A Tale of Two Companies and Their Banks

“It was the best of times, it was the worst of times, it was… “, well, you get the picture. Over the past several months I’ve been consulting with two magento development services separate companies as an outsourced CFO. Both companies need bank financing to stabilize their operations and achieve growth, both companies have struggled through trying economic times, both companies know they need to invest in processes,

procedures and personnel in order to grow and achieve desired returns for their owners. I want to share with you how these two companies have been working through the process of structuring bank loans, hiring personnel and investing in internal systems in order to develop companies that can deliver desired shareholder returns. But first, some background information.

Company A has been in existence for just over 4 years. The company acquired the assets of an existing business and in the first 3 years grew the operations in excess of 15% per year. Coupled with a strategic acquisition, Company A is now almost twice the size of the business it acquired.

Margins have been good and the company has been able to distribute cash to the owner each year. With the rapid rise in the business the company was stretching its internal processes and personnel to the limit. Additionally, existing systems and equipment needed to be upgraded in order to support future growth.

In the middle of year 4 the storm clouds began forming for Company A. The company needed to hire additional personnel to manage the growth it had experienced and to support anticipated continued increases in revenue.

Unfortunately the rapid rise of the business meant that woefully stressed systems and personnel lead to quality lapses which resulted in several large customers leaving for competitors. Additionally, two management team members left the company and started a competing business. They took other customers by offering cheaper prices for similar services. Hurried investments in capital equipment that were designed to reduce labor costs were being run inefficiently and had resulted in large increases in supply expense. Company A was now losing money and needed to make changes quickly in order to right the ship. Additionally, the company’s current bank debt needed to be refinanced in order to alleviate cash flow concerns.

Company B has been in existence for just over 5 years. The company was a start-up that the owner was able to bootstrap to achieve recurring revenue levels that allowed the company to achieve profitability quickly. Cash flow was the focus and the company had been able to return cash to the owner each year. The company had been built with the owner overseeing all strategic initiatives and managing all activities of the company. As the company grew the operations of the business could no longer be effectively managed by an individual person.

During year 5 the owner of Company B realized that experienced personnel needed to be brought on board to effectively manage the business. Prior growth had been funded through customer advance payments and the company had no bank debt.

As recurring revenue was building it was time to make the appropriate investments in personnel and systems in order to take the company to the next level. Personnel hiring would be critically managed and coincide with incoming cash in order to manage the new expenses on a cash positive basis. New customer opportunities were growing and would be funded in part by bank debt along with customer advance payments. Company B was beginning to show profitable operations and needed to make the right investments in order to manage growth.

Both companies needed assistance in order to manage through the difficult times they were experiencing. So which one would fair better in discussions with the bank given their circumstances?

Things were looking rather bleak for Company A. Various missteps resulted in losing customers and allowing former management team members to start a competing business. Personnel were hired too late to alleviate quality concerns and now there were too many employees to support the existing business. Capital equipment investments that were supposed to reduce labor costs had dramatically increased supply costs and further draining cash from the company. Current bank terms had put the company in a position where the line of credit was continuing to increase because of the losses from operations. The company needed to refinance existing bank agreements in order to avert a situation that could cripple the business.

In order to see how Company A managed through this difficult time, we have to look back to when the company was initially formed. At that time the new owner realized that there was a unique opportunity to grow the business quickly based on the business environment. This meant that it was imperative from the beginning to have a core management team lead by a strong CEO.

The CEO knew that it was important to develop strong banking relationships and put in place processes for managing the financial performance of the business. The new owner put cash in the business to fund a substantial portion of the acquisition and the CEO negotiated the banking relationship. The bank provided term debt to help fund the transaction and a line of credit to finance working capital needs.

Because the new owner put adequate cash in the business, the bank didn’t require any personal guarantees related to the loans and financial covenants were set at reasonable levels. Company A was required to have annual audits as part of the bank financing but this was something the new owner and CEO viewed as necessary for the business even if it wasn’t a bank requirement.

When difficult times hit, Company A had a good track record with the bank and had made substantial principal payments on the existing term debt facilities. The CEO met periodically with the bank to explain what the company was going through and what management was doing to address those issues, including bringing in an experienced CFO to assist in working through the tight liquidity situation.

The CEO and CFO showed the bank that there were adequate assets in the company to refinance the existing debt and line of credit in order to free up cash flow. Personnel levels were reduced primarily through attrition but through this process the company was actually able to upgrade the quality of the overall workforce. The company worked with the manufacturer of the new equipment to address the issues that had lead to increased supply costs and was able to fix those issues over a few months.

Historical audits provided the bank with the comfort that Company A realized the importance of strong financial controls. The bank refinanced the existing loan agreements and even agreed to provide financing for new equipment purchases the company needed to make. No personal guarantees were required from the owner and debt covenants were set at reasonable levels. With the assistance from the bank the company was able to manage through a time of tight liquidity.

