A Downside of Debt
By Loren Smith
_________________________________
Because borrowing money to finance various business activities is such a normal
practice, I am often asked about the pros and cons of incurring debt.The best way for me to respond to this question is anecdotally, based on my own years as head of my wire har- ness company.
To change careers and acquire Monona Wire Corporation, at the time generating less than $1 million annually, I needed to borrow capital. I chose a medium-size bank for my financing.
Within a few years, I had two credit facilities with the financial institution––a working capital loan and equipment financing––and my growth plan was working. I was mak- ing money. But then I got a surprise call from my loan officer.
He informed me that the bank had been sold and, as a result, the bank’s credit criteria had been modified. Our small company fell below their size minimum, and all customers who no longer fit the credit criteria were required to pay off their loans. Although all of our loan covenants were in compliance, my attorney ad- vised me to move quickly, as a bank can always find a legal reason to ask for its money.
We didn’t have the cash flow to enable us to immediately pay off the debt; nor did I have the personal wherewithal to pay it off.As a conse- quence, we had to find another lend- er quickly, which we did, but the time crunch made that process disruptive. Most critically, the tight time frame prevented us from finding an optimal deal or the right financial institution for our needs at the time.
A number of years later, we had long since weathered loan problem #1 when we had a similar experi- ence. Even though we were now gen- erating approximately $20 million in annual revenue, I got a call from our
Loren Smith CEO Blue Valley Capital
bank at that time letting me know new management had revised the bank’s credit criteria. Though prof- itable and with all of our loan cov- enants fully compliant, we neverthe- less encountered déjà vu.
Thankfully, I now had the abil- ity to pay everything off within sev- eral days, and I then resolved that as long as I owned a harness company I would be debt-free.
Given that bank financing is a nec- essary part of business, experiences like mine are not that unusual––be- cause changes in the ownership or policies of financial institutions are not unusual. For that reason, I rec- ommend that business owners con- templating borrowing money from a bank make sure they have a solid plan B.You can never be certain you won’t need to contend with a call like the two I received.
Loren Smith can be reached at [email protected] or www. bluevalleycapital.com
