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By John Hart
| November 17, 2015
When it comes to the current state of business loans, credit and debt, there’s no shortage of advice, information—and, of course, opinions. Interest-rate uncertainty and an expansion of available credit vehicles have added further complications for business owners considering their financing options.
To help clarify some of these issues, we checked in with Rockland Trust’s James Rizzo, senior vice president in commercial banking, and George Couto, vice president in small-business lending. Rizzo and Couto shared their thoughts on the state of credit and lending today.
The Current Credit Environment
So how does the lending market look right now? “The current credit environment is very strong,” said Rizzo. “Businesses have many credit avenues to choose from. Credit is being provided to worthy borrowers by banks, large and small.”
Although every business market—small, mid-size and large—is somewhat different, Rizzo explained, “Competition among lenders to provide funding for solid real estate projects and strong operating companies is robust. It’s great for businesses. There’s a lot of capital out there for smart people to access.”
Couto agreed, saying the environment has done “a 180 (degree turn) from ’09 – 2010,“ when it was “difficult to obtain credit or even stay alive” as a business. “Overall, businesses—especially in Massachusetts—seem to be doing very well,” he added. Couto also pointed out that lending levels have seen “quite a large improvement,” singling out the very high rate of lending from the U.S. Small Business Administration (SBA), and the government’s decision to waive guaranty fees for loans up to $150,000.
Interest Rate Considerations
On the closely watched issue of interest rates, Rizzo said, “It seems to me that with interest rates at historic lows, the likely direction is up. The question is when.” Although it’s anyone’s guess if or when rates will change, Rizzo said, “a good way to determine how the market feels about rates is to watch interest-rate futures and the shape of the curve.“
But while low rates can be a positive for operating businesses, the current rate environment has its own risks—especially “reliance on low interest-rate debt for capital structure,” according to Rizzo. A company may have enough cash flow to cover their current debt service, but might run into trouble if rates increase. Companies “should be developing cash flows for a higher interest-rate environment,’’ he added.
Couto agrees, saying, “Today, interest rates are very low, including on real estate loans.” But he also urged business owners to work with their CPAs to plan for interest-rate contingencies.
Considering Alternative Credit Sources
Another recent factor in the financing landscape is the proliferation of alternative lending sources such as Direct Banks like Ally, non-bank online lenders like Kabbage and On-Deck, and options like leasing, factoring, and crowdsourcing.
Online, non-bank platforms offer speed and flexibility through technology to fill borrowers’ needs, versus traditional channels that may be more risk averse.
Leasing products provide businesses with the ability to finance equipment purchases that might otherwise be prohibitive. Factoring allows a business to sell its accounts receivable at a discount to a financial institution, offering immediate funds when necessary. Crowdsourcing options like Kickstarter offer businesses access to funding from individuals online, and many entrepreneurs have funded the early stages of their start-ups this way.
While banks are starting to offer leasing products, they aren’t able to offer some other non-traditional credit products, according to Couto. Vehicles like factoring, for example, are more common in cases where risk is above a bank’s conventional tolerance level. In these cases, lenders are “basically buying accounts receivable,” said Couto.
Alternative credit sources like these “may be more expensive and less consistent,” said Rizzo, but he notes that some of these options are still in their early stages of development. Borrowers should be completely aware of all the terms and conditions before making a decision.
Looking for a Loan? First, Look at Your Business
When considering whether a business should seek a loan, “one clear piece of advice is that the only time a company should take on debt is when it has a very clear, realistic source of repayment,” Rizzo said. Quoting a former boss’s memorable line, he adds, “Hope is not a strategy.”
A business owner should never be in a position where “debt is managing you,” Couto said. “Plan to fix problems first.” Couto also advised business owners to be aware of when conditions might not be right for taking out a loan – such as rate environment, industry downturn, or having already leveraged debt. Businesses must ask themselves, “Is it prudent to take on debt?” he said.
“Each case is different,” said Rizzo. “A company needs to weigh the plusses and minuses of using debt and/or internal capital.” He suggests doing a sensitivity analysis. “Play with variables,” the most common one being revenue.
For example, if overhead is fixed, but sales decline, “assuming the same gross margins, can you still service the debt?” Conversely, if revenues are steady, but margins are variable, a company must sensitize its cash flows for this possibility. “Don’t rely on a best-case scenario to service the debt,” Rizzo urged.
Couto also emphasized the importance of seeking the guidance of an accountant, trusted peers and mentors for additional insights and direction. For small businesses, other resources include state small-business development centers, workshops through local Chambers of Commerce, the SBA, the SCORE Association and the Center for Women & Enterprise.
Looking Good to Lenders
Once a business determines that it’s wise to apply for a loan, the next stage is making its best case to potential lenders. As the American Bankers Association notes, “In any borrower/lender relationship, it is essential that the borrower provide an understanding of the business through an up-to-date set of financial and production records.”
Rizzo said a company must have a clear purpose for the capital and an identifiable, credible source of repayment. “Banks tend to view historical performance as one of the cornerstones of underwriting,” so if a company demonstrates “thin profits or losses coupled with weak cash flow, management must have a realistic road map…to improve its operating performance and generate sufficient cash flow to service debt.”
The SBA noted that business owners must understand that “lenders will be looking closely at your education and experience, as well as that of your key managers.” Rizzo also emphasized the importance of knowledgeable, experienced leadership for a business. “Do they really understand the business they’re in?” He says a common problem is “looking in the rear view versus the windshield” — that is, a business owner who understands where the business has been, but not where it’s going.
Lenders will also be on the lookout for reliable cash flow to service the debt; liquidity, as a fallback if cash flow becomes unreliable; and if all else fails, collateral. It’s a “last line of defense, but something we carefully consider,” said Rizzo.
Company leaders often fear debt, but lenders say a prudent, thoughtful approach to borrowing can help fuel business growth.
“Businesses have life cycles,” said Couto. “Lenders like to catch businesses in the growth stage, so they can grow with you.” Lenders take pride in their clients’ success, he says. “It’s always good to see someone go from a small business to a huge chain.”
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