If 2020 taught us anything, it’s that we should expect the unexpected. After all, who could have predicted a pandemic that shut down entire industries, and dramatically alters how we live and work?
As we move towards the (hopeful) end of the pandemic, the financial and industry impacts will be dealt with and overcome, and companies will navigate forward into their “new normal”. But the emotional impacts will remain.
Just like a consumer will never be without an extra pack of toilet paper again, companies are working harder than ever to preserve maximum financial flexibility that can withstand the unforeseen. And one place these companies are creating and maintaining financial flexibility is when they borrow.
Whether companies are acquiring operating capital, looking to expand, or financing equipment, there are three key aspects related to borrowing that companies are paying a lot more attention to:
Fixed Interest Rates
“No surprises” is a strong business motivator in the post-COVID world. And one place a company can eliminate surprises is by locking in a fixed interest rate on borrowed funds.
The obvious upside to this is when a company finances an equipment purchase or other loan, a fixed rate gives them predictable payments for the entire loan term. Knowing beyond all doubt what your finance payment will be two, three, or even five years from now allows for better planning and forecasting.
It also shields companies against wild rate swings – locking in a rate now could make for a very advantageous position in a year or three. Again, who knows what the future holds?
As I write this in early 2021, it takes on an even larger importance, because right now, rates are at historic lows. A company could do a lot worse than locking in a rate now.
Fewer Liens and Restrictions
Many lenders, including almost all banks, impose widespread restrictions and covenants on borrowers. These include blanket liens, minimum balances, and requalifying for the loan annually.
Blanket liens put a lien on all a company’s assets. This can severely limit a company, since every asset on their books now has a lien on it, and will require the lender’s permission before it can be sold/etc.
For example, if a company is looking to finance a new delivery truck, and they use a local bank, the bank will put a blanket lien on everything. So if the company later decides to sell an old machine they own “free and clear”, they cannot, because technically, they don’t own it free and “clear” anymore.
Minimum Balances are exactly what they sound like. Many banks will want a borrower to keep 80% of the loan value in the bank. This can severely limit a company, because technically, they can’t spend that money, or even change banks. Plus, if 80% of the loan value is tied up, how much money did the bank really lend them?
Requalifying Annually is also a common restriction. If a company has a bad year, the lender can use this clause to call in the loan immediately (and since 80% of the loan is already IN the bank due to the preceding clause, it’s easy to enforce.) This can obviously cripple a company.
As we move forward, companies are increasingly looking for lenders that do not use these three key restrictions, as they limit financial flexibility.
Borrowing to Save
During the pandemic, an interesting phenomena happened – in the face of uncertainty, companies started borrowing more.
According to a March 2020 study done by Autonomous Research LLP, businesses took out more than $240 billion in new loans during the first weeks of the crisis, which is double the new lending normally taken in a full year.
As a lending professional, I can attest anecdotally that this has been the case for most of 2020. Even companies who never previously borrowed have started financing equipment purchases and similar. And why did they start borrowing? Because in the face of uncertainty, companies felt it was better to keep their own cash in the bank, and instead borrow for needed equipment and similar. One of the strongest positions any company can be in is to have ample cash reserves, and borrowing instead of laying out cash for necessities is an easy way to obtain that.
Right now, companies are more mindful of how and where they spend, and they are taking a much closer look at borrowing. Having been through a healthy dose of “anything can happen”, companies are keeping more of their cash, and when they do borrow, are insisting on fixed rates and fewer restrictions.
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