In the business world, cooperation between lenders and borrowers is essential and, as in any relationship, communication is the key to success. This is especially true for a financially distressed borrower. While maintaining positive and transparent communications with lenders is an important part of running a business during both good and bad times, the task simultaneously becomes more critical and more difficult when a business is having financial problems.
As soon as a loan is transferred from a bank’s relationship managers to its workout department, the quality and quantity of information the borrower is required to produce often increase dramatically. Facing the possibility of a loss, the lender needs to know the exact condition of its investment. Companies that normally generate figures monthly or quarterly may suddenly find themselves having to develop weekly or even daily reports.
Preparing accurate and effective reports is often the only way a company can keep its lenders’ trust and convince them that a business’s operations remain viable. Unfortunately, these increased reporting demands come precisely when companies are entangled in other problems and are therefore ill-equipped to handle any new responsibilities.
During times of distress, a breakdown in communications between lenders and borrowers often amplifies the problems at hand, resulting in very noncohesive and noncooperative relationships at the worst possible time. Two recent engagements by a turnaround advisory firm illustrate this problem. One involved a large heavy equipment dealership, and the other involved a marine transportation company.
In each case, the lenders were fatigued, frustrated, and angry, and they turned to a turnaround firm for help. They needed to find out precisely what was happening with the borrowers so that they could determine the appropriate degree of concern they should have and weigh the degree of support they were willing to provide.
In situations like these, a good strategy can be summarized with three Cs: clarity, credibility, and consistency. Remembering the three Cs can help any company survive a period of distress without driving its lender to frustration.
Clarity is always at the center of positive communications. If a lender cannot easily locate and understand critical information within a company’s reports, then those reports serve little purpose. The first step in ensuring that lenders receive what they need is to know what that information is. Asking in advance what a lender expects in terms of content and format can help companies avoid wasting scarce resources to generate reports that are ultimately useless, because they fail to deliver the necessary information.
By attempting to include all potentially relevant information, companies often make the mistake of burying crucial data. By trying to create models that include every possible variable, they end up with products that can be understood only by their creators. Rather than communicating everything, they communicate nothing. The best approach is to design financial models and reports specifically with lenders’ needs in mind, highlighting the most important information, while relegating supplementary facts to more detailed appendices and tables.
A lack of clarity was at the center of the communication issues with the heavy equipment dealership. Unable to extract the information it needed from the reports it received from the business, the dealership’s bank group was ready to throw its hands up in the air.
The turnaround firm’s team quickly analyzed the information and produced a new and concise, yet detailed, cash-flow model and a set of reports that the lender group understood and that met industry standards. In addition to detailed 13-week cash-flow reports and other forecasts, the team put together an easy-to-understand weekly dashboard that provided a quick snapshot of the company’s health on a weekly basis (Figure 1).
Based on this sample dashboard, a lender group could quickly see the following key information:
The estimated collections from operations of $11.4 million and the $1.8 million of funds available, or cash in the bank, were not enough to cover the $15 million in payments required for the month, the planned bank debt payment of $500,000, and the $2 million cash balance requirement.
A shortfall of about $4.3 million would occur by the end of the month as a result.
Of $15 million in mandatory payments, $11 million was related to the main vendor.
From this information, the lender might quickly conclude that without the cooperation of the main vendor in allowing for stretched payments, large excess inventory dispositions would be necessary to generate cash immediately, which could affect the long-term viability of the business.
Before the turnaround firm became involved, the lender group had not had access to the breakdown of the mandatory payments and had no easy way to visualize the company’s weekly financial situation. It had no way of seeing, therefore, what impact negotiations to gain the cooperation of the main vendor might have on the situation.
The new reports opened useful communications between the company and the lender group and helped restore trust between the two. Once the lender group had a clear understanding of what was happening, the lenders felt far more comfortable with the company and its operations. A forbearance agreement was put in place that allowed the company to refocus and become stable. Thus, the company was set on a path that provided for the lender group to be paid in full.
In addition to being able to understand the data it’s receiving, a lender group must be able to trust that information. Consistently failing to meet projections is one of the fastest ways to lose a lender’s trust. Companies can’t be expected to see into the future, and so the occasional missed projection is inevitable. But when a company falls short of its targets month after month, such projections lose their meaning.
