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Protect Your Small Business Financing: How to Assess the Risk of Your Bank Calling Your Small Business Loan

Are you in danger of losing your bank loan? Learn how to measure the risk of your bank calling your small-business loan, and what to do if you need recapitalization. (This self-assessment applies to businesses with annual sales from $1 million to over $100 million, regardless of type of business.)

As a result of the recent “Great Recession,” many businesses are in danger of losing their bank loans. Loans can be pulled for a number of reasons but the most common are either poor financial performance by your business or your bank’s credit problems. A bank’s financial problems can also lead to its desire to take less risk and reduce your loan balances. Unfortunately, your bank will generally not tell you your loan will be “called,” or will not be renewed, until right before it takes action. It’s a little like when a bank fails and is taken over by the FDIC: we never hear about it until the Monday after the weekend when the takeover happened.

How can you assess if your business is being considered for termination? There are a few fundamental and relatively simple questions you can ask yourself to determine your risk of losing your small business loans.

Essentially, there are two categories of assessment when measuring the risk of losing your small business financing: the type of loans your company has and your company’s financial performance.

Loan type criteria

The type of bank loans your company are categorized below from riskiest, and currently least popular with the banks, to safest and most popular for the banks to hold.

Considered riskiest, and therefore least popular, is a combination of the following types of lending to one business from the same bank:

1. Real Estate: A commercial real estate term loan for your place of business
2. Machinery and Equipment: A term loan on machinery and equipment used for your business
3. Inventory: A revolving line of credit tied to your inventory balances
4. Accounts Receivable: A revolving line of credit tied to your accounts receivable balances

If your business has all four of these types of loans in place, all from the same bank, you are at the greatest risk of losing all or part of your financing. Banks are reluctant now to make all of these types of loans to a single client. They would usually welcome the opportunity to get out of loans with this breadth of exposure.

As you eliminate loans on real estate through accounts receivable, your perceived risk to the bank declines. It is possible your bank will be happy to keep your credit in place with all these loans in place if your financial performance is as good as, or better than, it was last year. But a word off caution: if your bank has had unusually high loan losses, is financially weak, or has recently been taken over by another institution, it may call your loans even if your company is strong.

Company performance criteria

How was your company’s financial performance over the past twelve months? If there has been a decline in financial results or a drop in company asset values, you may be at risk of losing your small business loans.

The following financial problems are considered most damaging to your business’s prospects of keeping its bank loans:

1. Less accounts receivable and/or inventory assets than agreed as the “borrowing base” required for the revolving line of credit amount currently outstanding
2. Insufficient trailing and projected cash flow to make debt service
3. Net operating losses for the current reporting period
4. A top-line sales decline from last year to this year
5. Fixed-asset devaluation below the agreed loan-to-value ratio (i.e. your building is worth much less than when you got your bank loan on it)

What to do if you need recapitalization

If, after this brief assessment, it appears you are at moderate or great risk of having your bank loans pulled or not renewed, what should you do? The answer is “shop your loan,” or have a professional shop it for you.

Most commercial banks are essentially the same when it comes to credit assessment and the types of loans they can make. In the current climate it is nearly impossible to find another bank to take over your loan if your current bank wants you to exit. So walking up and down the street to shop your loan will not be productive.

Where else can you turn? The answer is alternative lenders. These are primarily independent asset-based lenders and financial services arms of banks. Where do you find alternative lenders? Here lies the problem. In the small-business lending world, alternative lending is fragmented and difficult to navigate. There are many lenders and an abundance of financial products but few lenders that will make one loan on all the assets of your company, like you probably had with the bank. Usually, each alternative lender specializes in a certain asset class. They generally will not loan on other asset classes.

Additionally, the pricing for this alternative lending can range from extremely expensive to very reasonable and similar to your commercial bank pricing. These pricing variables are based on a risk assessment of the loan and the type of risk exposure these respective lenders specialize in. If you happen to pick the wrong group of lenders to shop your loan, you will be paying more than you deserve to pay at close.

You are also, of course, left with the problem of having three or four new lenders, each with different terms and pricing, lending on different collateral. This “circus” of lenders can definitely be coordinated to successfully replace the loans your bank has terminated, but it can be difficult, frustrating, and time-consuming for any small-business CEO or CFO. Finding the correct lenders, getting them to cooperate with complex legal documents such as subordination agreements, and then helping them to close simultaneously is challenging. Add to this the normal operational duties of your business, lack of experience in the sector, and an aggressive bank harassing you to get out, and the entire exercise can be exhausting.

Finding the right advisor to help you

A smart alternative is to spend time finding an advisor who knows what he or she is doing in the alternative lending space. You need someone who is familiar with the many lenders and who has experience negotiating and shopping loans to appropriately priced sources of capital. In the small-business world these are called advisors; in the mid- to large-business arena, they are called investment bankers.

There are a few true investment bankers in the small-business arena, such as our firm US Capital Partners, Inc. US Capital is both a lender and lead arranger or advisor on restructuring small-business debt. When it is cost effective, US Capital will bring in another lender for your loan, then provide additional capital from its own fund to “fill the gap” in required capital to take the bank out in the most cost-effective way.

When looking for a recapitalization advisor or small business investment banker, it is important to look for someone with recent experience in arranging or making loans similar in size to your requirement. Working with someone who has a track-record of larger deals may not be the best choice. The world of large-business or middle-market finance is very different to the world of small-business finance as far as lenders and structure are concerned. The chances are the advisor for larger businesses, although competent, will not be very familiar with the particular lenders in small business or even the common loan structures in this space. They will therefore take longer to get results, and those results may not be optimal.

The bottom line: If you choose to use an advisor to assist you with the financial restructuring of your company, consider someone who does, and has done, deals of your size.

If you would like to know more about how your business can secure the funding it needs, visit US Capital Partners at http://www.uscapitalpartners.net or call (415) 882-7160.

About the Author

Jeffrey Sweeney is an investment banker with years of experience in direct lending and corporate finance for small- to middle-market companies. He is the CEO and Managing Director of US Capital Partners, Inc. , an innovator in small- to middle-market business lending. Since 1998, US Capital has been providing prompt and reliable financing solutions, including lending, corporate financing, and debt restructuring, to businesses across the United States and abroad. The company’s innovative approach allows it to provide the best financing available, not only for companies in excellent financial condition, but also for companies who may have been refused credit by traditional lenders.

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