Things were actually looking pretty good for Company B. The company had managed to grow the business by being very frugal and only spending money when necessary. The company was debt free because the owner was able to get customers to make advance payments in order to fund necessary capital equipment expansion. The owner now just needed to bring on some experienced personnel to take the company to the next level. Some assistance from the bank in the form of a line of credit would be needed to make this happen, but this all seemed to be pretty doable from the standpoint of the owner.

Once again we need to look back to when the company was initially formed to fully understand the overall situation. Company B was formed because the owner had a unique opportunity to address a specific customer need. The owner was able to negotiate a large deposit from the customer and didn’t need to secure bank financing.

All of the operations of the business were managed by the owner in order to minimize expenses and conserve as much cash as possible. Since the owner managed all of the operations, including signing checks, there was no value perceived to having an audit or review of the company’s financial statements. This would simply be an unnecessary expense to the business and less cash to the owner.

When Company B needed financial assistance the owner met with the bank to discuss providing some availability in the form of a line of credit or term debt facility. The owner explained the company’s needs and that a CEO and other personnel were being hired to help grow the company. The bank asked about the availability of audits or reviews of the company’s books in order to help assist the bank in determining the quality of the company’s records. The owner explained that an audit or review had been considered an unnecessary business expense and that an outside accountant had only been used to prepare tax returns. The bank indicated that given the lack of an audit or review, coupled with no loan history with the bank, any business loan would need to be personally guaranteed by the owner.

And that was assuming the owner had adequate personal assets to qualify as collateral. The bank suggested that the owner consider putting personal cash deposits in accounts at the bank that would act as the necessary collateral for a business loan. What the owner had viewed as being a relatively easy problem to solve was now proving to be problematic to the overall business and the owner personally. The owner decided to look at other banks but kept hearing the same story over and over again.

So what lessons are learned from these two companies and how can you as a business owner apply these to your company?

Even though times were difficult, Company A was able to renegotiate its bank debt which lifted a huge financial burden from company management and the owner.

The bank had stepped up and provided desperately needed financing and shown its support to the owner because of the following factors:

  1. Company A treated the bank as a business partner from Day 1 – The company always kept the bank informed as to their financial condition and never surprised the bank on short notice with bad news. Communication was always straight forward and above board. When the company needed the bank to do something they simply presented a plan and asked for what they wanted. They didn’t always get everything they asked for, but what they did get was usually adequate to meet their most urgent needs.
  2. Company A knew the importance of having an outside accountant prepare yearly audited financial statements – The CEO knew that a yearly audit would provide the bank, the owner and company management a level of comfort that the reported operating results were accurate. The outside accountant also provided good tax planning advice that helped the company save on taxes.
  3. Company A knew the importance of preparing yearly budgets and evaluating monthly performance against those budgets – Company A had developed a budgeting process that they have refined over time and continue to refine today. Budgeting operating results is an art and not a science, but it is important to get started at some level and improve the process as you go along. Without some type of a budget it is difficult to know where changes need to be made in the business in order to improve operating results.

Even though times were relatively good, Company B found it difficult to develop any kind of working relationship with a bank. Banks were unwilling to provide financing on any terms that were perceived to be reasonable by the owner for the following reasons:

  1. Company B didn’t view the bank as a business partner and hadn’t developed a lending relationship with the bank – The company was always able to finance growth in the business by convincing customers to advance payment for services to be provided. While this worked well for the company in eliminating the initial need for bank financing, there were never any discussions with the bank to explain the company’s overall business plan and how a bank would be needed at some point.
  2. Company B didn’t see any value in having an outside accountant prepare yearly audits or reviews of the financial statements – The owner simply viewed this as an expense the company didn’t need to incur. There was no thought that down the road these type of financials would be necessary when it came time to secure bank financing and to try to get that financing without providing personal guarantees.
  3. Company B didn’t have any process for preparing internal budgets that could then be used to measure actual results – The company would typically embark on new projects based on high level analysis performed by the owner. Consideration was not always given to how a new project might impact the long term value of the company, but focused more on if it would create cash for the company in the short term.

So what lessons can you as a business owner take from the examples of these two companies?

  1. Always treat the bank as a business partner – For many business owners the bank will always be your largest creditor. The bank is vested in your success and should be communicated with as if they were a partner in your business because in reality they are. Many bankers are able to advise business owners on a number of matters that impact their businesses and you should willing draw on that expertise.
  2. Give adequate consideration to having an outside accountant prepare audits or reviews of your financial statements – These external financials will give the bank, and yourself, a level of comfort in the numbers being reported. An accounting firm provides good oversight to your business and can act as a trusted advisor as you are evaluating investment alternatives, including when it comes time to sell your business.
  3. Preparing a yearly budget that is then compared to actual results is probably the single most important step that you as a business owner can take to improve your overall company – Not only does a well prepared budget give you meaningful insight into your business, it will also improve your chances of survival in a highly competitive business environment. It is imperative that you create a plan each year that you can measure actual results against and to which you can hold yourself and your employees accountable.

At the Owners University we teach business owners how to improve their businesses in order to increase their overall value. Our program is designed to educate you, on your timetable, how to improve your business.

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