KFA Writes

Five Principles to Consider in Choosing the Right Lender for Your Business

2018-10-11

There are BANKS and there are Banks

How do you choose the best one?

Five Principles to Consider in Choosing the Right Lender for Your Business

Today, even as businesses stretch their resources to cope with such issues as a sluggish economy and increased corporate oversight, they also face dramatic shifts in their relationships with their lenders. Driven by the market and regulatory forces, more lenders are reassessing their appetite for risk, showing a greater willingness to either cut financial ties or impose onerous transaction fees. However, by keeping five interrelated principles in mind, borrowers can significantly improve their chances of making a good match of their business with their lenders.

1. Know your lender's business philosophy.

Banks are highly regulated, while many non-bank lenders (with the exception of institutions like insurance companies) generally have less oversight. This gives non-banks some operating advantages since they have more freedom in capital reserves and other areas. But at the same time, some customers gain comfort from the implied safety of a heavily regulated institution. Although a high level of regulation can mean an inhibited ability to innovate, and an inability to understand the way a particular business is managed. Before one signs with a lender, a business must make sure that it understands the lender’s operating philosophy. Does it take a business approach to bank or a banking approach to business? The difference is significant, particularly if the company needs flexibility in its covenants or an increase in its borrowing capacity.

A financial institution, on the other hand, should think strategically with a customer and understand what it wants. Instead of focusing exclusively on ratios and regulatory guidelines, it should gain a thorough understanding of business, and then be able to articulate a capital structure that meets the company's needs, not the market's or regulator's needs.

2. Make sure the lender really wants to make the loan.

Banks are highly regulated, while many non-bank lenders (with the exception of institutions like insurance companies) generally have less oversight. This gives non-banks some operating advantages since they have more freedom in capital reserves and other areas. But at the same time, some customers gain comfort from the implied safety of a heavily regulated institution. Although a high level of regulation can mean an inhibited ability to innovate, and an inability to understand the way a particular business is managed. Before one signs with a lender, a business must make sure that it understands the lender’s operating philosophy. Does it take a business approach to bank or a banking approach to business? The difference is significant, particularly if the company needs flexibility in its covenants or an increase in its borrowing capacity.

A financial institution, on the other hand, should think strategically with a customer and understand what it wants. Instead of focusing exclusively on ratios and regulatory guidelines, it should gain a thorough understanding of business, and then be able to articulate a capital structure that meets the company's needs, not the market's or regulator's needs.

3. Make sure the lender has adequate depth and capacity.

In order to properly service a customer, a financial institution should have a deep, broad understanding of its borrower's business, the expertise to structure a transaction that meets the customer's needs, the desire to work with the customer on a long-term basis, and the ability to articulate all of this in a way that makes business feel comfortable. The lender should be able to call upon intellectual resources that include a comprehensive, cross-industry knowledge base, enabling it to meet the business’s timeline and other needs. It should also have financial resources that let it take a significant hold position and maintain it for an appropriate term.

4. Look for a lender that wants to build a relationship, not just a transaction.

True "relationship banking" is important to the success of a borrower's relationship with its lender. For borrowers, it’s very helpful to be able to pick up the phone and speak with someone who knows its business. Such a relationship may help the borrower to get over some rough spots. However, that many borrowers abandon this approach when money gets tight. Even though there are long-term benefits to working with a relationship-oriented lender, many companies just focus on interest rates during a difficult economy. In the bull market of the 1990s, for example, everyone seemed to be focused on building relationships. Now, though, borrowers seem to be ignoring relationship banking and are focusing only on price.

In today's challenging environment, CFOs and other top executives are often hard-pressed for time, and may be tempted to move fast when it comes to financing arrangements. But if they take the time now to select the appropriate lender for their particular needs, understanding such factors as the institution's capabilities, underwriting abilities, breadth of products, and risk appetite, they may capture significant long-term benefits.

It is very important to determine whether or not a lender can add true value to the business.

5. Consider all the costs related to your debt.

For many borrowers, choosing a lender often comes down to simply looking for the most attractive interest rate. But that approach may actually result in higher overall costs. The key is to consider all of the costs involved in the debt facility, not just the stated interest rate.

For example, the final price of a syndicated transaction is determined by the market, so if a lending institution does not have solid syndication capability or the transaction isn't structured properly, the loan may have to clear at a higher price, wiping out any savings delivered by a seemingly cheaper proposal or "term sheet" interest rate.

The value of a lender's knowledge and other added services might also be factored into a borrower's true cost of capital by considering the value that can be added (or potentially deducted unwittingly) on income statement lines other than interest expense. It should not be taken lightly that partnering with the wrong lender could result in the business relationship being terminated, or flexibility being limited, at an inopportune time.

 

Choosing the Right Lender Can Help to Make or Break Your Business

Choosing the right lender is more than just a one-off transaction. Instead, it is the beginning of a long-term relationship. The following are few important questions to consider in evaluating potential lenders to make the right choice for the first time:

1. Is your lender competing solely on price?

A good interest rate is only part of the total cost of a loan. Your lender's holding capacity, its reputation and other factors will all influence syndication and other costs.

2. Does the lender have the ability to add value, beyond an extension of the loan?

Ideally, your lender will be able to enhance your business with knowledge as well as capital. A lender that offers knowledge can help you to improve your company's business strategy-and its familiarity with your company's operations may keep the lender from abandoning you during difficult periods.

3. What is the Risk Appetite of the lender?

A financial institution that's willing to accept a reasonable amount of risk is more likely to stay with you during lean times as well as good ones. But in the event of a slowdown, it's more likely to be difficult to deal with a lender that operates largely by ratios and rigid covenants.

4. What is the lender's hold level?

A lender that maintains its position on a loan sends a positive signal to the marketplace, and may be able reduce transaction fees. Determine your lender's ultimate hold capacity, not just what it is willing to underwrite for the initial placement of your loan.

5. Can I expect to have a consistent relationship manager as my needs change?

It takes time to build a relationship with your lender, and your company's financial and other requirements will change substantially over its lifecycle. Will your advocate or relationship manager be there over the long term?

6. Is the lender highly regulated?

How will this impact a firm? An excessively regulated environment may stifle innovation. Does your lender take a business approach to banking, or a banking approach to business? The difference is significant, particularly if your company needs flexibility in its covenants, or an increase in its borrowing capacity.

 

-Resta Jha

The Author is Chairman of KFA, leading Institute providing Training, Education and Consulting Services to various sectors in Nepal.

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