In the first quarter of 2009, 22% of CPA financial executives said previous sources of credit had dried up, according to the AICPA/UNC Kenan-Flagler Economic Outlook Survey. As a result, many businesses are shopping for new loan sources. Consider the following before you talk to a lender:
Negotiate
and monitor ratios. You know your business better
than your lender does. Covenants usually include a
loan-to-tangible-net-worth ratio and often quick-and-current ratios.
Banks used to pad ratios by 20% to give the borrower wiggle room,
and the borrower would have to be out of compliance for two
consecutive quarters to be in default. “I’m not seeing those kinds
of things being done anymore,” says Sam Thacker of consulting firm
Business Finance Solutions. However, Thacker says ratios can be
negotiated upfront. Ed Lette, CPA, chairman and CEO of Austin-based
Business Bank of Texas, says in order to be prepared for a ratio
discussion with potential lenders, look up ratios provided by the
Risk Management Association. Most importantly, track your key
financial ratios monthly.
Prepare
to be audited. “In the last 12 months we are
seeing a trend where smaller companies are being asked to provide
audited financial statements more than ever before,” Thacker says.
Although it is important to consider all costs associated with
maintaining loan covenants, for an unaudited business to provide
audited financial statements—especially for the first time—is a
major undertaking that can be very costly. It will take many hours
of staff and management time to formalize accounting policies in
accordance with GAAP, train staff, and set up and test internal controls.
Watch
out for a positive cash flow covenant. “One new
covenant that I’m seeing is ‘Maintain positive cash flow measured on
a quarterly basis,’ ” Thacker says. If your business cycle is longer
than 90 days or you are borrowing against lagging accounts
receivable, this could be an unacceptable covenant for your business.
Get
ready for new rate structures. Rate calculation
has changed dramatically in the last six months, according to
Thacker. Traditionally, operating loans and lines of credit have
used a prime + X% rate structure. “As prime went down, many lenders
put a floor in place,” he says. Many are also now using the higher
of the prime rate as published in The Wall Street Journal or Libor
(the London interbank offered rate).
Be
prepared for more stringent “personal guarantees.”
The old standard was that owners who had a 20% or higher stake were
required to sign guarantees, Lette said. Now many lenders require
guarantees from 5% owners and even lower, depending on the company’s
structure. U.S. managers of foreign-owned companies are also likely
to be asked to sign personal guarantees.
Know
what’s typical. Typical affirmative loan covenants
include the requirement to maintain various kinds of hazard
insurance such as property and general liability and to maintain
“key man” life insurance on certain managers. It is common for the
lender to require submission of quarterly or monthly financial
statements, the annual corporate tax return and guarantors’ personal
tax returns. Shareholder loans to the business typically must be
subordinate to the loan, and the lender will require you to maintain
liquidity and performance ratios. All taxes and state fees must be
paid and kept current.
For operating capital loans, lenders will typically want a monthly report of accounts payable and accounts receivable as well as copies of IRS Form 941 (payroll taxes) payments and quarterly 941 filings.
Negative loan covenants typically prohibit: changes in management or a merger without the lender’s permission; a distribution of profits without prior lender approval; further loans from other sources without lender approval; an increase on an owner’s annual draw or distribution without prior lender approval; and the sale of equipment without prior lender approval.
—By Matthew G. Lamoreaux, JofA senior editor. His e-mail address is mlamoreaux@aicpa.org.
