Smart Borrowing

By Daniel T. Zapton

How to prevent a nervous banker from pulling your credit.

Many bankers aren't in a good mood these days. Some banks, smarting from losses on their portfolios and feeling the sting of federal regulators, are getting much tougher when it comes to making loans to small and medium-sized firms. Loan officers who used to rely heavily on instinct when sizing up a borrower now want hard-core indications that a company will repay its debt. Even long-time customers should anticipate a skeptical eye when they renew credit agreements.

Trouble from his banker was the last thing on Joe Anderson's mind when his son, Arthur, joined the family's printing company last year.

Arthur, 31, had an eight-year track record as a successful commodities trader. Joe had long dreamed of persuading his son to join the $25 million company. Joe's offer to install his son as president and chief operating officer immediately was too good to refuse, The company had lost almost $1 million over two years under the previous, nonfamily president Joe fired to make way for his son. Despite Arthur's obvious lack of trade and administrative experience, Joe felt his son was smart, aggressive, and creative enough to turn the company around.

His banker did not agree. When Joe announced the management change, the banker, a man Joe had known for 15 years, told him that the appointment was a big mistake. Then he turned down the company's request to renew its $7 million line of credit, which funded receivables, inventory, and equipment. The sudden credit crunch prohibited the firm from bidding on lucrative jobs for existing customers and new prospects. Even Joe's offer to pledge personal assets against the loan didn't change the banker's mind,

Bankers are often uneasy about management transitions, especially in family businesses. When a young member of the next generation suddenly ascends to a top spot, even when the company has a well thought-out grooming program, lenders understandably question the impact on the business — and its continuing ability to repay debt.

Today, a sudden management change is just one of many red flags that might cause a bank to reevaluate a customer's creditworthiness; back-office controls is another. While his company had been growing in the mid-eighties, Joe had never installed sophisticated financial controls. Now that Joe was losing money, the banker feared that he had neither the systems nor the people in place to reverse the trend. His son's sudden appearance was the last straw.

Joe could have avoided his problem had he been closer to his banker. He should have solicited his loan officer's opinion about business developments regularly, and involved him early in the transition process. Family businesses like Joe's, without an outside board of directors, a credible business plan, or sophisticated financials, can usually get valuable feedback from a well-informed loan officer. The closer your relationship with your banker, the less likely it is that the two of you will encounter unpleasant surprises.

Here is the essential information your banker wants to see:


  • At least three years of financials, including profit-and-loss statements and balance sheets. If possible, try to get an outside auditor's unqualified opinion.


  • A description of the company's products, pricing formula, market, niche, if any, customers, and suppliers.


  • A yearly budget, updated quarterly, comparing actual results to budget estimates (you should also explain discrepancies of more than 5 percent).


  • A three-year projection of future sales, earnings, capital investment, and research and development.


  • Brief bios of key family and nonfamily managers, along with an outline of training programs to attack shortcomings.


  • A complete list of insurance holdings for the building and for assets, and the details of a buy-sell agreement — make one if you haven't already — which should include the amount of life insurance held by the owner to fund both the sale and taxes. This shows your banker you are providing for the continuity of the company, should something happen to the owner or one of the principals.


  • A description of back-office controls. Bankers love computerized, perpetual inventory systems, automated aging of receivables, and the monthly computation of current assets, on which most loans are secured. Such systems will cost anywhere from $15,000 to $50,000.

Joe did not have most of this data. But after learning that his credit line was at risk, he immediately plotted a defensive course of action. He sketched a transition plan for his son, outlining how other managers would assist and train Arthur in his areas of weakness. Joe pledged personal assets as collateral, with a plan to phase them out as certain business goals were met. Joe also asked his banker for the names of possible outside directors and vendors of inventory and financial accounting systems.

Joe did convince his banker to renew the credit line. As important, he helped equip his son with the skills and tools he would need to succeed on the job.

These days, Joe and Arthur are keeping in closer contact with their lender. They invite the banker, and his superior, on a tour of their facilities once a year. They send him all advertising and news clippings. When hiring important new managers — family or nonfamily — they ask the banker to review top candidates' resumes and to interview the runners up. Last, they have set up some of their trust business with the bank, in the hopes that in any future down years, their relationship will be broad and solid enough not to be dismissed so quickly.


Daniel T. Zapton is senior lender and chairman of the executive committee at Boulevard Bank National Association in Chicago.



What is most likely to scare your banker:


  • Flimsy financial reports.


  • Sudden and frequent management changes, especially of plant manager or senior salesmen.


  • Lack of management depth. The more the business depends on one person, the riskier the business seems.


  • Unsophisticated ledger postings.


  • Dependency on only one or two customers,


  • Accounts payables moving from 30 days to 90 days.


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July/August 1990

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