Despite the barrage of recession-related doom-and-gloom stories, financing is still available for family-owned businesses. Many healthy banks are hungry to lend to the right clients. Even in these trying times, business owners who do their homework can find a stable lender that understands their industry.
Leaders of family firms should be aware, though, that prospective lenders know the family dynamic can pre-sent a unique set of challenges. When making a decision about financing, lenders will do more than just review the company’s past achievements. They will also look for evidence that a solid succession plan is in place, and that the family is on board with the company’s strategic plan.
Show your stability
Loan officers will look closely at the history of a family-owned business, reviewing the roles of each family member within the company and how harmonious those relationships have been through the years. A history of discontent or strife among family employees will cause lenders to question whether the company is a sound investment.
This is particularly true when it comes to the issue of transition between the first and second generations. Business owners should be aware that lenders will scrutinize the dynamic between the founder and the second-generation members. Before providing financing, lenders will want to see how the senior generation has planned and prepared for the transition. Banks want to know to what extent the founder will remain involved, if at all, once the roles have been turned over. The nuance of that dynamic is a very important factor.
Regardless of the size of the business, lenders need to know that a solid plan exists for the founder to step back and accept a diminished role in order to move the company forward. Years of hard work, sacrifice and deep personal involvement can make it extremely difficult for a founder to hand over authority and responsibility to the next generation. If the senior leader is only willing to pass on responsibility, but not authority, a divide can be created between the generations that can jeopardize the future of the company. Lenders who sense such a divide will not view the company as a viable loan candidate.
A lender considering financing a family-owned business will want to see more than just the plan for the changing of the guard. The microscope will also shift to the next generation and whether or not they have been properly groomed to maintain and grow the business.
The bank will ask the hard transitional questions when making a loan decision. On top of that list is whether the second generation is capable. Just because a member of the team is related does not mean he or she is the best choice to move into the position of chief executive officer. Perhaps the daughter or son would better serve the company in a technology or human resources role.
Lenders look favorably on outside experience. Next-generation members who have previously earned significant experience outside the family business have a fresh perspective and a more neutral approach when it comes to strategizing for the future once the transition is complete. Lenders find well-rounded, experienced second-generation leadership very appealing.
If bank executives sense that the key players are not on the same page about the future of the company, the bank will reconsider its decision to make a loan. Dissent forecasts roadblocks to future success—and it also shows the family’s lack of preparation.
One common subject of dissent is the requirement of significant owners to personally guarantee bank loans. Banks typically require any principal of a non-public company with an ownership stake of 20% or more to guarantee the loan. To the banker, the guarantee provides a secondary source of repayment, as well as a show of good faith that the principals believe in their company and are willing to support it. Owners who do not share the same level of conviction for their company raise a serious red flag for the banker.
An excellent example of a family business with a successful banking relationship is BC Rentals of Southern California, whose owners have been banking with Sunwest Bank for 13 years. The partnership began in 1996 with Robert and Sally Carson’s first company, Breezer Construction Services. Since then, Sunwest Bank has assisted the Carsons with financing for equipment, a commercial building and a working capital line of credit.
Breezer Construction was eventually sold and BC Rentals was formed for the purpose of renting arrow boards for use in directing traffic, along with message boards, cones, compressors and other equipment used in conjunction with highway safety and construction.
The Carsons and BC Rentals have maintained a strong relationship with Sunwest Bank, using debt to finance capital purchases when appropriate. Robert and Sally Carson operate the business as a team; Robert handles day-to-day business operations while Sally manages the office and administrative matters.
Throughout eight successful loans with Sunwest Bank, the Carsons have personally stood behind all of their loans, a true testament to their confidence in BC Rentals’ ability to perform to the bank’s expectations.
You better shop around
In today’s economy, obtaining financing involves more than just planning internally to make a presentation that appeals to a bank. With so many financial institutions in crisis, it is very important for business owners to protect themselves through due diligence research to ensure they are partnering with a stable bank that fits.
Most financial institutions have a “sweet spot” for lending. Owners must consider the amount of credit they are seeking before they approach a bank for a loan. Just like the old fairy tale of Goldilocks and the three bears, the amount should be “just right” for the bank, not too high or too low. A relationship that is the right fit can grow as the business grows.
