Meeting The Banker

WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK.  FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON

After conferring with the Directors of BBE, Alice met with Sam, the bank officer in charge of the company's accounts.  She explained the company's need for more servers, employees and space and asked him what sort of loan support the bank could provide. Sam offered the company a loan to buy the equipment.  However, he said it would not be an unsecured loan.  The bank would make the loan but would need the company to pledge the new servers being purchased and all of the other hard assets of the company (servers, computers and office furniture).  The interest rate for BBE's secured loan would be fixed for its term with regular monthly payments of principal and interest sufficient to completely amortize (repay) the loan in the loan's five year term. 

If BBE were to default on the loan, the bank would have first right to take the company's pledged assets, the collateral, sell them and apply the proceeds against the debt.  This is a secured loan, i.e., the bank would have first call on the assets of the company ahead of any general creditors of the company if BBE were to go bankrupt. General creditors of a business are usually vendors who sell items or provide services to the company on a regular basis, but do not collect their money immediately.  Such sellers extend short term credit, without charging interest, to the company and expect to be paid at the end of each month.  BBE's utility provider would be a general creditor.  Another example would be the alarm company which provides the security system for BBE's office space and, like the electric utility, is paid monthly.  General creditors do not have a prior claim on the assets of a business.  They share equally in any assets or cash remaining in a business' bankruptcy after any secured creditors have received proceeds from the sale of assets on which they have a security interest.  

Alice and Sam briefly discussed the company's need for more space.  Sam said that she should come back to discuss a mortgage loan if BBE decided to buy a building to house its expanding operations.  A mortgage loan is used to finance a real estate purchase. It is a secured loan with a longer maturity which is secured by a lien (evidenced by a document called a mortgage) on the land and building being financed.  The land and building are collateral, and, like any other pledged assets, a bank would have the right to foreclose a borrower's interest in the real estate and apply the proceeds against its loan ahead of any other creditors.  Since, at this time, BBE intended to lease another floor of the building presently housing its operations, they agreed that this was a topic for another day.

Alice then brought up another issue the company faced.  Cash flow was occasionally a problem.  The blog readers paid for their subscriptions at various times.  Some subscribers paid annually, some monthly and some weekly.  New blog readers sometimes paid daily with a credit card until they decided that they would subscribe to their favorite blog.  Consequently, cash flow was uneven, which, at times, resulted in difficulties meeting recurring  obligations.  Although the company received adequate revenues to pay its expenses over the year, the income stream was not steady.  Some months, the company received small amounts of subscription payments.  Other months, large amounts of money would flow in.  The company, however, had rent, utilities, payroll and other recurring expenses to pay each month.  On two occasions, the company had had just barely enough cash on hand to make those payments.

Sam said that cash flow was a common problem with small businesses.  The bank could make a specific type of loan to address BBE's cash flow problems, one very similar to a credit card loan.  Sam suggested a revolving loan, commonly called a "revolver".  The bank establishes a fixed amount of money BBE can borrow, but the company can take out the money if and when it is needed to meet its obligations and then pay the loan back when subscriptions were received.  BBE can then reborrow the money when it is needed again.  Interest is charged only on the amounts actually borrowed at a variable interest rate, which is based on the bank's prime rate.  A prime rate is the publicly announced lowest interest rate which the bank offers to eligible borrowers.  BBE's interest rate would be prime plus 1%.  If the bank's  prime rate, which can change daily, is 4% when BBE draws down money from the revolving loan, it would pay interest at 5% on that amount.  If BBE made a second draw on the revolver later when the prime rate was 3%, then its interest rate for that amount of money would be 4%.  A revolving loan is typically secured by a pledge of the borrower's accounts receivable.  Accounts receivable are the amounts which the BBE's customers owe but have not yet paid.  If a borrower defaults on a loan secured by receivables, the bank has the right to collect the receivables from the customers.  A revolving loan provides a company with the necessary funds to meet its obligations before customer payments have been received.  The loan "evens out" the company's cash flow over the year.  The bank generally makes the loan with a one year term for a first time borrower, such as BBE.  If the bank is satisfied with the company's performance under the loan, i.e., prompt repayment of borrowed funds when BBE receives its subscribers' payments, it will probably renew the revolver after the first year for a longer term.

Alice reported all of this to the Board, which immediately approved BBE's entering into the secured loan for the new equipment of $50,000 and the revolving loan of $25,000.  The loan documents were signed, and the company used the borrowed funds to expand its business yet again.  The revolver immediately improved its cash flow.  As with the first expansion, revenues did not increase immediately, but BBE was able to make its new loan payments and continue distributing dividends on both the preferred and common stock.

We will continue with BBE in the next blog.

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