What Small Business Borrowers Should Expect in 2012

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The downturn in small business borrowing over the last couple of years may be rebounding.

The commercial lending market has been in recovery mode since 2008.  There is, however, belief and optimism about small business lending experiencing a positive turnaround in 2011.  The signs of this positive turnaround can be found in a variety of data sources that tracked 2011 commercial lending activity from “traditional” lenders (commercial banks) to “alternative” lenders (credit unions and accounts receivable financiers).  Due to increased competition among lenders and in order to win new business, some lenders are making loans on increasingly borrower-friendly terms.

For those small businesses that are looking to obtain debt financing, this is the time position themselves to tap into the improved credit markets.  There are some strategic planning tips small businesses should consider before approaching potential lenders.

Small Business Borrower Telling Its Story to Make a Good First Impression

As the saying goes, you only get one chance to make a first impression.  With lenders, that first impression is all-important; and failing to make it can be the difference between a lender making or not making a loan.  Alternatively, it can significantly influence the financial and non-financial terms on which a lender will make a loan.

For lenders, the loan/no-loan decision hinges mostly on a potential borrower’s “creditworthiness.” This is the financial and non-financial analysis lenders conduct of a borrower to determine whether the borrower is a “good” risk or a “bad” risk.

In a sense, making a good first impression is about a borrower telling its “story.”  And, the success or failure of that story turns on the borrower’s ability to portray its creditworthiness.  If the story is convincing, a lender will likely view the borrower as a good risk.  If the story has holes in it or it generally does not track, a lender will likely view the borrower as a bad risk.

Arguably, a small business’s greatest asset is its “status,” and a lender will want to confidently rely on it in making a loan.  A convincing borrower story should include, among other things, (i) complete and current corporate records (that show clearly who owns the company), (ii) if 8(a) or SDVOSB, clear organizational documents (that clearly demonstrate requisite ownership and control), (iii) financial statements and tax returns, reviewed, if not audited, by a CPA firm, and (iv) a good business plan.

Shop Around and Negotiate Critical Terms before Signing a Commitment Letter or Loan Agreement

Lenders have the money, and for the most part, they get to make the rules.  Loan agreements are inherently one-sided in favor of the lender.  For those small businesses that have told their story well, there should be room to negotiate key borrowing terms and level the playing field somewhat.  Shopping around for the right lender is critical.  Choices breed competition and frequently more favorable loan terms.  The timing to negotiate loan terms is critical too.  The negotiating needs to be done beforesigning a loan commitment letter.  The loan commitment letter will provide and essentially lock in the material financial and non-financial terms of the loan.  Lenders are most flexible and open to negotiating when they are competing to secure a borrower’s business (afterwards, not so much).  This is the point in time when a borrower should engage legal counsel and other professional advisors.

Loan Agreement: Lender’s & Borrower’s Goals

A lender wants a loan agreement which controls and monitors a borrower’s business activities to ensure that the loan will be repaid.  A lender achieves this by requiring, among other provisions, financial and non-financial “covenants” in the loan agreement stating what a borrower can and cannot do.  Conversely, a borrower’s goal is to negotiate a loan agreement with fair and reasonable terms; one that will allow the borrower to operate strategically and grow its business, free from overly restrictive covenants.  A borrower will, at all costs, want to avoid entering into a loan agreement with covenants that borrower is in breach of or on the verge of breaching at the beginning of the loan.  Breaching these covenants leads to a lender’s right to call the borrower in “default” and accelerate the loan, requiring it to be repaid promptly.

Conclusion

Small business borrowers that have a good story to tell should find more opportunities to obtain debt financing in 2012.  With advance strategic planning and good legal and other professional counsel, a borrower should be able to secure a loan on terms that will allow the borrower to achieve its business goals and objectives.

About the Author: Dean Nordlinger is counsel with PilieroMazza PLLC and leads the firm’s Business & Corporate law practice.  He represents companies, private equity firms, entrepreneurs and others on a variety of corporate matters across varied industries. He can be reached at dnordlinger@pilieromazza.com.    

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