Businesses have increased borrowing levels to the point where debt outstanding for nonfinancial businesses was over $15 trillion as of September 2018, according to Deloitte. Businesses borrow for a number of reasons: to buy assets such as equipment and real estate, to acquire other businesses, to support working capital, to expand into new segments and geographies, to return capital to owners and a variety of other reasons. If a company needs to borrow, the questions are many, including where and how much to borrow, which terms are most important, and how to work with a bank or other lender.
Where to go to borrow money: Today’s financial system has more options than ever for the business owner, but the important factor here is doing your homework and making sure the person and firm you are dealing with have integrity and a good track record. Ask your network for references, and make sure to ask a lot of questions. Sometimes the lender that offers the lowest pricing or loosest structure will be the one in trouble when the economy turns or unwilling to ride out the cycle with you because the debt structure is inherently riskier. Get to know different lenders so you have someone to turn to in the event you need to make a change.
How much to borrow: Weigh the risks of taking on too much debt vs. potential missed business opportunities. Generally, banks will look at some combination of your cash flow for priorities such as debt service, the collateral or other support you can provide, and the level of debt to a rough cash-flow proxy. Lenders will set covenants based on what you project (and their comfort level), so it is important to be open about future plans. If your financial performance is poor, the lender may not be willing to waive a default, so it is important to think through different scenarios. You want to be able to focus on running the business vs. what your bank needs.
Which terms are most important: This must be decided before you start accepting term sheets so you can outline your priorities. A skilled banker can help you think through the questions you need to address. Is a lower annual payment more important than the interest rate? What kind of capital expenditures do you have planned? Are there distributions needed to pay taxes or support the owner’s family? Is more debt better than flexibility in covenants? There are tradeoffs inherent in different structures such as amount of debt vs. pricing and/or limitations on spending for capital expenditures or distributions to ownership. Creativity is a key attribute you need from your banker so you can live with the tradeoffs.
How to work with a banker: The most important factor is building a relationship based on trust and communication. Don’t wait to share bad news. Additionally, make your banker a partner. Experienced bankers will have knowledge to share best practices, foresee economic trends, introduce you to valuable strategic partners and show you how to take the next steps to grow your business. They can even walk you through the steps to transition ownership or sell your business. New banking technologies can save you money and allow you to improve cash flow. Your lender should know you will be looking at alternatives to keep pricing fair, but make sure you are sharing profitable business with your most important capital providers so you get support when you need it. Do not feel that you have to have an immediate need to meet with a banker. The job of a good banker is to develop relationships and add value over time, not walk in and immediately sell a product or service.
According to Federal Reserve Chair Jerome Powell, “Business debt is near record levels, and recent issuance has been concentrated in the riskiest segments. As a result, some businesses may come under severe financial strain if the economy deteriorates.” Now is the time to do a complete review of your balance sheet and make sure you are getting everything you need from your lending relationship.
The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the views of Mutual of Omaha Bank. For any matters concerning your specific needs and objective, you should seek the professional advice of your own independent legal counsel, insurance advisers or other consultants.
For more information, visit www.mutualofomahabank.com.
