I previously wrote about the importance of getting agreements in writing. From personal experiences and observations I have seen great detriments in relying on vague verbal assurances. Among other things, reducing an agreement to writing ensures commitment and helps clarify important details between the parties to the agreement.
Written financing agreements are particularly important because the financial function is a key enabler of business strategy and operations. When the organization’s existence is riding on the line, a controller or CFO cannot rely upon flimsy verbal promises from potential lenders or investors. Senior financial leaders must take charge in clarifying the exact nature and requirements of the funding agreements.
A recent CFO.com article details the importance of looking for quirks in financing agreements. Here are some takeaways:
- Be prepared for stringent documentation requirements and financial covenants, especially if your business is a first-time borrower or has a checkered credit history.
- Don’t assume that the math will be straightforward in calculating credit limits for asset-based borrowing. For example, lenders might discount certain categories of receivables such that the company is unable to borrow against them.
- Banks can use their own judgment and criteria, seemingly without a tight quantitative basis, for excluding certain assets from the collateral base. This effectively reduces the amount of credit available for the borrower. Factor this in when making decisions about managing working capital and short-term cash flow.
- Have an eagle eye for fees. Don’t base your borrowing decisions exclusively on the quoted interest rate while ignoring hidden expenses that drive the effective borrowing costs higher.
- Be aware of initially odd requirements such as segregating inventory used as collateral from other inventory in a separate warehouse. Rather than having to worry about a padlocked warehouse and drawn-out, expensive litigation, banks want easy access to the security in case the borrower goes bankrupt. This places added complexity, requirements, and (likely) expenses on the borrower.
Communicate effectively to make sure all relevant details are negotiated and finalized in the lending agreement. Both the borrower and the lender need to be clear on making sure their economic interests are served by the agreement. Both sides have to exercise due diligence to ensure that they are getting a workable deal.