In our previous article, we discussed the need for middle-market companies to have both working capital and capital to fund their growth to become a successful entity. But how do you start? What are the essential steps you should take to obtain the financing you need for your company?
3 Essential Steps to Help Your Company Get and Keep Bank Credit
1. Find a banker who can understand your business.
To take advantage of an opportunity to get bank credit, a business owner must first of all understand and be able to explain his/her own business’s operating model and earning cycle. As a borrower the cash flow that results from turnover of your assets is the basis of your ability to service and repay debt. Profitability or net worth displayed in your financial statements is much less relevant to your ability to repay than asset turnover.
A simple definition of asset turnover: how quickly you pay vendors for goods and services versus how quickly your customers pay you. It makes no sense to borrow on 90 day notes when it takes 120 days to turn your assets and collect cash. Nor does it make sense to finance long term assets like plant and equipment or real estate by borrowing under a working capital line.
Lenders who know your industry and are prepared to understand what is distinctive about your business will best serve you. Avoid lenders who make decisions solely based on an automated credit scoring model or by-the-book industry and company analyses. The right lender for you is the one who takes the time to understand the purchasing, earning and collection cycle at the heart of your business. Asset turnover varies by industry:
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A jewelry store turns over its inventory only twice a year whereas a clothing store turns over its inventory faster.
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Services companies may have seasonal fluctuations and their service hours are perishable.
You want a lender who will assess your business for creditworthiness on its own terms, then work with you to identify the right amounts and maturities for financing your needs in the short and longer term.
2. Take control of the process.
Take the initiative to create a term sheet that you can take to banks, which explains what you need. Have in hand basic financial statements, including clear footnotes and documented financial control policies. Present your key metrics: cash flow; sale to cash and purchase to payment cycles, inventory holding period/turns, etc. Be ready to provide projections of your growth plan for the next one to three years, with enough detail to be believable.
It’s best if all this is part of an overall business plan. The plan does not have to be voluminous but should address: keys to success, target customers, sales/marketing plans; development of leadership team and evolution of infrastructure. Be very clear as to your intended use of loan proceeds and how they will be paid back.
Be prepared also to present an analysis of your operating margins and the quality of your earnings. Be ready to explain the capabilities of your current management team and how it is capable of executing your growth plan. Be ready to explain the capabilities of your management team and how you will leverage it without expanding payroll, as your company grows.
3. Identify the risks of your business.
Include this in your loan request package as a separate exhibit. When a banker develops a credit write up about your loan, he/she must identify the business risks and hopefully the mitigating factors. Take the initiative to present an analysis of how you transfer, mitigate and manage the risks of your business. This will highlight your managerial competence and facilitate loan approval.
For example, if your financial statements show that your profitability is narrowing, share your plans to diversify your customer base and build more pricing power. Be prepared to explain your pricing predicate and model: cost plus, value based, royalty-based, etc.
Contributing Authors
The below Newport partners came together to share their expertise concerning middle market companies and their need to find and keep adequate funding.
