You finally did it. You got the loan you needed to build your business, buy a building, have working capital, or whatever. Think you’re done? Think again. Once you have any sort of financing in place, there are a myriad of requirements, reviews and covenants that you have to keep in check indefinitely in order to keep your lender happy. There are also some tricks up the sleeves of the banks that can change the rules once you think you know how to play the game.
Here are some of the most common:
1. Annual loan review
This is like underwriting all over again. Every year. Forever. Or at least until you pay off the loan. You will need to provide your tax returns – both business and personal, your financial statements and probably W-2’s.
The review committee will make sure you still “look good.” Meaning you can still afford their loan. This is different than what you may be used to with your personal mortgage where you basically “set it and forget it.” In a commercial or business loan, you will have a loan review every year and will need to be able to defend your financial results.
2. Compliance with loan covenants
Loan covenants are terms within a loan that say you will do certain things as long as you owe them money. Some common loan covenants are debt coverage ratios and rest periods. Debt coverage is most common with commercial real estate. It means that the rent received less the expenses of the building are at least as much as the debt and usually a multiple of it.
Rest periods come into play with lines of credit. You can use the line throughout the year, but for a set period of usually thirty days each year, the line needs to have a zero balance. This is to prove to the bank that you are in fact using the line for short term working capital needs and not long term financing.
3. Shrinking credit lines
If you are carrying high balances on credit cards and suddenly make a large payment to pay it down, don’t be surprised if the credit card company quickly swoops in and lowers your limit.
Credit card companies are regularly reviewing a company’s credit score and thus their risk. If they feel you have become a more risky client, they can lower your credit limit. If you paid down the balance, so you could make room to make more purchases, this can put a serious dent in your cashflow.
4. The almighty capital call
The annual loan review above is intended to provide the bank with comfort that you are still a viable borrower. If the loan is for real property – land or a building – they will also confirm that the loan is low enough to meet their loan to value requirements.
If you do not provide acceptable responses to their inquiries and if they feel that the value of whatever they have loaned money on has decreased, the lender could send you a capital call. This minor clause in many a loan doc has caused countless businesses into bankruptcy. Savvy developers, experienced retailers, longstanding manufacturers and property owners that would otherwise make payments and carry on have been forced out of business by a several digit deep capital call.