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What Your Banker Wants You To Know

What Your Banker Wants You To Know

In small or large businesses, we often end up dealing with banks and bankers beyond the checking account. When you have debt with your bank (your lender), the relationship takes on another dynamic. The typical loan agreement for traditional debt includes loan amount, terms, collateral provided, the covenants you must live by, and the dos and don’ts allowed. When things are going well, the relationship with your banker seems to always go well.  It is in difficult times that things get tough. Let’s look at what your banker wants you to know.

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What Your Banker Wants You To Know

Your banks wants to know the bad new sooner than later. Furthermore, your banker does not want surprises. If you are having issues with your business, then discuss these early on with your banker. If you’re getting close to the limitations of your covenants, then let your banker know. In addition, if you see a change coming in your industry, then let your banker know early on. Be sure to give your banker the good news also. If you are planning on changes to Sr. Management, then mention these to your banker.

The banking world changes based on the economy, regulations, and markets. We remember 2008 when new credit at banking institutions basically shut down. Before that, it was fairly easy to get credit. And loan requirements were not as cumbersome – which is not always good. But the crisis caused a change in behavior at banks – some of it self implemented and some implemented by regulators.

In today’s market, money is still relatively cheap. There is an abundance of liquidity in the markets. So banks do want to loan money, but you must meet some basic guidelines.

What Your Banker Wants You To KnowWhat Commercial Banks Want

In order to loan you money, commercial banks basically want just a few things:

  1. They want to have collateral that secures their loan
  2. They want to know you have the cash flow to payback their loan
  3. They want to understand your business and they want to know what the funds will be used for
  4. They want to understand how much they will make $ on their loan to you

Different Types of Lenders

There are different types of lenders, including the following:

The cost of that capital goes from cheapest to most expensive lender on the list above. The structure of the debt also goes from easiest to most complex structure in the list above. Some want collateral (security), and some do not.

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Keep Your Eye on Your Debt Covenants

Most likely, if you have commercial debt, then you may have some debt covenants stated in your loan agreement. Covenants are the requirements you as the Borrower must maintain to be in good standing with your loan agreement.

Oftentimes, the bank and banker find out something is wrong when you turn in your financials and/or bank compliance certificate. They find that one of the covenants is out of whack. You may have a debt/EBITDA covenant ratio as part of your covenants. This is a common requirement. Do not wait for you to “bust your covenants” before you reach out to your banker. Monitor your covenants closely. If you see drivers in your business that may create a problem with your covenants, then reach out to your banker.

Renegotiate Covenants

Believe it or not, I have been in situations where the loan agreement is already a few years old. The company has become much more financially healthy, and I went back to renegotiate certain covenants to ease the reporting burden. The bank was very open to modifying some covenants. Usually, you have to be in good standing and have a good historical track record to modify or request to modify covenants. But do not be shy. Simply ask. The worst that can happen is your banker says, “no”.

Most bankers in today’s market do really care about the relationship, even at the biggest banks. Your banker does want to see you succeed. If you are living through troublesome times, then your banker does want to see you get financially healthy. But you need to communicate with your banker. The worst thing you could do is hide something from your banker or try to sweep something “under the rug”. That will eventually come, out and you will have burned a bridge with your banker. After you hide something, or if you do not disclose something, your banker will always carry that doubt in the back of his mind. And they may not be there for you when you really need to negotiate that debt covenant.

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What Your Banker Wants You To Know
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What Your Banker Wants You To Know

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Mezzanine Financing

See Also:
External Sources of Cash
What Does A Lender Want To Know
Finding The Right Lender
Due Diligence on Lenders
Weighted Average Cost of Capital (WACC)

Mezzanine Financing

A mezzanine lender, provider of mezzanine financing, functions similar to a bank in terms of providing a source of capital for companies. They get their capital from private investors who look to make a profit off of the investments the mezzanine lenders make. Often times, the firm is structured as a limited partnership for tax purposes.

There comes a time in every company’s life cycle when the company and/or the entrepreneur need some more cash. Perhaps the company needs more working capital or some additional money to help fund an expansion. Or, maybe the entrepreneur feels that it’s time to reap the benefit of all those years of hard work. Whichever the case may be, the entrepreneur will be faced with many different financing options. An interesting and often over-looked option is that of bringing in a private equity partner in the form of mezzanine funding.


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Mezzanine Lenders

Mezzanine lenders are similar to banks … but they are not banks. The interest they charge is going to be higher than what commercial banks charge. Many entrepreneurs blench at the thought. But consider, other than maxing out your credit cards, what other alternatives do you have? Mezzanine lenders will charge you approximately what credit cards charge you. Their cost of capital ranges from the high teens to low twenties (18-23%). This may seem quite high, but if your enterprise is so risky that a bank will not touch it, then it is only fair that you reward someone for taking on this extra risk. Also, what bank would feel comfortable about an entrepreneur taking the bank’s money and pocketing it for personal gain? No bank would. Mezzanine lenders do.

