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SBA Loans & Turnarounds: A Surprising Marriage

SBA loans and turnarounds are two phrases you may not be use to hearing together. In our experience, it isn’t well-known that flexibility does in fact exist for an SBA lender to accomplish a turnaround. However, they can go hand-in-hand with some knowledge about the process. Planning for and accommodating lender and SBA requirements is necessary when a loan is in distress as the lack of documentation can null and void all good turnaround efforts. Losing the turnaround upside can cause a lender to further suffer “repairs” to the SBA guarantee creating unnecessary lender losses.

Planning for an SBA Loan Turnaround

In order to successfully achieve a turnaround (and highest loan recovery) where an SBA loan exists, we advise the following process. While this is not a complete set of instructions, it is fairly comprehensive. There are several things that must happen up front in a good plan. Among them is some documentation of what the borrower will do, and what the borrow has done to help the lender – what’s known as consideration.

1. Perform Due Diligence

Documentation is key. Collect the guarantor’s personal financial statement (SBA Form 770) and ensure it’s signed and less than 90 days old. You’ll also need 2 years of the business’ tax returns and 2 years of personal tax returns on 20% or more owners. Review loan documents and clear any exceptions you can.

Physically, it’s important to conduct a site visit. Observe the condition of collateral and working assets like equipment and inventory in order to determine the ability to produce revenue under the workout agreement. Use all the information you’ve collected to assess the business’s ability to succeed under a workout agreement.

2. Plan

Put your plan in writing. Include a list of events of default to date. Confirm collateral including who has priority position on various assets. Define a forbearance period, the workout options employed, and the events that constitute a default under the workout as well as the consequences of default under the workout agreement. The lender and the borrower must sign this plan. Also, at this point, it may be necessary to get a fresh set of eyes on the situation to assess what is really achievable. Understand that while the SBA is watching, they encourage lenders to take proactive unilateral steps to fix the situation and help the owner turn the company around.

3. Report

The workout plan must move from concept to implementation within 60 days of the default. If this cannot happen, enforced collection must be pursued. There are several things that must happen up front in a good plan. Among them is some documentation of what the borrower will do, and what the borrow has done to help the lender – consideration.

Consideration is required for a workout plan. Examples of consideration include:

  • Correct Loan Document errors
  • Waive defenses
  • Release lender liability claims
  • Provide additional collateral
  • Consent to a speedy and inexpensive method of liquidating the loan if the workout fails

4. Documentation

Be sure to provide a written workout plan following all steps found in SOP 5057-2 (Just revised released). SBA does not have to approve the plan; it’s typically a unilateral action unless the principal balance is being compromised as part of the plan.

5. Monitoring

While there is no requirement for a 13-Week Cash Flow Model, we believe a prudent lender would employ one. It is the fastest way to determine if a plan is working. At the least, financials should be collected at least quarterly, if not monthly.

6. Deferment and Modification

Consider the three elements that show the SBA can be flexible:

  • Forbearance: enforced collection activities may be postponed for a stated period of time in order to provide the borrower with an opportunity to improve its cash flow and avoid foreclosure
  • Deferment: delinquent and future payments of principal, interest, or both may be deferred for a stated period of time to enable the borrower to overcome a temporary cash flow problem
  • Modification of repayment terms of Note: the repayment terms of the Note may be modified, including lowering the payment amount or interest rate or extending the maturity date of the loan.

7. Subordination

The priority position of a lien securing the loan may be subordinated to a short-term working capital loan. This is unique to the SBA and not possible in most conventional loans showing more flexibility by the SBA. It is not typical for lenders to do this, but it possible with the SBA’s support.

8. Sale of assets

The borrower may be allowed to voluntarily sell all or part of the collateral, However, the sale must be closely monitored in order to ensure it is commercially reasonable and that all of the net proceeds are applied to the principal balance of the SBA loan or used to facilitate the workout plan. “Commercially reasonable” is defined as obtaining appraisals and valuations. In order to make a sale of a distressed business work, these actions must be completed before a sale happens. It requires coordination and working with a professional who can manage this extra effort in a timely fashion.

If you are involved in a relationship with an SBA loan and a distressed company, Newpoint can help. Our Cash Flow Launcher will create a 13-Week Cash Flow Model that quickly identifies areas of concern and uses actual transaction data to better analyze and scrutinize forecast assumptions. Contact us today for a consultation.

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Cash Flow Checklist

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Cash flow problems can drive the demise or progress of a business but you appreciate the validity of the phrase “cash is king.” Use the checklist below to ensure you implement and maintain an accurate model.

  1. Plan for change

    2. Cash flow models tell you what will happen when you gain or lose orders. Have Plan B ready.

  2. Forecast sales

    3. Even if sales change week to week, forecasting will help keep a realistic tally of your expectations.

  3. Forecast collections

    4. Know who pays you and when. Call them when they disappoint you. Don’t wait!

  4. Be suspicious of inventory (manufacturing) or capacity (service business)

    5. Both look pretty on paper, but they eat cash.

  5. Schedule bill payments

    6. Don’t react to bills. If you see a cash flow issue forecasted in a month, ask the vendor for flexibility. They’ll usually accept your request and offer leniency on future issues.

