Engage The Bank: How to Navigate The Covenant Canal

It is important to carry out an exploration of your business before approaching the bank to renew or increase your line of credit. Bankers want to form a relationship with you as a business owner and will appreciate the time you took to address the concerns. In order to develop this relationship and earn credibility, you must begin with the company story of your business. While your website has company information, not all bankers look at it. Don’t be shy. Talk about:

1. The evolution of the company and the reason you exist.

2. Give a history of leadership with the company and how the company is structured. Banks appreciate a chronology of management changes.

3. Describe the type of work you perform and the projects completed. Who are your major customers?

4. Discuss labor source and geographical presence.

5. Describe the job procurement process, business development methods, and estimating and bidding procedures.

6. Describe the change order management process. What level of senior management exists on a regular basis?

7. Discuss your company’s bonding arrangements which includes your surety provider, capacity and history.

A bank will require historical and current financial information. Be ready to provide:

The last 4 years of audited or reviewed financial statements.

  • Recent interim financial statements along with the prior year comparable
    • Income statement
    • Balance sheet
    • Statement of cash flows
  • Accounts receivable and accounts payable agings for the last year end along with interim.
  • Work-In-Progress schedules for the last 2 audits/reviews along with the last interim with the prior year comparable.

In terms of credit, know what you want and be prepared to ask for it. Know how much credit you are applying for and why. A forecasted cash flow will add a significant bonus for both the bank and the contractor. When applying for term loans, describe what the loans will be used for whether it be for refinancing, equipment purchases or dividend distributions. In summary, here is a checklist you can follow when optimizing your outcome with the bank:

  • Start with a month by month forecasted Income Statement and Cash Flow.
  • You know the jobs under contract and the estimated margin.
  • You have an idea of when they are to start and the work/billing schedule.
  • You know the overhead.
  • Prepare a schedule similar to the schedule that follows
  • Is your line of credit large enough? Ask for more before you need – you just built your case.

A covenant is a term placed in a loan or other type of debt agreement that requires the borrower to either maintain or refrain from certain business activities. Covenants are there to protect the lender from risk they did not consider when calculating the loans riskiness. They are also there to ensure that the borrower stays financially healthy and is able to pay back the loan.

Covenants are established to provide a guide to the business’ expectations. Changes in the various covenant ratios indicate a possible change in the business. The bank would like to understand what drives those changes. How the bank may respond is dependent on the factors that drive the change in financial condition. How often it occurs is also considered.

Be proactive in communicating with the bank. Describe what happened, whether it be a bad job or jobs, lack of volume or a bad employee.

Discuss what the company will do to change/improve the situation. The company may need to improve procedures and controls, reduce overhead and/or make the necessary personnel changes.

Talk about when the situation is expected to be remedied. Discuss when you expect the covenant violations to be cured.

When entering a loan agreement, be sure to take the following into consideration:

  • Make sure you understand how the covenants will be calculated and how frequently they will be tested.
  • Have them defined in your credit agreement.
  • Ask for a form of compliance certificate.
  • Calculate the covenants in conjunction with your forecast to ensure ongoing compliance.
  • Credit agreements may include different types of covenants.
  • Test them regularly internally.


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