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B-B-Bad To The Loan

Rough roads ahead have you fearing a loan default? Here are some ways to bargain with your banker.
February 1, 2000
URL: http://www.entrepreneur.com/article/19052

When Mike Schwartz, 40, walked into an ailing Harley-Davidson motorcycle dealership in 1992, he could smell the opportunity. The dealership was located in a part of Wilmington, Delaware, that had seen better days. And when he was told the bike he ordered would take two years to arrive, it was clear service was a problem. Management, a throwback to an era that owed more to the racing circuit than the business circuit, didn't seem to have its heart in the business anymore. Schwartz told the owner to contact him if he ever wanted to sell.

Two years later, in the winter of 1994, Schwartz got a call from the owner, who was ready to unload the business. Schwartz bought the company, which consisted of a note from the seller and about $300,000 in equipment and inventory, for less than $1 million. Working as both owner and general manager,Schwartz returned the dealership to robust health within a year and a half, a period during which the Harley nameplate enjoyed a popular resurgence.

But he didn't have long to rest on his laurels. His lease was set to expire, and Schwartz was about to make some big decisions.

Rather than staying put, or moving to the other side of town, Schwartz set out to create a "destination" dealership. To realize his vision, Schwartz bought land in nearby New Castle, Delaware, razed the existing buildings, and started building from the ground up. The result was Mike's Famous Roadside Rest, a 42,000-square-foot complex complete with a restaurant, dealership and museum, all just off the main artery of the northeast corridor of Interstate 95.

And a "destination" is exactly what it became. On some weekends in the spring of 1999--the dealership's first spring season since completion--upwards of 5,000 Harley faithful (as well as the merely curious) made the pilgrimage to Mike's Famous to bask in the glow of one of America's great cultural icons.

No Guts, No Glory

But vision takes guts. Schwartz displayed his by taking out a $6 million loan from the financing arm of Harley-Davidson to bring his vision to fruition. And while things look great today, that can change overnight, and Schwartz is well aware of the risks. "Harleys," he says, "are essentially a luxury item, not a primary means of transportation. Rises in interest rates or a change in economic conditions could significantly change the demand for our product." Or, he adds, the cyclical nature of the market could turn against him before the business is ready to handle it.

So what happens to entrepreneurs who take out a business loan under one set of circumstances, only to have things turn bad down the road? Do they have to lose their business? That depends on how well the entrepreneur manages the process of a so-called loan workout with the lender, says A. Barry Cappello, a borrower's rights attorney in Santa Barbara, California, who has more than 19 years' experience representing businesses.

Prep Time

Cappello says that approaching the bank about a loan workout assumes the bank is ready to deal when you're in trouble. Unfortunately, what you may find when you inform your lender you're anticipating money problems is that the bank may call in your loan early. If this happens to you, a loan workout is probably no longer an option and you may have to seek a legal remedy against promise to pay the lender to protect yourself.

In truth, however, most lenders don't want to foreclose on a loan. A foreclosure involves litigation. There may be environmental liabilities involving repossessed property. Collateral will have to be sold at fire-sale prices. Indeed, the situation can be a lot harder for the bank than simply working out new terms with the borrower.

Before even suggesting a workout to your lender, however, you've got to decide whether the problem that's making your loan difficult to repay is temporary or permanent. If the problem is permanent, the workout may not help, and bankruptcy may be your only alternative. But if the problem is temporary, you've got wiggle room.

The first step in the process is to meet with the lender to let it know you see a problem coming and that some changes to the loan will be necessary to prevent the situation from getting worse. "It's important to talk to the lender as soon as you can," says Cappello. "Obviously it's better to see a tidal wave on the horizon than it is to see it on the beach."

Letting the lender see the stark reality, however, might spook it into moving against you. Cappello suggests two strategies to prevent this.

First, let it drop in the initial meeting that you've met with counsel, and based on financial projections, he or she thinks a workout is viable. It's the old velvet hammer. "Basically," says Cappello, "by meeting with counsel and letting the lender know it, you're telling [the bank] you have the ability and the inclination to fight a foreclosure."

Now that you have your lender's attention, it's time for step two: Bring to the meeting a financial forecast showing what sales you expect the business to generate during the next year or next several quarters, how you plan to cut back on costs and how the bank can help. And don't forget to document your financial assumptions with footnotes.

Zigs And Zags

After getting your lender ready, there are a number of different kinds of workout structures you can propose. So-called skips are the easiest to understand. They're just what they sound like, an agreement to skip a negotiated number of payments. If the problem is small, you may only have to skip three payments. If the problem is thornier, you might try to negotiate a six-month skip.

Another tack is to get the loan recast. An 11 percent five-year loan for a $250,000 principal balance will cost a borrower $5,345 per month in principal and interest. Let's say, after a year, when the balance is $211,455, the borrower runs into trouble. If the loan is recast, say, with a seven-year term, a tough but attainable time frame, then the monthly payments would go down to $3,620. One point to keep in mind about recasting: A lender may not want to do it, but it may still be preferable to writing down the value of a loan on its books. You've got to use your persuasive powers to get the lender to agree.

As part of a workout, you might promise to pay the lender off in a few months with the proceeds from another loan or equity financing. In return, you get some breathing room to try to solve your financial problem or to find another lender. Of course, if you're in trouble with one lender, why would another step up to the plate? Because there are all sorts of lenders with differing appetites for risk. What makes one lender shriek may be just the kind of deal another lender is looking for.

Finally, Cappello says the gutsiest move you can make is to ask for over-advance financing. In short, what you're doing is asking for more money--at a time when you're having trouble paying what has already been borrowed. Crazy? Maybe. But there may be several plausible situations--say, if a big overseas customer delays, but doesn't cancel, a large order--when an additional dollop of working capital can make the whole problem go away.

Of course, none of this is going to come cheap. You can pretty much count on your lender giving you the cold-blooded squeeze, which is fine as long as you don't take it personally. Cappello says that, as the result of a workout, you can expect to pay points and a higher rate of interest, and to surrender more collateral. Points are usually added to the balance of the loan and are often calculated on the amount of foregone payment the lender is enduring. For instance, if you're skipping six months of payments at $10,000 per month, expect to pay one to three points on the $60,000 you'll owe.

As for a higher interest rate, you shouldn't balk too much (unless rates have come way down since you took out the loan) because you have in fact proven your business loan to be more risky. Cappello says you should never offer to pay a higher interest rate because the banker will get around to raising it sooner or later anyway. Just be prepared for it and recognize that if you are trying to reduce costs, and the lender is trying to help you get there, there's a price to pay somewhere down the road.

Although the process is never pleasant, Cappello says the resolution should be satisfying to all. "In a good workout," he says, "the borrower gets over the hump, the business gets back on track and the lender still has a borrower."

Over at Mike's Famous Roadside Rest, Schwartz is pretty comfortable. Projected sales of $12 million for his dealership--a figure presumably upon which the loan was negotiated and approved--turned out to be conservative. Schwartz estimates he'll do nearly $20 million in his first full year. Still, he says, you just never know what the future might bring.


David R. Evanson's newest book about raising capital is called Where to Go When the Bank Says No: Alternatives for Financing Your Business(Bloomberg Press). Call (800) 233-4830 for ordering information. Art Beroff, a principal of Beroff Associates in Howard Beach, New York, helps companies raise capital and go public and is a member of the National Advisory Committee for the SBA.

Contact Sources

Cappello & McCann, (805) 564-2444, abcappello@cappellomccann.com

Mike's Famous Roadside Rest, (800) FAMOUS-HD, customerservice@mikesfamous.com