  6. Plan for bills

    7. Don’t get caught with a “gotcha” bill. Looking forward a few months will remind you about the big, infrequent bills you need to plan for.

  7. Write down your cash flow assumptions

    8. Examine the ridiculous ideas in your managerial head. Review them for common sense.

  8. Review the cash flow model with others

    9. Pick a trusted advisor, your spouse, or even the family pet. Just say it out loud.

  9. Don’t hide!

    10. If your cash flow model is forecasting bad news, turn to Plan B and start moving.

Take control of your cash flow challenges once and for all.
Call us at (312) 656-9750 for more information on Cash Flow Launcher.

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Woes of a “Broken” Cash Flow Model

By Brian Hartford, Managing Director

Business clichés are a dime a dozen but few provide value when integrated into the psyche of business professionals. None speaks more truth to power than my personal favorite: “Cash is King!” Yet, even with an understanding of the importance of cash, many small and middle-market business owners are naive when it comes to cash flow management and forecasting. It’s especially true for those who are facing troubled and uncertain times. While there are many methods to predict cash flow from financial statements, the 13 Week Cash Flow Model (TWCFM) is the most reliable and dynamic tool for cash flow management and forecasting. In fact, when cash is tight due to growth or distress, it’s the model toward which all professionals gravitate.

The TWCFM is a simple tool that accomplishes many goals, and not just for owners and managers. Banks, creditors, stockholders, and other business constituents all benefit from a functioning TWCFM. But disbelieving clients are often skeptical. What exactly is it? And how can it possibly help the growth potential of—or, on the other hand, how can it possibly save—the business?

The TWCFM is a dynamic, short-term method to forecast all sources and uses of cash. It’s long-term enough to predict immediate liquidity needs without being speculative. It improves transparency by ignoring the accounting conventions prescribed by GAAP that tend to obfuscate and confuse readers of financial statements on the true cash position of the company. When the liquidity position of the company is understood in plain terms, developing and implementing a turnaround plan for the business becomes not just attainable but accepted by stakeholders and decision makers.

A “Failed” Cash Flow Model

Despite its simplicity, those who attempt to implement the TWCFM are frustrated when it “fails.” The truth is, though, often when a TWCFM fails, it’s actually working exactly as it’s supposed to function. At Newpoint, we’ve found many TWCFM users develop models that predict healthy, break-even cash flow, yet are confused when cash flow turns negative. In most cases, the model is illustrating a lack of transparency. Unlike five-year pro forma models that rely on GAAP methods to predict aggregate account values and accommodate rounding and forecast errors in growth and discount rates (such as discounted cash flow valuation models), the TWCFM requires the user to be as granular as possible. Down-to-the-penny is all but impossible in a five-year forecast, but is achievable in a 13-week period. When the TWCFM accounts for cash costs, it forces the user to understand how the business produces and consumes cash, thereby providing transparency to the liquidity position of the company.

When Cash Flow Predications Fail to Materialize

A client once developed a cash flow model that predicted the company would run out of cash in six weeks. With its line of credit frozen and all other sources of cash tapped out, the company faced serious choices. Inventory management, or lack thereof, was at the top of the list. The nature of the business afforded the client the opportunity to move closer to a Just-in-Time (JIT) management system. Inventory had a virtually unlimited shelf life, lead-time on new orders was 48 hours, and there was no borrowing base dependent on inventory levels. However, the 45 year-old family business maintained a healthy (but now not helpful) inventory level and a the idea of a JIT system pushed the boundaries of management’s comfort zone. Our client made the difficult choice to reduce spending on inventory and conserve cash as they headed into a cash flow ebb. As a result, rather than a cash deficit, we emerged with an even larger cash balance than we’d had in robust times.

The TWCFM predicted doom and gloom if steps weren’t taken. They were, and the day was saved. Surprisingly, our client was more skeptical than ever before of the TWCFM! In his mind, the company should have gone out of business right then and there, not come out stronger than ever. In his words, “This model is useless. It was way off!” He failed to understand the model did exactly what it was supposed to do: it predicted intermediate-term liquidity needs and highlighted the actions required to address those needs. We had the opportunity to explain this to him and it was a genuine “aha!” moment resulting in a bona fide paradigm shift.

TWCFM = Dynamism

A final benefit of the TWCFM is its dynamism. Because the model’s timeline is short, it can essentially be updated in real-time. As weeks pass, a TWCFM user can compare what was predicted to happen with what actually happened. By analyzing these variances, users can evaluate their forecasting skills and determine if they are as granular as they need to be. Weekly variances enable users to fine-tune their assumptions and increase the accuracy of the model as it is updated and weeks accumulate. And as users are educated on the true cash costs of a particular disbursement, the increases in accuracy reflect the granularity of the model.

The TWCFM is a reality check for all stakeholders. A well-developed model forces users to confront their bias and reveals a level of detail and transparency in the liquidity position of the business. This simple tool, when completed with objectivity, offers increased stability for a struggling company.