Business activity ground to a halt in many areas during the pandemic. Fortunately, the Paycheck Protection Plan (PPP) program and other relief programs rescued many small enterprises from financial crisis. If certain requirements are met, all or part of PPP loan proceeds may be forgivable — similar to a grant from the federal government.
The PPP loan program ended on May 31, 2021. Now, struggling businesses might be applying for affordable conventional loans — or negotiating more favorable terms for their existing debt. Doing so can help reduce interest expense and working capital requirements. Don’t wait for lenders to make the first move. Here’s how to get the optimal terms from your lender.
Read the Fine Print
If you already have a loan, take some time to review the fine print on your loan agreement. Or, if you’re applying for a new loan, don’t take the offered terms at face value. The initial offer is generally what the lender hopes you’ll agree to, but there may be some room for negotiation.
Similarly, the assumptions the lender has made about your business’s level of credit risk might need to be challenged. You could be in a prime position to negotiate, for example, if your company’s performance or your personal credit score has improved over time. Your leverage hinges on how competitive the lending environment is in your geographic area or business sector.
Evaluate Loan Terms
Before delving into negotiating tactics, think about the particular loan terms you want or need. Those might include:
Loan amount. It’s time to negotiate if, for example, you need $200,000 but a lender’s first offer is only for $150,000.
Collateral requirements. Pledging personal assets, such as investment accounts and home equity, makes you financially vulnerable. But it may be necessary in some situations.
“Cash dominion” terms. Some loans require that all payments on your receivables be directed to a lockbox at your bank that the lender controls so that it can claim enough of that incoming cash to cover your loan repayment obligations. Some borrowers view that as an unappealingly operating restriction, however.
Repayment term. If the loan term is uncomfortably short, you could negotiate for a longer one to give you greater financial flexibility and predictability.
Loan covenants. These are the requirements and restrictions that take up a lot of space in loan agreements. Some covenants are entirely reasonable, such as required property and casualty insurance coverage levels. Others may make you feel like a child under the watchful eye of a strict parent. For example, you may be required to notify your lender if your business suffers any setbacks and give your lender access to all of your financial records upon request. You also might be required to keep executive pay and dividend distributions below a specified ceiling.
Interest rate. This is the loan term that generally gets the most attention, usually for good reason. It’s the “cost” of the loan, which may either be fixed or variable based on a market index.
External factors can also affect your leverage in negotiations with lenders. For example, when numerous lenders compete for business from a small pool of prospective borrowers, you may have more leverage when applying for new loans and renegotiating old ones. Businesses in this situation may be able to play lenders against one another to get the most favorable terms.
It’s important to prioritize loan terms, based on what’s most important to your business. For example, you might be willing to “give” on collateral requirements to get a more favorable interest rate or longer repayment term.
When negotiating financing, the trick is to refrain from overplaying your hand and impairing your credibility with prospective lenders. Gathering some intelligence on loan terms extended to similar businesses can help give you a feel for the market and what terms a lender would be likely to accept.
You can gain some insights by having casual conversations with a preliminary list of lender prospects. In doing so, you can also save yourself time by eliminating lenders from the list that don’t deal with many businesses like yours.
Assemble the Paperwork
How you present your business is critical. Lenders prefer borrowers that are professional, prepared and transparent. If there are any blemishes on your financial record, such as a negative credit report or outstanding tax issues, try to rectify them before seeking a loan or attempting to renegotiate an existing one.
When you meet with your lender, bring a full set of financial records, insurance contracts and other documents that might be relevant. The more evidence you have to show that you understand what lenders need, the better. Similarly, prepare your responses to potentially challenging questions that might be asked about your business.
We Can Help
Your CPA can be an excellent source of insights on how to use debt to meet your working capital and other financial needs. He or she can also help negotiate or renegotiate loan agreements with terms that make sense for your situation.