In the life cycle of a business there are always opportunities. The transaction could be a start-up, a commitment to growth, a merger, an acquisition, the buy-out of a partner or any number of other possibilities that occur in getting and staying in business. As a business begins sizing up these possibilities, the key question may be,” How is this transaction going to be financed?” Understanding that the largest single source of external capital for the typical business is a commercial bank, it is ironic that most companies have a very difficult time borrowing money. For the borrowing business to be successful with the banks, management must be successful in communicating its story to the bank, it must understand the constraints the bank must work within, and it needs to understand the tools it has available to meet these constraints.
A relationship with the bank is an ongoing process that occurs whether or not the business is presently borrowing funds. The bank must understand how the company makes money. The bank should be familiar with the company’s business plan and the key employees of the company. The owners of the business must know their loan officer and other key bank employees who make decisions regarding the borrowings of their company. The bank needs to know the company’s plans for the future and what role they are expected to fulfill. The bank must know how the loan proceeds will be used, how they are to be repaid and how repayment will occur if the business plan fails. This does not mean that the business owner must approach the commercial bank as a beggar. In many respects, the bank should be treated the same as all major suppliers of the company.
The borrowing company needs to understand the constraints the bank must work within. If the bank’s rules state that the business may borrow 80% of current receivables, 50% of inventory, 80% of all fixed asset purchases, and that company must maintain a current ratio of 2 to 1, a debt to equity ratio of less than 4 to 1 and a cash flow equal to 3 times the annual debt service, the transaction must be structured to meet these requirements. If the company finds its financial statements falling outside these constraints, the earlier the bank knows the greater the chance the company has of maintaining a positive banking relationship. Explaining the change and projecting the future ratios within a one to three year period may enable the company to continue to borrow money at an opportune time.
Whenever a business opportunity arises, a shrewd business owner possesses a number of tools for making the potential transaction bankable. These tools include, but are not limited to, non-compete agreements, consulting agreements, the real estate partnership, supplier agreements and seller financing. As the management of a business begins to outline the feasibility of an opportunity they may use these tools to make the deal bankable.
Looking beyond the various tax consequences, non-compete and consulting agreements may provide the mechanics to keep debt off the company’s financial statements. In transactions involving the purchase and financing of assets, including the company’s own common stock, a portion of this acquisition cost can be to a non-compete or consulting agreement, resulting in a monthly pay out to the selling party. In effect, this transaction keeps the debt off the financial statements, and enables the company to pay the sellers what they are due.
These arrangements can go even further in helping cash flow. By properly structuring the outgoing payments to fit the necessary cash flow constraints imposed by the bank, the company operations can demonstrate the necessary profitability in order to service the bank debt. These agreements can even be structured to be a percentage of sales’ dollars, thereby, being more supportive of company cash flow in down turns in the economy. The total dollars of these agreements can be fixed; however, the time of pay out can vary with the cycles of the business.
There are numerous tax reasons for organizing a partnership outside the corporation for the purchase of real estate. There also are some very good banking reasons for making this move outside the corporation. In a lot of cases, it keeps a non-producing asset off the balance sheet, but more importantly, it keeps the corresponding debt off the records of the corporation. In later years, the partners can show the real estate on their personal financial statement at its fair market value, as opposed to the corporation that would be restricted to showing the real estate at its net book value (purchase price less accumulated depreciation). A real estate partnership will also provide a lot of potential banking opportunities in future years assuming the fair market value of the real estate continues to increase. The cash flow of the company can be controlled by the owners simply by increasing or decreasing the company’s rents. The real estate partnership can provide the flexibility to the business owners to accommodate any number of business transactions.
Arrangements made with major suppliers can also provide positive cash flow results. Suppliers, as well as anyone, understand the difficulty in financing growth. They are willing to consider payment arrangements provided there exists a well thought out company plan. Suppliers’ help, coupled with bank assistance, may provide the impetus in being able to fund profitable growth.
Seller financing can also be an alternative to bank financing, or it can be used in combination with bank debt. As well as working effectively for the seller, owner financing subordinate to bank debt can free additional collateral, provide credibility, and with the right terms aid in cash flow.
Without the assistance of a commercial bank many opportunities will not be available to the majority of businesses. In order to make a good deal bankable, company management must be a good communicator, a good listener and a determined planner.