Mezzanine lenders can also benefit the firm in other ways as well. They can help entrepreneurs upgrade their talent resources by finding professional management staff. They can help with finding better technology, placement with new customers or help you find sourcing alternatives. Remember, the best business partner is someone who brings more than just money to the table.

Financing typically comes in the form of either a loan and/or equity interest. Sometimes the debt is convertible into equity. Many people worry when they hear that their equity is compromised. This is actually not so. Mezzanine lenders are open to having their equity interest bought out. Think of it as a “pop” for taking on the risk.

Purpose of Mezzanine Financing / Mezzanine Capital

So, what is the purpose of mezzanine financing or mezzanine capital? First, let us consider a common business dilemma: 1) lack of working capital or 2) lack of funds for capital expansion. Entrepreneurs by nature are optimists and passionate people, especially when it comes to their companies. They want and need a financial partner that can grow with them. Typically, your first option of choice is your friendly, neighborhood commercial bank. There are several issues that one often encounters here:

1. Debt – Is your company too leveraged for the bank to accept?

2. Profitability – Is there enough profit to sustain the enterprise?

3. Cash Flow – Is your company generating enough cash to pay the bills?

4. Inventory – Are you turning it over fast enough?

5. Equity – Do you have enough skin in the game?

If your firm can pass the litmus test, then by all means you should go with your friendly, neighborhood commercial bank. They are typically your cheapest source of money.

Next, let us consider a more interesting question from the entrepreneur’s perspective. I’ve worked this long and hard. Don’t I deserve to be rewarded? Don’t I deserve to be a millionaire? If you don’t already have a million dollars in the bank, then the bank will probably be the first to tell you, “No.” So what’s a hard-working entrepreneur to do? Surprisingly, this issue is one that is faced by countless business owners as they face retirement or just want to “take some chips off the table” for security purposes.

The above cases represent typical situations where it makes sense to consider other financing options such as a Mezzanine Debt Financing.

Recapitalization Example

Below are some typical scenarios where you might want to consider working with a mezzanine lender:

1: Company needs capital infusion for either working capital or CAPEX.

2: Entrepreneur would like to buy out a partner.

3: Entrepreneur would like to “take some chips off the table” to provide security for his/her family.

4: Entrepreneur would like to pass along management to next generation.

5: Entrepreneur would like to share some equity with management staff and/or employees.

6: Entrepreneur would like help with selling the company to a strategic buyer at a good profit so s/he can retire.

Mezzanine Recapitalization: Conclusion

Entrepreneurs should consider mezzanine lenders a strategic financial resource. They many not always be your first choice, but they just might be your best choice. They have a higher cost of capital than banks. But, for the money, they provide a lot of strategic options to the entrepreneur that commercial banks could not be party to.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

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mezzanine financing

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Letter of Credit

See Also:
Line of Credit (Bank Line)
Annual Percentage Rate (APR)
Company Life Cycle
How Important is Personal Credit While Negotiating a Commercial Loan?

Letter of Credit Definition

What are letters of credit? Define a letter of credit as a document issued by a bank that guarantee payment to a seller on behalf of a buyer. Letters of credit essentially eliminate the seller’s risk of non-payment by substituting the bank’s credit for the buyer’s credit.

A letter of credit specifies the payment amount and the time period in which the letter of credit is good. Once a letter of credit has been issued and the terms and conditions of the contract have been met, the bank must make the payment to the seller on behalf of the buyer. Companies often use letters of credit in international transactions, where the buyers and sellers may be unsure of each other’s credit or reliability.

Letter of Credit Explanation

Companies often issues letters of credit in international transactions. They typically involve four parties: the importer, the importer’s bank, the exporter, and the exporter’s bank. Importer’s and exporter’s banks, in this case, simply refer to a commercial bank domiciled in the importer’s country and a commercial bank domiciled in the exporter’s country. The importer may be unsure of the reliability of the exporter and the quality of the exporter’s goods; the exporter may be unsure of the importer’s creditworthiness and ability to make payment. By using banks as intermediaries, you alleviate all of these concerns.

Once an importer and an exporter have agreed to a trade transaction, but before money or goods have changed hands, the importer will go to the importer’s bank and, for a fee, apply for a letter of credit. The importer’s bank then issues a letter of credit for a set amount and a set time period. Then the bank guarantees payment to the exporter as long as the exporter meets the terms and conditions of the contract.

The importer’s bank then sends this letter of credit to the exporter’s bank, saying they’ll guarantee payment once the exporter’s bank provides documents proving the goods have been shipment. Once the importer’s bank sees these documents, the importer’s bank makes a full payment to the exporter’s bank. The exporter can then collect its money from the exporter’s bank and the importer will receive its purchased goods.

Types of Letters of Credit

There are several types of letters of credit, though the most common type is a confirmed irrevocable letter of credit. You cannot change or alter this type of letter of credit in any way without the consent of all relevant parties. Therefore, the issuing bank is obligated pay the seller.

