Posted on: May 17th, 2019
Term loans are great funding tools as they stretch out over time and allow you to invest a large amount upfront. The periodic amount of payback can vary depending on the type of loan. For equipment based term loans, the principal amortization period is usually 60 equal monthly principal repayments. For a mezzanine term loan, there is very little principal amortization in the first 2 years of the term, and often there is no principal amortization required until the maturity date of the loan, 5 years from the funding date. Term loans usually have covenants such as fixed charge or leverage tests, to ensure the underlying business is performing at a level to ensure timely principal payments. While stable to growing performance is expected by both lender and borrower, reality tends to get in the way. Most companies over a 5 year period will have at least a bad quarter or two. In fact, most companies tend to have at least one down year over a 5 year span. Whether the economy is tough, or a large customer is lost, bad things can happen to good, well managed companies which result in covenant failures. While a good company cannot control all of the variables that lead to a down year, they can control their reaction and the manner in which they engage with their lender to deal with this situation. How they react to the lender is the most important variable. A covenant default can seem like the end of the world, but the reality is that most companies bust covenants at some time or another. Lender’s understand and almost expect covenant issues with their borrowers. The trick is getting the lender comfortable with what happened and what you are doing to fix it. They will be more likely to help you reset the loan, if they feel comfortable. It is as much of a communication exercise as it is an operational exercise. Here are 4 tips to help you manage the situation and successful restructure your term loan.
- Get out in front and communicate early – lenders like knowing that you have a high level of situational awareness as to where you are, and are on top of things. Rather than wait and not disclose it until your financial statements are issued, it is best to tell them as you see the situation developing.
- Identify the real problem – often management misses the root cause of the problem, and attributes the performance lapse to a superficial reason. You get one shot from a lender to get the turnaround right. Make sure you are attacking the right problem.
- New conservative financial forecast–Reset your monthly budget for the year and develop a new projection that shows the under performance as well as your actions to remedy it. Whatever your new turnaround plan is, it must be built into a monthly budget with realistic time frames. Make sure you give yourself enough time for the turnaround to take hold.
- Use positive measurables to your advantage – all lenders are human and ultimately respond to good news, even when you have busted a covenant. Whenever you are explaining the depth and severity of the turnaround, bring some good news that you can frame in financially measurable ways – backlog is up 10%, costs are down 5%, industry outlook is up 15%, etc. This will build hope in your lender and get them to see this as a temporary condition.