Guide for CFOs: 5 tips to navigate a financing deal process
Any CFO with prior experience getting a loan for their business — be it a middle-market company or venture capital-backed startup — would probably agree that lenders never seem to run out of due-diligence questions.
Lenders, on the other hand, often find themselves pulling teeth trying to get their questions answered.
Inexperienced borrowers think they probably need only two to three weeks to get a loan funded; in reality, that is how long it typically takes just to get a non-binding letter of intent signed. Without an informed CFO, such mismatched expectations are likely to derail a company’s financing deal process.
Based on our experience at Rho, having worked with alternative lenders ranging from credit hedge funds and BDCs to venture debt firms and family offices, here are five pointers for managing your financing deal process.
Lenders want to review your most-recent financials to, among other things, form an opinion about where your business might be headed and whether there might be any short-term liquidity issues. This means that lenders will ask for P&L and cash flow statements through the last month and balance sheet as of the last month’s end. This means you might not want to approach your lender in August while your latest financials are as of May.
Because the middle-market loan underwriting process typically lasts four to six weeks, lenders will request a new set of monthly financials prior to funding the loan. Your failure to promptly update and deliver financials signals to the lenders that you lack proper financial control, or worse, it might even plant a seed of doubt in their minds about concealment of the true financial position of your company.
Lenders understand there are ups and downs in any business; you just need to have an explanation for any oddities in your numbers or any material changes from the prior period. For example, “Why did revenue drop 5% last month?” “What caused the $1 million increase in SG&A in the last quarter?” “What explains the uptick in days sales outstanding in the last 12 months?” If your business recently experienced a material setback such as losing a key customer or being pulled into a high-profile lawsuit, lenders will want to understand how that setback might affect your ability to repay the loan.
Lenders will need to understand any concentrated sources of risk, and may ask for detailed segment information such as revenue breakdown by product categories, by end markets, or by types of customers (e.g., direct-to-consumer vs. wholesale, repeat vs. new clients).
Generally speaking, bullet-point explanations, footnotes, Excel tables, and charts are preferred over lengthy paragraphs. By being upfront and proactive in your explanation, you have an opportunity to gather facts, retain control of the narrative, and minimize the risk of lenders discovering those issues on their own and wondering what else you might try to sweep under the rug. Depending on the lender, you might find yourself having to re-explain what you already did, initially to that lender’s origination (or business development) team and subsequently to its underwriting team.
Such repetition tends to happen when dealing with lenders that have separate, specialized teams for sourcing deals vs. closing deals where you will need to repeat the stories and explanations about your company.
Being consistent in how you present financial results from month to month, and year to year, helps lenders quickly get a grip on your business and underwrite the deal.
On the contrary, any material reporting inconsistencies, whether with respect to the way you re-classify business segments or the new accounting methodology you adopt, can hinder the lenders’ credit review process or, worse, might even come across as your attempt to hide a financial setback.
One lender told us that a potential borrower recently submitted financials that showed an unexplained recent switch in accounting methodology from accrual to cash; that was enough to stop the lender right in his tracks. If you have a bona fide reason to adjust your financial presentation, be prepared to explain your rationale and the impact those adjustments would have had on the financial results of the prior periods.
Being prepared not only reduces the likelihood of both sides exchanging endless emails but also demonstrates that you manage a proficient finance team that knows the business “cold.”
Being prepared goes beyond delivering the most up-to-date monthly financials or providing detailed analyses of your recent financial results; it also means you (i) do your homework about your lenders, including their investment philosophy and the types of loans they make, (ii) anticipate the types of questions they will ask, and (iii) prepare your answers, in written form, ahead of time.
For example, if you forecasted significant revenue growth due to an uptick in volume, then you might want to start gathering the supporting customer contracts and purchase orders in case you are asked to provide them; if you claimed that most of your revenue is recurring, then it would not hurt to put together an analysis of your repeat customers and their historical contributions to your company’s annual revenue; or, if you insisted that your company has no near-term liquidity issues, especially in the context of the COVID-19 pandemic, then it might make sense to prepare a 13-week cash flow forecast that supports your belief.
Additionally, if you are seeking a loan today, your lenders will want to know how the COVID-19 pandemic has impacted your business, what remedial measures you have taken, and whether you view such measures as temporary or permanent.
Form matters, too. In fact, some lenders insist that financial data be delivered in Excel instead of PDF; some prefer using a virtual data room over emails for information sharing; and, some require due diligence responses be in writing as opposed to verbally. Regardless of the form of communication, having supporting information handy is one pragmatic way to demonstrate your firm grip on the business; conversely, a lack of preparation makes lenders nervous.
Lenders will be scrutinizing your company’s financial statements — double-check the accuracy and completeness of your financial information before sharing it.
Lenders have high expectations for CFOs, even with respect to non-financial areas such as legal and compliance, because you are the key person that they rely on for accurate information about your company. One lender told us about a borrower that included a footnote to its P&L adjustment that simply says, “Ask my accountant.” So, take your time to dot the i’s and cross the t’s.
Enlist other members of your team as needed to review with you all important information beforehand. In any case, you will likely need them in the later phase of the due diligence process, anyway.
In following the aforementioned five tips, you demonstrate to lenders that you are a reliable, transparent, and trustworthy counterparty which is the foundation for a productive borrower-lender relationship.
That being said, any seasoned CFO would agree that the process of getting a business loan is a marathon; however, while you can’t unilaterally finish this race, the tips we shared above might help bring you closer to the finish line — and hopefully, with fewer blisters.
After all, you probably have only this one race to run and have to finish it; your lenders, on the other hand, have many concurrent races, and they don’t have to finish all of them.