As the nation and the world labored under the yoke of a deadly pandemic the past year, business owners have struggled to navigate an unfamiliar financing landscape. Sales for many firms have slumped, sometimes drastically, and at the same time lenders have placed tougher requirements on borrowers. In this new world, businesses have to be resourceful when it comes to financing.
An October 2020 Federal Reserve survey of loan officers at 84 institutions found banks tightening standards and terms on loans to businesses of all sizes. Lenders were asking borrowers to put up more collateral, accept stricter covenants and pay premiums on riskier loans. The lenders said their actions were caused by an uncertain economic outlook, deteriorating conditions in some industries and a lower overall appetite for risk.
Managing financing can be difficult, even for business owners who have navigated previous recessions, says Jason Cherubini, founder of Seraphim Associates International, a Bethesda, Maryland-based management consulting firm focused on helping small firms find on financing.
“A lot of people are looking at 2020 in a similar vein to what we went through in 2008, but they’re entirely different,” Cherubini says. “2008 was a credit crunch. It was a structural problem, where there wasn’t enough credit available to big commercial banks and that trickled down so credit was not available to small business. That’s not the case now. Credit lines are open and lending is happening.”
This time the problem is that pandemic-related shutdowns and interruptions have shaken the economy and left some businesses in poor financial shape.
“Banks are ready and willing and able to lend to companies that remain sound,” says Chris Young, chief financial officer and director of operations at private equity firm Montage Partners in Scottsdale, Arizona. “But banks are constrained by the economic realities of today.”
That reality translates to business owners not being able to borrow, just when many need it most.
“The current lending environment appears to be more difficult to obtain financing,” confirms Cassie Ferrer, a business financial management consultant in Clermont, Florida. “Many of my clients that historically were able to get lines of credit from banks have been turned down due to various reasons.”
Part of the reason, she says, is that declining sales and cash flow have made it so that businesses no longer meet bank requirements.
Consider Financing When You Don’t Need It
One surprising feature of the current financing landscape? Even as the economy roller-coastered from a 31.4 percent drop in real GDP in the second quarter of 2020 to a 33.4 increase in the third quarter, businesses were actually less active in seeking financing.
The Fed’s October bank loan officer survey, for instance, found weaker demand for loans from businesses of all sizes. At the anecdotal level, Cherubini said his clients were asking him about the wisdom of tapping personal savings and taking out home equity loans to finance their firms during the pandemic.
According to Cherubini, a wiser move may be to conserve cash and arrange to borrow if you can. That’s true even if—or especially if—you don’t need it at the moment, Cherubini says. “It’s better to do those things now than to hope things will work out,” he says.
Young advises businesses to be sure to maintain existing lines of credit. That may mean renewing lines annually when they aren’t being used. That could require providing updated financial statements or paying a small fee.
The administrative overhead and expense are likely to be worth it, though, Young says. Even if for no other reason than that it helps you sleep at night knowing you have available credit. And if something unexpected happens, such as losing a major client or having to endure an extended shutdown, the cost may be well worth it.
The adage about banks not lending to borrowers who need money is fitting here. The best occasion to seek or renew a credit line is when your financial situation is strong. The worst is when you’re about to fall behind on your bills. “By the time you need it,” Young observes, ‘it’s too late.”
Ferrer cautions, however, against using line of credit financing for anything besides short-term cash requirements such as paying vendors while waiting to collect accounts receivables. “Lines of credit should be used for working capital needs and should not be used for equipment and other fixed asset purchases," she says.
Explore Government Options—Including State and Local Ones
An unprecedented feature of business financing today is the availability of many new government programs. These include federal initiatives like the 2020 and 2021 editions of the Payroll Protection Program, Economic Injury Disaster Loan Emergency Advances, SBA Express Bridge Loans and SBA Debt Relief.
Cut fast. Cut deep. Cut once… [B]etter to tighten your belt all at once than to try and hold on and only start cutting after things are a problem.
– Jason Cherubini, founder of Seraphim Associates International
These federal programs are just part of the current government financing landscape. To fulfill mandates of pandemic relief legislation, the Fed has set up a plethora of facilities to provide state and local governments with low-cost funds that can be used to support businesses. Cherubini advises business owners to check into local government programs if they can’t qualify for national loan initiatives.
Cherubini says, “It’s up to the business owner to research what’s available and go after it.”
Implement Cost Controls Now
Whether financing is available or not, managing expenses is essential in an uncertain economy. Ferrer urges business owners to craft detailed financial projections and keep them up to date so that they can see cash crunches coming well in advance.
“Also prepare a sensitivity analysis to see if cash flow will become negative should the company lose one of its clients or if expenses increase,” Ferrer adds. This sort of stress testing using alternate scenarios is a basic financial management practice, but one that is especially important when it's difficult to know what might happen next.
If cash is about to turn south, a good first step may be to contact vendors to discuss longer payment terms to bridge the cash gap. For more lasting solutions, Cherubini suggests taking a hard look at ongoing expenses—the sooner the better. “Cut fast. Cut deep. Cut once,” he advises. “At the beginning of economic turmoil, it is better to tighten your belt all at once than to try and hold on and only start cutting after things are a problem.”
Young suggests setting a minimum cash balance and reacting if you start to approach it. “Accessing additional sources of liquidity should be done before breaching the minimum cash limit,” he says. Many businesses that are still in good financial shape may be able to significantly cut costs by taking advantage of historically attractive borrowing costs, Young adds. “Interest rates are low right now,” he says, “so it’s a great time to refinance higher cost debt, if possible.”
Proceed with Cautious Optimism
Cherubini expects recent changes in Washington, D.C. will lead to a number of new programs to help businesses cope with the ongoing pandemic. “For the next 12 to 18 months, the government is going to be facilitating things like PPP,” he says.
But Ferrer cautions against assuming it will be clear sailing ahead. “In the near future, the financing environment may be tightened,” she says. “Once everything starts opening again, we should see improvement. But it’s best to cut down on unnecessary expenses at this time and postpone projects that are not likely to be profitable in the beginning.”
These days, Montage Partners preaches the wisdom of being financially conservative to its portfolio of companies. “We have regular conversations around cash flow and financing with our management partners,” Young says. “If COVID has taught us anything, it’s to expect the unexpected and be prepared for a rainy day, week, month or year.”
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