the problem will be even bigger by the time you finally tell the lender about it.
And their reaction will be, why did you wait so long to tell me, you miserable bum? And also, if you dump a really big crisis on them at the last minute, how likely are they going to be to work with you to resolve the problem?
So you do the reverse, and keep them informed up front. If you take that approach, you’re keeping the level of trust as high as possible, and you’re also giving the lender some time to see if there needs to be a workaround for your debt.
Now you may say that the lender has to work with you in a crisis, because what other choice do they have if they want to see their money again? Sure, that’s true – but you have to think long-term – after you get through that crisis, the lender is going to drop the relationship for certain, because you didn’t keep them informed.
Centralize Banking Activity
On to another topic. Let’s assume that the lender is a bank. The bank will want you to shift all of your banking business over to it as soon as it extends you a loan, so that it can earn fees on all of your other banking activity. And that’s an accepted part of doing business with lenders.
If you have a lot of banking activity, you might want to consider bending over backwards to shift even more banking activity over to the lender than they expect. When you do that, the amount of fees that the lender makes from the entire relationship starts to look pretty nice. And that helps when you want better loan terms. So if you make the relationship more valuable for the lender, it might be more willing to work with you over the long term.
Avoid Playing Off Vendors
And while I’m on the topic of fees, do not try to play lenders off against each other to get the absolute best possible price, and then keep doing it over time. If you have that kind of track record, lenders won’t be interested in a long-term relationship, and they’ll back out on you just when you need them the most. Instead, give them a fair profit.
Parting Thoughts
So in summary, the best lender relationship is based on not overly optimistic expectations, lots of communications, and giving the lender a fair amount of fees. Or, to flip that around, the worst relationship is based on absurdly high projections, no meetings, and pounding on the lender to cut fees down to the last penny.