Published on December 5, 2019 in the Rochester Business Journal

When engaging in a discussion regarding business financing, does your bank engage in a strategic dialogue or do you just talk about the proposed interest rate and term of the loan? Business loans are a tool to assist your business success; however, if your bank does not have a thorough understanding of your business operation and cash flow, many businesses end up with the wrong loan structure which can be costly, frustrating and time consuming. The bank should take the time to understand the business goals, strategic plan and cash flow to support loan structures for commercial and industrial businesses and commercial real estate projects.

Commercial and industrial companies can be any operating business including manufacturing, wholesale distribution, and service companies, to name a few. These businesses are dynamic and require strategic planning, budgeting and marketing efforts that will impact the company’s balance sheet, income statement and cash flow. Banks should spend time understanding how the company operates and elements of the strategic plan including: target market, product differentiation, gross margin, competition, access to supply chain, trade cycle/working capital needs, capital expenditure requirements, physical plant capacity for growth, and succession planning which impact current and future cash flow. These discussion points assist the bank in helping design the right capital structure for the company, keeping cost of capital low. For example, a high sales growth company may need longer term debt to assist working capital, inventory and capital expenditure needs for increased capacity. If the bank puts this type of company in short term debt or does not provide adequate debt to support growth, the company could be exposed to opportunity costs on sales growth and be exposed to interest rate fluctuations as they seek new funding. However, if the bank discussed the strategic plan, they would better assist the company with long term debt and enough funding to support growth.

Commercial real estate businesses and their specific projects take considerable strategic planning. Real estate projects involve large amounts of hard and soft costs, incorrect loan structures can be very costly. Banks should spend time understanding the goals and plan of the borrowers real estate business as well as each specific project that may be developed. In general, real estate businesses will engage in acquisition of property and building that may or may not need improvements or raw land with new building construction. Real estate management and development takes place among various types of real estate asset classes including: multifamily, office, hospitality, retail, affordable housing, and mixed use, to name a few. Strategic discussion with the real estate business include conversation on their global cash flow of all current and future projects, the long term strategic plan of the developer/borrower, asset class specialization, leasing philosophy, target market, competition, broker relationships, tenancy management, growth plans, capital improvement plans, liquidity and overall capital structure. Project specific discussion may include how the project fits into the overall business strategic plan, project to be held by the business long term or more transactional for sale in 1-3 years, appraisal and environmental issues, tenant lease structure (which can determine whether landlord or tenant pays properties utilities, taxes, insurance and common area maintenance), project budget, new construction requirements/costs and tenant absorption plan. For example, a borrower interested in engaging in new construction of a multi-family project will need a construction mortgage loan, permanent mortgage loan and will need bank guidance on the construction budget, loan administration, interest rate risk management and overall global cash flow while the new project is absorbing with tenants. Understanding whether the borrower would like to hold this project long term or develop it to sell also provides debt structure alternatives. Understanding the entire development business and each project allows the bank to provide the correct loan structures.

Debt is a key element of a business capital structure and has a big impact on funding your business for success. Whether your business is small or large, new at real estate development or you are a professional with many projects under your belt, your bank should engage in a strategic dialogue to understand your goals and strategic plan. The ultimate debt structure that your bank provides has more impact to financial success than just vanilla rate or term discussion. Banks should work hard to match your goals and strategic plan to the debt structure that goes into your balance sheet otherwise negative consequences will impact cost and cash flow which far outweigh the rate.