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  Ideas and Advice
  When Benjamin Franklin said that birth, death and taxes are the only certainties in life, he may well have added a fourth: Change. Which makes communication with your bank all that more important

Very little in business remains static so when change occurs, those affected—like your bank—would like to know what’s happening. Similarly, we owe it to our customers to keep them in the loop. Just as customers don’t like surprises, neither do banks—but if we know of a problem or an opportunity we should be able to help.

Some customers have endured tough times during the past two years. But how their banks reacted most likely was influenced by the way customers have communicated. In cases where communication has been open and two-way, banks will have had the opportunity to work with their customers and look at options to navigate through tough issues.

Here’s what we mean by open communication:

  • Providing both historical and budget information and covenant reporting as promised, and on time. It’s also important that customers can explain significant variances to budgets;
  • Updating business plans and sharing that information, or involving the bank in the updating exercise;
  • Advising, ahead of time, when debt is going to overrun (outside of contractual arrangements) or breaches of covenants will occur;
  • Making sure that bank funds are only used for the purposes for which they were borrowed;
  • Identifying any issues proactively, and developing solutions in partnership with the bank; and
  • Ensuring there are no surprises. Holding off telling bad news can make the situation worse.

Granted, in boom times some of these disciplines may have fallen by the wayside. Now is the time to resurrect them.

Our side of the bargain

Not surprisingly, there have been a few changes to the way banks operate following the financial crisis. These include:

  • More conservative debt multiples (against cash flow) and percentages of lending against specific assets (for example, land and buildings);
  • The need to include some of your own funds in investments. There has also been a return to the inclusion of equity ratios as one of the covenants in deals;
  • A need in some cases for customers to repay a portion of debt;
  • A move back to core principles of banking, which include having more than one way out for debt repayment. This could be a combination of cash flow, sale of assets, sale of a business or the ability of shareholders or guarantors to make appropriate contributions;
  • The increased cost of bank funding influenced by investor and depositor returns, competition for funds and Reserve Bank of New Zealand capital requirements.

What it means for succession

First and foremost some of the ground rules and conditions have changed. Again, by being involved in the process and helping to manage expectations and some conditions, we may be the difference between success and otherwise.

Of late we have noticed that:

  • There are investors with equity looking for investments. For example, local private equity firms have access to the necessary funds if good opportunities exist, and there are many individuals or groups looking for appropriate investments;
  • Fewer investment deals are closing than before the financial crisis, because the quality required (in terms of both the business and its earnings) are not being met;
  • Some great businesses have had a couple of tough years with reduced cash flow. Owners are rebuilding their cash flows and profits to maximise the price of their business;
  • Banks are requiring greater capital investment from buyers;
  • The acquisition multiples have returned to more “normal” levels.

One of the biggest flow-on effects of the crisis has been a change in business values. Before the crisis, a hypothetical business with an EBITDA of $5 million, might have buyers prepared to pay a multiple of five times. That business had an enterprise value of $25 million. Now, the EBITDA on that same business may have reduced to $3 million, the multiple a buyer is prepared to pay has reduced to 4 times, so the business now has an enterprise value of only $12 million.

While the owner may build the business back up to an EBITDA of $5 million, the question remains: will the multiple go back up?

Only time will tell. But in the meantime if you haven’t talked to your bank of late, change the situation.

David Verry is a Relationship
Executive at ASB.