Edition 27 – Lending Covenants

Most family business owners and managers have heard of the term lending covenants, but don’t necessarily understand what it means.

Essentially, a lending covenant is a borrower’s obligation to their bank or financial institution. Sometimes it is around reporting obligations. Other times it is around operating within certain trading ratios. However, there is one aspect of them that family business owners and managers must be acutely aware of. If you breach a lending covenant, your bank has the right to withdraw funding to your family business. Immediately. With no correspondence entered into.

With that in mind, it is important to understand some of the basic lending covenants that banks enforce.

1. Reporting deadlines — for some banks, they want to see monthly or quarterly financial reports within 45 days of the end of the reporting period. This is the most overlooked lending covenant, as most family businesses forget about this until they are chased by their bankers. Why not be on the front foot and diarise when the bank wants reports from you?
2. Ratios — the way your bank can compare your performance quickly is by reviewing your ratios. They take the numbers from your financial statements and run a series of calculations to determine EBIT, Current Ratio, Debt to Equity Ratio, amongst many. With these calculations, they review your business’ performance relative to their entire lending book and against other businesses on their books in your industry. If your ratios stack up, great. If they don’t, expect some follow up questions.
3. Pay your tax on time — from time to time, businesses may need to enter into payment arrangements with the ATO. That’s OK. However, ignore your obligations to the Tax Office and all of a sudden, you might find yourself with a garnishee notice. If that happens, you’re in trouble as an ATO garnishee notice is a default event. If that happens, your bank will be notified and you will have breached a lending covenant. Be warned!
4. Signed financial reports — a little enforced, yet extremely important lending covenant. Once your year end financial reports are finalised, you need to make available a signed copy of them to your bank. Sometimes this is up to 210 days after the end of financial year, hence why it is easy to forget, for both the business and the banker.

We’ve written an E-book titled “How to Make your Bank love your Family Business”, available for download here.

We cover some more around lending covenants in our great E-Book. However, the key point we wanted to convey in the E-book is that most family businesses don’t take full advantage of their relationship with their banks.

Your bank should be seen as a partner in your business. Banks have huge resources available that few family businesses take advantage of. The closer you’re willing to work with them, the more likely the possibility of achieving your business goals. Working closely with your bank also means you’re more likely to operate within your lending covenants.

This Week’s Tip

If you adopt a proactive stance in relation to your business’ relationship with your bank, and tell them early enough what your plans are, you will find them extremely accommodating, in both good and tough times.