Negotiating a SBA loan modification or a deferment is an art – not a science. It is a delicate dance between the borrowing business, the guarantors, and the lender. The business needs to prove it is in need of assistance but it also needs to demonstrate that it is still a viable business capable of repayment. Show too much distress and the lenders deny the request and will likely elect to liquidate the business. If you demonstrate too much cash flow and the lender will deny the request and demand regular payments, leaving the business and its owners with few options.
So how does a business owner get a modification or loan deferment? First, it is important that we differentiate between the two.
Businesses that qualify for a SBA loan modification are experiencing systemic issues that result in debt service not being paid as agreed. These businesses may be facing reduced revenues, increased competition, increased cost of goods, or other long-term market forces that affect financial performance. Perhaps their original business plan never panned out and their business environment for the foreseeable future is depressed and they need to seek payment relief in order to remain in business. Unlike debt workouts, where a portion of the principal balance goes unpaid, borrowers seeking a modification are intending on paying 100% of the amount owed plus interest. They are seeking longer amortizations, balloon payments due at the maturity of the loan, or a reduction in interest rate all in an effort to reduce their monthly debt service.
Different from an SBA loan modification, businesses that seek loan deferments are businesses that are experiencing short term cash flow issues such as seasonality, inventory crunches, and past due vendor payments. They are seeking temporary relief from their lenders in order to be able to address their cash flow concerns. Other than when coupled with a modification, loan deferments are meant to offer short term relief only, to be immediately followed by regular payments. Deferments are typically between 30-90 days but can span for as long as the lender is willing and typically come in two main forms.
- The first is an interest only deferment, where the business continues to honor the interest portion of the note payment while the principal portion is deferred.
- The other is a complete payment deferment, where both interest and principal are deferred. The type of loan and the business performance will determine which type of deferment is available to the borrower. In the world of SBA financing, deferments are typically issued in 90 day increments for as much as 1 year.
Now that we understand the difference, what kind of business qualifies for a SBA loan modification or deferments and what should business owners do to increase their chance of approval by their lenders?
First, the business owner needs to understand what type of relief they truly need. Remember, you are asking the bank to take less than what was agreed on a monthly basis, so you want to make sure that if you get the relief you are seeking, that it will actually solve the problems you are facing. There is no reason to negotiate an interest only deferment with your lender, only to immediately default after the 90 days expire because what the business really needed was a modification and not a short term deferment. Likewise there is no reason to negotiate a modification with your lender only to default on the new payments because what the business truly needed was a debt workout. Look at your business and the challenges it is facing. Are you in a short term cash crunch or are your problems more systemic? Is this something the business will recover from or are you experiencing a consistent trend in performance that needs to be addressed in the long term? If you are unclear about what you should do, consult with an expert in this field.
Once you determine what type of relief you are seeking, it is time to prepare a package to present to your bank and to begin negotiating. Before doing that, a business owner should understand the risks associated with requesting relief from their lender and what the outcomes could be if their request is denied. If your presentation is rejected because your business shows too much cash flow and the lender believes they should be paid as agreed, you as the business owner are left with few options. You will need to cut costs elsewhere, reduce your personal salary and benefits, raise additional capital, or consider selling the business in order to pay down the debt. If your request is rejected due to the fact that there is inadequate asset value or cash flow, then the bank will not only reject your request but will begin liquidation proceedings. Many borrowers believe they are doing the right thing by requesting relief from their banks but shortly after putting forth the request, the bank begins the process of liquidating the business. If this is the case, the borrower will be forced to consider winding down their business and/or submitting an offer in compromise in order to avoid bankruptcy. The paradox here is that a business needs to prove that it cannot afford full principal and interest payments to their lender in order to obtain relief. However, by seeking relief from their lender, you are likely in technical default under their loan covenants and are therefore faced with the possibility of liquidation. With this in mind, it is important that the business owner be aware of how their request will be evaluated and be confident on their ability to perform on any relief agreement requested. It is also highly recommended that you seek representation of an expert with experience in these matters given how sensitive these discussions can be. Otherwise it may be in your best interest to seek other options rather than a modification or deferment.
SBA Loan deferments are the simpler of the two requests for relief. They involve a lot of financial documentation which include two years of tax returns, Personal Financial Statements, Balance Sheet, Accounts Payable schedule, Accounts Receivable schedule, and Income Statements, along with other requests the individual lender may have. The banker’s job is then to review that information to see whether or not they feel a deferment is warranted and whether or not they believe that regular payments will resume after the deferment expires. They determine that by looking at the following items:
- Business performance – The bank will review to see if the relief granted will resolve the short term cash problems. The will evaluate your AR position and determine the likelihood of enough revenue being realized to cover operational expenses and to honor the deferment agreement.
- Business collateral – The bank will review its collateral for the loan and will evaluate its current value. They do this to determine how secured their lending position is. If the collateral has depreciated in value and the business performance is poor, they may elect to liquidate now rather than to allow more time to pass in which the business assets continue to decline in value.
- Guarantor character – The bank will also review their working relationship with you. They will look through your performance to date, determine whether you have been a reliable payer, evaluate your communication and candor, and determine whether you are likely to honor your commitment as the business owner and guarantor.
SBA loan modifications can be a more complicated request, simply because the relief sought out by the business owner is long-term. However, we experience often that bankers review loan modification requests in a similar manor of that of deferment requests, often to the demise of the business owner. The documentation supporting the request is similar; tax returns, personal financial statements and business financials. If left to their own, many banks will make their determination with just this information and nothing else. The flaw there is that in addition to the criteria listed above, the bank makes projections for future performance of the business without input from the owner. Banks must project the likelihood of a business honoring a long term modification and in order to do that, they must have some expectation of the future business performance. Allowing the banks to complete that exercise without the business owner’s input often results in inaccuracies that have negative consequences. Therefore we highly suggest that every modification request include the following two pieces, even if they are not requested by the lender:
- Letter of Explanation – This is a formal written letter from the business owner to his banker. It should summarize all conversations had to date with the banker, discuss the current financial standing of the company, and spell out exactly what is being requested of the bank and why the business will be able to honor such a request.
- Cash Flow Pro Forma – Many business owners have no experience when it comes to projecting accurately and may need the assistance of an expert in order to do so. An accurate pro-forma is a critical element in obtaining a modification from your lender, so seek help if you do not know how to put one together or download this guide. By providing accurate, month-by-month projections going out at least 12 months, it takes the guess work out of the equation for the bank. They no longer have to make assumptions based on past performance alone and therefore will not come to inaccurate conclusions.
These two items tell your story. Many of these decisions are made by committees of bankers and not just the representative you may regularly speak with. Therefore without these items, your voice is not heard throughout the process and you have no platform in which to affect the outcome.
Regardless of what form of relief you and your business are seeking, it is highly advised that you seek the assistance of an expert prior to engaging in negotiations with your bank. Not only will they represent your best interest during the negotiating and assure the best terms of relief possible but they will also be able to assist in creating and presenting a package that will be approved by your lenders.
Remember, this is a very delicate dance and an expert that has done this many times will be able to guide you through all the landmines that are out there. Whether you take on the negotiation yourself or hire an expert, best of luck in your negotiations and may your business survive this rocky patch!