While the most straightforward method to fix this problem might seem to be to err on the side of underpromising and overdelivering, outperforming projections can also erode a borrower’s credibility if it becomes a trend. The best approach, therefore, is to pay careful attention each time a projection is not met — whether it is exceeded or missed — and to analyze what flaws in the model led to the discrepancy. This information should then be shared with the lender and used to improve the quality of future projections.
Bridge analysis charts provide a particularly effective way to visualize how projections compare to actual figures or to explain what factors may contribute to the projected outcome. Figure 2 is an example of a bridge analysis prepared for the lender group of a marine transportation company. The analysis explained the different components of projected 2010 earnings before interest, taxes, depreciation, and amortization (EBITDA) and provided insight into how various components contributed to the final figures.
For example, the analysis clearly explained why projected EBITDA for 2010 would be significantly lower than it was in 2009. The biggest contributor was the expiration of long-term contracts. The analysis also gave the lender insight into where to look for improvement. It showed potentially damaging information—suggesting to the lender that the company was making no attempt to hide difficult realities—and provided enough information to help stakeholders move toward solutions, rather than panic.
Consistent presentation of information allows lenders to follow the status of a situation over time easily. Following regular procedures and using established templates ensures that information is comparable. For example, a category such as accounts receivable should be calculated and represented in the same way on internal reports from the borrower to the lender as it is on audited financials. When reports vary from audited financials for any reason, a clear bridge analysis should be provided to explain the difference.
In addition to ensuring that reports are consistent, it can be helpful to channel all lender communications through one key contact. This ensures that language and interpretations, as well as raw figures, remain constant to avoid possible confusion.
Companies also must be consistent in their contacts with their lenders. When lenders do not hear from company managers regularly and prior to any major decisions, they are forced to guess what is going on and often do not trust that information they do receive is comprehensive.
The task of creating consistency was another top priority for the turnaround firm in working with the distressed marine transportation company. The company frequently had failed to communicate at all with lenders before making major financial decisions, producing an atmosphere of distrust. When the company did communicate with the lenders, it was through a variety of individuals within the company, each of whom provided a different interpretation of the numbers. The lenders were left confused and unsure of how to proceed.
The turnaround team implemented a three-step plan to introduce consistency into the company’s reporting procedures:
First, the company’s management needed to be brought on board. The turnaround team coached and mentored executives to help them understand the importance of communicating with the lender group.
Next to be addressed were the lenders’ worries about the sporadic nature of the company’s communications. As a result, weekly conference calls were set up and held between the lender group and the company. Additional calls were scheduled whenever decisions were being made that would affect the lenders’ positions.
Finally, reports were created to allow the company to communicate consistently going forward. The team worked with the company’s management and operational staff to put together detailed reports and forecasts. In these reports, the team made certain that terms were defined in the same way they were on the audited financials and that the company always adhered to the same methods of categorization.
In addition to resolving consistency issues, the team addressed clarity by making sure the lender fully understood the new reports. Including detailed explanations of projections, such as the bridge analysis shown in Figure 2, helped resolve credibility issues.
The company’s management quickly came to understand the value of consistent communications with the lender group. As the turnaround team moved to the second and third steps of its plan, the lender group’s anxiety and frustration were mitigated. The lenders came to understand the company’s condition and operations.
Once the situation cleared, a private-equity group invested about $100 million in the company, reducing the bank group’s exposure by more than 50 percent and giving the company a chance to grow. The lenders’ trust was restored, and they became optimistic about the remaining debt.
For both the equipment dealership and the marine transportation company, the turnaround firm supplied assistance the companies could not provide themselves because they were so busy addressing the other problems involving the distress they faced. Given the importance of lender communications in distressed situations, it is often advantageous for companies to hire an outsider to manage the task. Experts on distressed situations are familiar with the needs of banks and other lenders, and can analyze and present data in the most useful way possible, allowing a company’s management to focus on resolving the problems that pushed the business into distress.
While the three Cs provide a general outline for effective communications, experience is the best teacher. Because the level of financial reporting necessary during times of distress is far greater than during ordinary times, few company managers have the relevant experience to handle the job successfully. Hiring an outside liaison, therefore, can ultimately be cost-effective and produce better results than having existing managers attempt to learn on the job, particularly during a crisis.
When a lender moves to bring in such advisors, companies may initially resent the outside scrutiny. In the end, however, improved communications help both parties, giving lenders the information they need to make key decisions and allowing companies to gain or regain those lenders’ trust.
Managing lender communications may be the last thing on managers’ minds during a crisis, but it’s often the first step to putting a troubled company back on its feet.