Managing your Business Banking Relationship to Avoid Tough Times.
Last week, I was lucky to be invited to a function hosted by the Turnaround Management Association (“TMA”).
As part of the event, the TMA hosted a panel discussion where two of the panel members are executives of listed companies that had experienced financial distress. These panel members told their own stories of how they turned around their companies and they also shared some of their experiences in dealing with financiers during the distressed period.
In this article, I will share three insights that came from this panel discussion. These insights are consistent with my experiences from within a bank and from the other side of the desk, helping businesses negotiate with their financiers through times of distress. I’ll also share three tips which are based on my experiences.
The three insights are:
1. Financial distress is rarely caused by one isolated circumstance, or event:
It is usually an accumulation of smaller issues that, when put together became a serious problem. The following is a hypothetical example of this point, borne from real situations:
A company involved in the wholesale industry
The Australian dollar moves against the company, making the cost of importing the goods more expensive
At the same time, the threat from online competitors is increasing and price competition is eroding margins.
Over time, the company has invested in property, plant and equipment, some of which is now surplus.
The directors decide that one way to improve the company position is to sell assets however, they find that the prices are low because of the overall economic environment.
The sale of these surplus assets would therefore result in a significant loss.
The dilemma for the directors is to ascertain whether to take the loss, or somehow to ‘ride-out’ the adverse conditions.
2. The experience of dealing with the banks can (will) become unpleasant:
When banks become aware that a business is not travelling well, control of the account moves to a ‘specialist’ area of the bank and the company finds that relationships that have been nurtured for many years suddenly do not exist.
The bank will start to ask a lot of questions because they want to assess the new ‘risk profile’. They will want a lot of information from the company, including financial reports, projections and a clearly outlined plan that details how the company will ‘turn-around’ its fortunes (including a timeframe for the turnaround).
The bank will often engage a professional firm (often an insolvency firm) to help it understand the current position of the business and whether the turnaround plans are realistic and achievable. This means that the level of financial reporting and forecasting increases significantly and can become all consuming (not to mention costly).
3. The key to successfully negotiating with lenders through a rebuild is to communicate.
Lenders want to know how the company is progressing through the ‘turnaround plan’ and they seek constant feedback on what is and what is not working. The last thing that any lender wants is a surprise.
Be urgent in your timeframe to fix the issues, but realistic when you communicate the timeline. Because financial distress is rarely caused by one event, it often takes time to correct the underlying issues. Once you communicate your ‘recovery plan’ to the bank, they will want to measure and monitor milestones and if you fail to meet the timing of your milestones, your credibility will suffer.
1. Forecast and monitor everything within your business:
Plan in advance for the things that could go wrong. This level of planning will not make your business infallible, but it will increase your chances of survival if (when?) things go wrong.
Aligned to this idea is the strategy to surround yourself with different skills and abilities to your own. Use your external accountant, lawyer, insurance and finance specialists. Diverse experience should lead to a better understanding of risks and the ability to identify the risks earlier.
2. Consider your company as if you are the bank:
Directors/ company owners often feel that there is a gap between the factors that are critical to the companies’ success and the type of information that is being sought by the banks. They feel like they are forced to simplify everything into a spreadsheet which ignores all of the non-financial aspects of the turnaround (the human aspects).
The reason for this is that the banks measure your company performance using ratios and other financial measures. Frame your communication in terms of these financial measures and use spreadsheets to outline the financial and non-financial strategies that you will use to return the company to viability.
3. Understand your bank offer documents and negotiate the terms of your loans:
I regularly hear a comment that a business has not met a covenant that they were not aware of. Another frequent comment is that a covenant has been breached due to some legitimate strategy that the business had adopted.
Banks don’t put covenants in place to deliberately trip-up borrowers, but often covenants are put into place that will be difficult to meet. We’ve also seen loan covenants that conflict with each other which means that the company can comply with one ratio and be in breach of another, when the ratio’s are measuring the same, or similar things.
Many borrowers do not realise that many of the loan covenants are negotiable. Before signing a loan offer, vet the document to make sure that you understand the ratio’s and covenants, make sure they are achievable and work out for yourself how comfortably your business is exceeding the covenants. For example, if the bank has a minimum interest cover ratio, work out what your most recent ratio is and how much your profit would need to reduce by to breach your ratio. If there is a realistic prospect of breaching a covenant, don’t sign the letter.
When things are not going well in a business, it can be very stressful for the owners and directors. During these times of stress, often the very last thing that is needed is an overbearing lender. It is important to recognise that your banking relationship is a two-way negotiation. Communicate well with your bank to make sure that the bank understands your business (in good and bad times).
Most importantly, make sure that you manage the bank relationship as you would any significant stakeholder. Negotiate your covenants and keep track on what it would take to breach the covenants, by doing so you will be able to anticipate and communicate any issues in advance,