You wouldn’t go to a podiatrist if you had a sinus infection, and it’s just as wrong to seek financing from a bank that does not know the industry your business is in. Research the bank to see if it has a history of lending to other companies in your industry, and to determine whether it understands family business in general.
During these tumultuous economic times, borrowers should put in the legwork to ensure they are partnering with an institution that is not in jeopardy of going under. There are many resources available to help you determine a bank’s stability.
Obtain a copy of the bank’s financial statements. Pay particular attention to the bank’s capital, its liquidity, its profitability and the amount of non-performing loans on its balance sheet relative to the total loan portfolio.
Never underestimate the power of a good reference. Conduct some independent research out in the community. If you ask for references, banks will provide them. However, just as one would never provide a bad reference on a résumé, the bank will always offer references that provide glowing reviews.
Check in with an outside accountant, attorney, insurance broker or other trusted adviser to see if they can provide a few independent references. Be certain to follow up to get a clear picture of the bank’s track record and client relationships and the contact’s view of the current management.
Don’t be afraid to go straight to the top. Potential borrowers should always meet with the bank’s senior management. Sitting down with the CEO or chief credit officer is important to ensure everyone is philosophically aligned.
Beware of red flags
Paying attention to some key indicators will help borrowers avoid doing business with a financial institution that is on the verge of crisis.
Beware of banks that offer the highest possible interest rates on CDs. This can be an indication that the bank is attempting to raise deposits, signaling that the bank’s liquidity is an issue.
The Federal Deposit Insurance Corporation (FDIC) is an invaluable resource for borrowers. Use the FDIC website (www.fdic.gov) to view a bank’s financial statements and, in particular, research the bank’s level of non-performing assets (NPA). Examine the bank’s NPA as a percentage of its total loan portfolio in addition to the absolute dollar amount.
Banks are in the business of risk and risk management. All banks will have non-performing loans at one time or another. The statistic that must be examined is the amount of money a given bank has on reserve, known as the allowance for loan loss. The ratio between the bank’s NPA and the reserve is the key indicator of a bank’s stability.
If a bank has $10 million in non-performing loans but $20 million in reserve to cover those problem loans, the bank is still stable and healthy enough for lending. A red flag is flying when the reserve is not sufficient to cover the NPA.
Put it in writing
Before going to meet with a prospective lender, there are two important steps a family business owner should take. First, meet with key family members. They must be in full agreement on the company’s vision and strategy.
Once all key family members are in agreement, put that plan into writing in an executive summary. Putting the business plan on paper helps organize the owners’ thoughts and shows a preparedness that is looked upon favorably by banks.
A written summary offers the opportunity to provide lenders with a brief narrative about each family member, what his or her background is and what role he or she fills in the company. It is also an opportunity to address the question of transition between the generations, describing the plan and demonstrating the company is prepared for its future.
The summary should not just state the company history. It is important to put some numbers behind the plan. Lenders focus heavily on current and historic financials, but it is also key to include hard numbers that show the company’s goals moving forward. Lenders want to see the company’s projection for the future and hear the assumptions behind those projections. Bank executives will ask tough questions to determine whether those projections and assumptions are realistic, so owners should be prepared to defend goals by answering “how” and “why.”
Hope is not a strategy
Particularly in today’s economic climate, prospective lenders want to know that hope is not a company’s primary strategy. In any bank underwriting process, the bank is going to conduct a stress test on the company. Owners will be presented with tough questions and “what if” scenarios regarding sales, gross margin and operating expenses.
Conducting the stress test internally before going to the bank makes the task easier for the lender and can improve your company’s chance of getting financed. Arriving with a strong “plan B” shows bank executives the company is prepared for the worst-case scenario with an action plan that addresses what you would do if the current plan does not pan out.
Yes, Virginia, you will need to do internal housekeeping, solid research and planning, but there are stable partners willing to finance family-owned business across the country.
Glenn Gray is the president and CEO of Sunwest Bank, a community bank in Orange County, Calif. (www.sunwestbank.com).
Ask yourself these questions to make sure your company makes the grade:
1. Does your company have a sustainable competitive advantage?
2. Does your company have a talented management team?
3. Are the family dynamics harmonious?
4. Does your company have a dependable cash flow?
5. Does your company have a solid underlying net worth, and are the primary owners willing to support the company’s credit request with a personal guarantee?