Having little understanding of banking could result in missed opportunities for growth or thorny problems that could put your firm out of business.
Most people who own AEC firms have some sort of bank financing to help ensure adequate working capital for their business. Most typical is a line of credit (LOC) that is secured by accounts receivable, although some companies also have term loans taken on for buybacks of ownership from departing owners, or loans for vehicles or equipment that they own. Then there is also building financing for those companies that own their own building(s) or company owners who have a building(s) they rent to the AEC firm.
But in spite of these very common borrowing relationships with their bank, many AEC firm owners seem to have little knowledge or understanding of banking and how that impacts or could impact their business. That can result in missed opportunities for growth or thorny problems that could actually put the AEC firm out of business.
I have worked with a lot of banks and had many banking relationships. My debt was at its peak of more than $20 million if you added it up across all of our businesses and real estate back about eight years ago. After selling most all of our real estate and business interests, thankfully it is nothing like that today. I was never scared of debt because I understood it and had confidence in our ability to pay it back. That said, I think it’s normal as you get older to start thinking it may be time to be more conservative in your approach to debt and that certainly did happen to me.
From my own personal experience as well as that of the companies I worked with, I have learned a lot about borrowing from banks that I thought might be helpful to some of our readers. Here are a few of those tidbits:
- Banks operate on very thin margins and are not equipped to take any real risks. The difference in what they pay for the money they lend to customers and what they lend it out for is typically around 3 percent. This is called “net interest margin.” They have to pay all of their people and all of their overhead and insurance and everything else out of that 3 percent. The truth is they have such a thin margin they cannot afford to have any debts to them go unpaid. So that means they have to be extremely careful in everything they do.
- Work with local or regional banks where you can get to know the decision-makers and have a personal relationship with them. I learned this very early on. My first company bank was Bank of New England. When they failed in January of 1991, we had a very small line of credit. Even though they eventually honored their credit relationship with us (after an initial scare when the feds took them over), I learned then that I wanted to have a banking relationship with a smaller bank where I knew the top people. We moved everything to a local mutual savings bank where I had a home mortgage, home improvement loans, and more, and where the bank chairman drove past my house every day on his way to work. I was known to them and we had a very good mutual relationship with them from that point on to when we sold our business to private equity in 2004. I have had a similar relationship with my bankers here over the past 20 years, and the top people in them are personal friends who have always supported me when I needed it.
- Have more than one banking relationship. Banks can sell, and the top people can retire or leave the bank for any number of reasons, so to protect your ability to get credit, it’s probably a good idea to have more than one bank that you do business with and that has people who know you. Most good bankers who care about you and want to help you actually appreciate it when you have another source of debt capital if you need it. The responsibility for keeping you in business doesn’t all fall on them. It doesn’t mean that you don’t have a primary bank where you always go to give them the first shot at your business, either.
- Commercial banking is a heavily regulated industry and there are limits as to what they can do for you. Banks have lending limits that could impact you. There’s a limit on the total amount of debt they can have from any one firm or individual, and you need to know what those limits are. They also have limits on what percentage of their total lending falls into particular buckets such as construction loans or investment properties that could impact you.
- For those of you who rely on a line of credit secured by accounts receiveable, you need to understand what a borrowing base is and know what your loan covenants are. Borrowing base is typically the total of all of your accounts receivable under 60 or 90 days, with, in some cases, deductions for what the banks consider “installment billings” based on percentage of completion. The bank will then typically allow you to borrow up to 75 percent of that total borrowing base on your line of credit. And by the way, that could be less than the total amount of your line of credit. That max is based only on your borrowing base. A lot of folks don’t understand that. And there are also typically covenants for things such as debt coverage ratio or debt-to-equity ratio, and some even include what is called a “cleanup clause” that mandates you have to be completely out of the line of credit for 30 days a year. Know your covenants and abide by them or your bank could be forced to cut you off.
- If you are a major owner in your firm, be ready to sign personal guarantees for your company’s debt. A lot of this depends on how long you have been in business and had credit, and how much of the firm you own. But understand that personal guarantees are very common. Your spouse needs to understand what you are committing to, also, with these guarantees.
- Banks like to be kept informed. I like to give them continuous reports on how the business is doing, good or bad. They don’t like surprise bad news and do like having time so they are equipped to help you. Banks want to help you if they can. It’s how they make money.
I could go on here but am out of space. This is an important topic, however, and if you aren’t schooled on it you had best do what it takes to get up to speed!
Mark Zweig is Zweig Group’s chairman and founder. Contact him at mzweig@zweiggroup.com.
