What’s the best way to establish a relationship with a bank?

Rodney Davis:Banks want predictability. Banks want confidence. Banks want transparency. And so, if you’re going to have a good relationship with the bank, you need to satisfy those three conditions and if you satisfy those three conditions, even in adverse times, you’re going to find it’s easier to deal with the banks.

There are inflection points in the life of any business, at which time, whether the cashflow suggested it or not, you should try to establish credit relationships that will serve you well, as you require them.

So, take a profitable business that suddenly started within the last few years. It generates positive cashflow all the time. Why would they go to a financial institution to establish relationships? Well, because if they’re growing, it’s very possible that you need resources to finance that growth, and it’s not necessarily the right source of financing to finance long-term growth with short-term operating results.

When you think about how you finance your business, if you’re financing your business entirely out of the profits of the business, then you should, as a business owner, consider that to be making additional equity investments in your business and a lot of owners don’t do that. If the business is financing itself, they consider that as they’re not making additional investments.

But the reality is, if you’re using only your operating profits to finance long-term sustainable growth, you may actually be missing the opportunity to better balance the capital, the total capital structure of your business, because you never know when you’re actually going to need financing. And the worst time to apply for financing is when you’re desperate for it and that goes back to predictability.

Why are relationships with banks often mismanaged?

Rodney Davis: The difficulty about the relationship between banks and their clients is we absolutely need banks. We have to have a repository for our funds. We have to have a vehicle of settling our accounts with our suppliers, with our staff, with our clients. It’s absolutely mandatory and so, sometimes as a client, we forget that we’re a client of the bank, as opposed to in desperate need of their services, and sometimes bankers like it that way. So, the relationship isn’t quite as balanced or set in the right method for it to be productive for both sides. It’s rarely not productive for the bank, unless there is a situation of default, but many times it’s not what it needs to be for the client. At the end of the day, you’re a client and if that relationship is going to work in the most efficient way for both sides, the supplier-client relationship should never be lost, and many companies find themselves not acting like a client with their bank.

How do I project whether I’ll need financing?

Rodney Davis: If you’re doing good business planning at the beginning or during your business cycle, which is your annual business cycle, it should give you a predictor of whether or not you’re going to need cash. 

Now I will tell you, a lot of businesses do forecasting or do their budgets and don’t budget their balance sheet. In fact, most businesses don’t budget their balance sheet. But the way that you know whether or not you’re going to need financing is by carrying through the operating and capital requirements of your business through to a projected balance sheet. Because that will tell you if you’re going to have periods during the year where you might have cash crunches, and therefore puts you in a position to start to negotiate ahead of time to put facilities in place to meet those cash crunches.

Is it wise to use your own personal credit?

Rodney Davis: I think you should do as much as you possibly can to separate your personal life from your business in terms of intermingling the financing and the credit and anything else that puts your home at risk for the purposes of your business.

And I say that, in law, you may know that a business is a person. A business is considered an individual in the eyes of the law, for tax purposes, for litigation purposes and for any other civil matters and even criminal – a business can be criminally indictable. They can indict a corporation, however, not a sole proprietorship because a sole proprietorship is an extension of you. 

Once you incorporate a business, that business takes on an individual existence of its own, separate and apart from you. And that’s done for a reason. The reason for that is to put you in a position whereby the actions of the business, which is typically governed by a board of directors, is separate and apart from the actions of an individual.

Of course, there are times when it is not only necessary, but not a bad thing, to put personal guarantees on the business, because that’s the only way that the bank will take the risk on you – on the basis that if you’re not willing to take a risk on your business why should they?

But when businesses get to a certain size, a certain predictability, it’s much easier for you to say to the bank, “Look, this business is predictable. I’ve been transparent with you. You can rely on where this business is going.” Therefore, you want to not need a personal guarantee. So, you should only guarantee your business as long as you have to. It should never be a choice. It should be something that’s necessary.

Is it important to have a financial advisor in these conversations?

Rodney Davis: I’ve seen situations where entrepreneurs have thought they could go at it alone and that same entrepreneur has seen the difference when they’ve had an advisor beside them.

I would recommend that if you’re in any kind of meaningful financial discussions with your bank as an entrepreneur, unless you have a financial background, I would think it would be wise to bring somebody who can speak bank-speak. The banker-client relationship is a very difficult relationship to navigate and often mismanaged. So the best advice I could give to anybody is understand from friends and colleagues who’ve had experience dealing with bankers over the years, and get some education on how you should manage your bank, particularly if your business is either going to go through a difficult period, go through periods of rapid growth or simply just needs to have the right capital structure.

It really is important that you take personal responsibility as the owner of business in helping to define what the relationship is going to be with the banks. 

I know a lot of clients who don’t even know their personal banker, their business banker. They may have a passing relationship with that individual and they’re proud of it because they say they don’t need the bank for financing. You should always know who your banker is.