Other types of letters of credit include revocable letters of credit (they may be altered by the issuing bank), revolving letters of credit (automatically renewed periodically to allow for recurring transactions between the same buyer and seller), and traveler’s letters of credit (issued on behalf of traveling customers). They list several banks that will honor the contract.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

Letter of Credit
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Letter of Credit

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Commercial Bank

See Also:
Investment Banks
5 C’s of Credit (5 C’s of Banking)
Categories of Banks
Bank Statement
How to manage your banking relationship.
Certificate of Deposit (CD)
Personal Credit for Commercial Loan
Alternative Forms of Financing
What Your Banker Wants You to Know

Commercial Bank Definition

Commercial banks are the most unrestricted and common of the different bank forms. A commercial bank is often considered a financial intermediary for transactions involving anything from a savings account to a certificate of deposit (CD).

Commercial Bank Meaning

A commercial bank often deals with daily transactions between checking and savings accounts. But they also deal with term deposits and money market accounts. These banks in the past was not allowed to take part in the capital markets under the Glass-Steagall Act. This activity was typically performed by investment banks. However, since the repeal of the act there has been less and less division between the two groups.

Commercial banks create money when they accept money from businesses or individuals owning a savings account, checking account, or a CD. It then loans these funds to businesses or individuals. It makes its profit by accepting interest payments.

This means that unlike most institutions, a bank’s assets are loans and bonds that it issues, while its liabilities are the savings and checking accounts along with other deposits. This is because these liabilities are payable on demand from the account holder unless it is a term deposit in which it is payable at the end of the term.

This is also why the Federal Reserve requires commercial bank reserves to ensure that a bank always has the proper amount of funds to meet its liabilities. This commercial bank regulation came after scares during the depression in which commercial banks were unable to meet their liabilities. This is why every bank is also required to carry Federal Deposit Insurance through the Federal Deposit Insurance Corporation (FDIC).

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commercial bank

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Certificate of Deposit (CD)

See Also:
Loan Term
Commercial Paper
Term Deposit
Treasury Bills (t bills)
Federal Funds Rate Definition

Certificate of Deposit (CD) Definition

A Certificate of Deposit or CD is a special type of time deposit used by many financial institutions, usually a commercial bank. Certificates of deposit generally offer fixed rates of return for periods of 1 month, 3 months, 6 months, 1 year, or more depending on the investor’s preference.

Certificate of Deposit (CD) Explained

A Certificate of Deposit is generally used by investors who need a short term arrangement to earn a fixed return. CD rates are better than a savings account, but are different in that the money can not be withdrawn until the end of the CD term. Certificate of deposit early withdrawal will cost the investor to pay a large penalty. This means that the investor must be absolutely sure the funds can remain untouched until the certificate of deposit maturity.

Certificates of deposit risks are generally restricted to the early withdrawal because it is unlikely that any of the financial institutions will default on CDs because of their short term nature. CDs that are denominated in $100,000 and above are referred to as negotiable certificates of deposit. This allows the investor to determine the penalty of early withdrawal as well as the rate of return. Other terms can also be calculated into the negotiable CD.

Certificate of Deposit (CD) Example

Bob has $1,000 in a savings account, but he would like to earn a greater return than the 0.5%. Bob goes to his bank and decides that he would like to invest his funds into a certificate of deposit so that he might earn a more meaningful return from the bank. The bank offers CD terms of 1.35% for a 3 month period. Bob decides to go forward with the agreement and at the end of the 3 month term he has earned interest of $3.38. This number is opposed to the $1.25 that would have been earned had Bob stayed with the savings account.

certificate of deposit

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Asset-Based Lending

If your company is in need of financing but it has been a challenge obtaining it from a traditional lender such as a bank, then you might consider alternative lending sources, such as asset-based lenders. Asset-based lending or ABLs will lend against collateral. Comparatively, other types of lenders lend based on your creditworthiness. As a result, this is what tends to make it difficult for start-ups and those with recent losses and cash flow difficulties from obtaining a bank loan.

Asset-Based Lending

I came across an interesting article in the Journal last week which detailed the benefits of asset-based lending, especially if it is difficult for you to quality for a bank loan.

Here’s a great article comparing traditional commercial bank financing to asset-based financing.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

Asset-Based Lending
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Asset-Based Lending

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Recapitalizing Your Company Using Mezzanine Financing

Recapitalizing Your Company Using Mezzanine Financing

“There comes a time in every company’s life cycle when the company and/or the entrepreneur need some more cash. Perhaps the company needs more working capital or some additional money to help fund an expansion. Or, maybe the entrepreneur feels that it’s time to reap the benefit of all those years of hard work. Whichever the case may be, the entrepreneur will be faced with many different financing options. An interesting and often over-looked option is that of bringing in a private equity partner in the form of mezzanine funding. Furthermore, the only option may be recapitalizing your company using mezzanine financing.

Why can’t I just go to a bank?

Let us consider a common business dilemma: 1) lack of working capital or 2) lack of funds for capital expansion. Entrepreneurs by nature are optimists and passionate people, especially when it comes to their companies. They want and need a financial partner that can grow with them. Typically, your first option of choice is your friendly, neighborhood commercial bank. There are several issues that one often encounters here…”

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Recapitalizing Your Company Using Mezzanine Financing

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