Your business loan is suddenly due in full. Sounds like a nightmare, but lenders can call your loan even if you’ve never missed a payment, thanks to covenants in your long-term secured debt agreement. These covenants are requirements that the lender sets that you must meet or not do certain things, such as timely reporting on business metrics and maintaining a minimum debt service coverage ratio. Violate the covenant, and you could be declared in default.
A firm that is already in financial trouble can breach a loan covenant unintentionally. When that happens, the lender may exercise remedies that the owner does not want exercised. When you “trip a covenant,” you commit a technical default under the loan and security agreement. With that trigger pulled, the bank can pull the emergency chain. Their toolkit varies: from insisting you hire a restructuring consultant right away, to demanding the whole loan be repaid. If you think there is even a remote chance that your bank might be calling your loans, you need to be prepared. You should understand all the requirements you must comply with or not violate in order to maintain the validity of your agreement with the lender.
The Era of Easy, Cheap Debt
It’s been a long time of easy money. For a decade the US economy has benefited from commercially available loans at attractively low interest rates. The economy is now approaching the end of one of the longest expansions in history. Many believe the era of easy, cheap debt is coming to an end. As it does, lenders are likely to tighten scrutiny of companies and be more stringent in enforcing debt agreements. Will your business last the next downturn?
Red flags for a lender include a drop in revenue, falling cash levels, higher input prices, an overleveraged balance sheet, a shrinking pipeline and backlog of orders, the loss or near-loss of a key account, or a supplier issue. When a business owner sees these warning signs, the lender usually sees them too. Business problems are not like wine. They don’t get better with age. Face them soon rather than later. It’s important to keep an eye on these metrics so you can anticipate any potential issues before they become unmanageable.
So where do you go once the loan is turning sour? It depends on how far along things are. At best, your bank will agree to amend the loan agreement and insert new covenants reflecting your financial projections. Less optimistically, the bank could insist on a forbearance agreement, potentially imposing limits on additional borrowing, capital spending, and distributions to owners. A forbearance agreement gives the company a chance to work with the bank to fix the situation before the bank has to resort to other remedies. Still worse, the bank could demand additional security, require a refinance with a different lender, or even begin foreclosure or liquidation proceedings. And the sooner you jump in, the more control you’ll have over which of those happens.
Restructuring Adviser
Banks often insist that you bring in a restructuring adviser. Before you let them choose, hire your own – especially if there’s a chance you’re about to breach a covenant. You get to pick the consultant, you get the consultant thinking about your issues first, you give yourself time to craft a plan, and you look like a credible party right from the start. That matters more than it might seem. You want to pick the advisor or be a part of selecting the advisor. It is important that you pick the person who you want to help you restructure your business. If you choose the advisor before the bank requires it, it shows the bank you are looking out for yourself and have a plan. This way the advisor works for you and not the bank.
A restructuring advisor is a kind of safety net between the owner and the bank. They begin by assessing the business’s cash flow and, if needed, develop a restructuring plan and negotiate with the bank. The aim is to get a fast, accurate picture of the company’s financial and operational situation, improve performance, put the bank at ease, devise a solution like a refinance, and get the company out as soon as possible.
We don’t want another expense, is the thought running through so many of your heads. We’re trying to survive and now we have to pay someone else for advice. A third party can relieve stress and be beneficial in the long run. In fact, the experts who were brought in early often identified ways of saving money that paid for their services. The sooner you get your advisor on board the more cost-effective the process can be.
A Financial Health Checkup
Where do you begin? With a financial health checkup. Just as doctors check a patient’s pulse and vitals before trying to improve overall health, a 13-week cash flow forecast is a good starting point. It will help you understand your current cash position and help you manage your company’s cash flow and liquidity needs. If you need to make any restructuring efforts, the cash flow forecast will be used throughout the restructuring process to evaluate your performance.
You’ve done the cash flow forecast – what’s next? Covenant sensitivity testing. The financial forecasting models can reveal how close your company is to default on its loans, which covenants are at risk, and when your company would most likely default on its debt under current and predicted business conditions. It also indicates when your company would likely default under a variety of what-if business scenarios.
There is no one size fits all when it comes to a health check. Sometimes all that’s required is a cash flow analysis and that can be completed within a few weeks. But if the cash flow analysis uncovers any areas that could cause a covenant violation, then it may make sense to extend the engagement to help develop a restructuring plan and negotiate with your lender.
Your business loan has been called. Or maybe a covenant was triggered. Either way, you have choices. Lenders are going to ask harder questions and hold owners to covenants with a tighter grip. Move now. Restructuring is possible, even when the news looks bad. It’s important that the business owner stays in the driver’s seat, and that means acting early. Have someone in your corner. Don’t wait for the bank to make a decision for you.
