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How Do Banks Exert Control and Influence on Business Loan and Working Capital Facilities

Most business owners and financial managers aren’t necessarily aware of the methods and factors that banks utilize to control and monitor their loan facilities with commercial customers. We are talking about two types of loans essentially, term loans, and also operating lines of credit, also called ‘revolvers’ by some. (Revolver – the credit line revolves, it goes up and down on a daily basis…)

Banks essentially use several different strategies to ensure they have maximum control and influence on the business borrower.

Banks often are reluctant to allow maximized borrowing from other parties for asset growth. Why? This is because when a customer has to service the additional non- bank debt they might be unable to service the banks loans. Banks have very well known and published cash flow ration and they want to ensure their customers can meet these rations on the bank debt. Naturally if a bank feels comfortable with a customer growth and cash flow profits they are much more likely to approve a third party financing. If they aren’t comfortable they may ask the company to at lease temporarily defer bonuses, dividends, or, in the case of a public company, a stock repurchase.

Bankers of course usually know the company very well, as a relationship and financial history has developed over the years. They will often want to have input into the company’s growth direction in an effort to ensure the customer is not going down a path that in their opinion, might lead to liquidity loss or profitability loss. This sort of ‘advice’ from a bank can come in a number of manners, one of which is simply providing a debt to equity ratio that cannot be overlooked by the customer.

Business owners know that it is no ones best interest for the bank to trigger a default on a loan – it’s clearly a case where both parties have a lot to lose. However if a bank feels on a number of fronts that the customer is spiraling downward they will take steps to ensure their loans are provided for.

What are some of those downward spiraling scenarios? They include:

Cash flow deterioration

Asset erosion

Working capital problems

Again, the worst case scenario is the bank ‘calling the loan ‘. We have agreed this benefits no one, so the bank usually prefers (as does the customer!) to return to the bargaining table. At this time business owners are strongly cautioned to prepare a corrective action scenario to satisfy the bank. It is at this time that the bank normally considers an interest rate increase, or more restrictive covenants.

We also want to point out to business owners that banks want to ensure that there is a proper ‘ matching ‘ of financing. By that we mean that the bank does not want the customer to borrow short term to finance long term scenarios. For this reason working capital ratios are put into place.

Finally banks utilize whets known as a ‘negative pledge ‘clause. This forces the company to consult the bank when pledging other assets or selling unencumbered assets. If such sales are agreed to the proceeds are usually used pay down the bank.

In summary, it benefits business owners to understand the whys and wherefores of bank strategy and influence and control around business loan scenarios. Understand where the bank is coming from allows a business owner to more proactively plan financing growth with a view towards successful financing.

Small Business Loans and Bad Credit

Do a search about business loans and bad credit and you will see result after result touting some way or another where you can fool the banks and lenders into giving you a business loan.

Follow those results and for the most part you will only end up poorer (paying those companies or individuals a fee) and still not getting the business loan you want or need.

Banks and lenders use credit histories and credit scores as a time saving measure. You request a loan, they pull your credit. If your credit is bad or below their threshold, they don’t waste anymore time on your deal request and can move on to other deals that have a better chance of getting funded.

I deal with entrepreneurs everyday that complain about how their bank or a private lender just won’t look at their deal because they have bad credit. I constantly hear the same thing:

“Why won’t they just look at the merits of my business and not focus so much on my personal credit as it is my business that will be paying the loan back!”

My answer is always the same:

1) That is how the financial markets work, and

2) If you want to get approved based solely on the merits of your business then find the right business loan that focuses only on the merits of your business.

Sounds simple and it really is.

Yes, there are business loans (and other types of business financing) that either do not look at your credit at all or if they do, do not place much weight on it (great for those credit scores that are borderline).

Let’s look at three examples:

1) Accounts Receivable (Invoice) Factoring: Your business writes an invoice for goods already shipped or delivered to your customer but you have to wait 10, 30, 60 days or more to get paid. Then, factor those invoices and get your cash today so that your business can pay its employees, suppliers or to complete that next job.

As your business has already completed the job and shipped the goods and is merely just waiting to get paid, the lender has no reason to even consider your credit history. Instead, they focus on the next cash event – which is your customer paying you. If your customer shows a strong promise to pay as agreed, then your loan request should be approved (without pulling your personal credit history).

2) Purchase Order Financing: Your business has already won over the customer and you have their job order in hand only to realize that your business does not have the cash on hand to purchase the materials and labor to complete that order.

Factor that job (purchase) order for up to 100% of the cash you need to complete it. When the job is done and you collect payment from your customer, you pay back the advance and keep the profits to be plowed back into the next deal.

Again, since your business has already demonstrated that it can win business, the focus of this loan approval is not based on your personal credit or the cash position of your company but in the next cash event – when your customer receives the completed order and pays you.

3) Business cash Advances: If your business accepts credit card payments from its customers, then your company could qualify for a business cash advance; based on your company’s ability to continue to get customers to purchase your goods and services.

Based on past results (your business’s past results and not your personal credit history), your firm could receive a cash advance to be used as working capital to re-stock inventory, pay employees, generate new business or whatever your business so desires.

And, since repayment of this advance (loan) is based on future cash flow from your credit card paying customers, these lenders are not that concerned with your personal credit scores but more concerned about your business’s ability to keep getting those paying customers in the door (which is what you wanted – a business loan based on your business results and future potential and not your past credit mistakes).

Now, while Business Cash Advance lenders place the onus of their loan/advance decision on your future cash flow potential, they may still pull your personal credit. The reason is that should your business shut down tomorrow, they want to be assured that you will still pay them back.

But, if your credit score is border line or just a bit below what a traditional lender requires, then a Business Cash Advance just might be the financing kick start your business needs.

These small business financing options were designed for businesses and business owners just like you – whether it is bad credit or a lack of cash flow or whatever reason a traditional lender states why they declined your loan request.

Thus, if you are one of the many that want a lender to focus their loan approval on your business and not on your credit, then seek the right business loan; a loan that has no reason to focus on your credit (as you and your business have already done the work) but focuses more on the merits and wherewithal of your company’s future potential.