There is a cyclical quality to all of this. The wonder is how this cycle is the “surprise” with which it is treated. Studies of economic history reveal that this current cycle is worse than many earlier ones with the exception of the “Great Depression” of the 1920s and 1930s. The Great Depression was preceded by securities speculation, a housing bubble, speculative building and speculative lending. The Glass-Steagle Act was authorized by Congress to prevent the banking excesses that strengthened and lengthened the effect of the Great Depression. Under pressure of the finance sector, Congress repealed the Glass-Steagle Act during the administration of President Bill Clinton, opening the floodgates to another round of speculative banking, wiping out economic gains made after its passage and causing a real estate-led recession.
So, why are banks slow to release capital into the private sector? Depending on their ownership structure, banks answer to competing interests. Publicly held as well as closely held banks answer to shareholders and regulators and have a fiduciary responsibility to depositors. In general, the banking industry is smarting from the losses caused by its most recent 15-year-round of imprudent behavior. It has returned to its historic lending roots.
Public complaints regarding a liquidity deficit are fairly widespread. Access to home equity loans (in a housing market awash with “underwater” existing loans and foreclosures) is practically nonexistent.
What do banks require from closely held company borrowers in the current lending environment? The same things they required prior to the securities bubble of the 1990s and the real estate bubble of 2000 through 2007/8:
- Collateral that is as close to cash in liquidity as possible.
- Reliable first source of cash flow repayment (have a well-paying job).
- Reliable secondary source of cash flow repayment (have a well-paying secondary source of income).
- Credit score and credit history of the business owners.
- Strong personal financial statement(s) in the case of a closely held business owner.
- Business plan that:
(b) Acceptably describes the use of funds, and
(c) Clearly describes the industry of the borrower.
(d) Includes published industry comparisons and data for the local geographic area.
The first five requirements are self-explanatory. The last requirement of a business plan needs to be fleshed out a bit more.
Bankers frequently say that the loan documents supplied to them by borrowers are not written for banker acceptability. A business plan is not merely wishful thinking put to paper. It is a “treasure map” that requires periodic refinement as conditions change. It ought to be written with bankers in mind.
If used for acquiring start-up financing, it requires an approach grounded in well-researched projected revenues, budgeted start-up costs, costs of depreciable and amortizable assets, costs of ongoing operations, debt servicing and projected income tax effects. Support for the projections should accompany the business plan. A five-year plan is recommended by many authors, usually accompanied with a warning about the virtual impossibility of projecting out more than three years with an acceptable degree of accuracy.
The same requirements, plus additional ones, exist when preparing for mezzanine financing or financing by an already existing business entity. Historical financial statements with a healthy profit, cash flow and debt service ratio and comparable entity federal income tax return copies for at least three years are added to the previously mentioned business plan, as well as personal financial statements and individual income tax returns for the shareholder officer(s) of the entity. A comparison of the existing entity’s results with published industry results for the geographic area is a welcome part of a loan package and business plan.
Lenders view some industries and sectors more favorably than others. Startup dentistry is a good example. Under limited circumstances, lenders make 100 percent loan-to-value credit available for practices being acquired or started by young dentists with at least several years of clinical experience under their belts. Apparently, dentistry has one of the lowest loan default rates in the economy (as low as 1 percent). This is in spite of the fact that the average dental student graduates from dental school with approximately $250,000 of student loan debt. Of course this favorable assessment can easily dry up when, after a number of years in practice, a practitioner’s economic house out of order through maintaining a style of living in excess of disposable income.
By Stanley I. Foodman CPA, CFE, CAMS, CFF and
Stan S. Zelman DDS, CFP, CDFA
Foodman CPAs & Advisors
1201 Brickell Ave., Suite 610
Miami, FL 33131
South Florida Legal Guide 2013 Edition