Bullish or Bearish?
Which Way to Lean When Preparing your Financial Model for a Mid-Market Loan
Before engaging with lenders for refinancing or sourcing new credit facilities, developing a thoughtful financial model is one of the most important things you should do as a borrower.
Lenders use your financial model to set loan structure and covenants, and a thoughtful financial model proves your understanding of your business and its future.
Different companies have different approaches in preparing their financial models, and most companies constantly fluctuate between a conservative reality and an aggressive dream state. Bullish or bearish, each plan has its own pros and cons. Here is what you need to know before deciding which way to lean when preparing your financial model.
The temptation to go bullish
A deciding factor on why some companies like to be optimistic with their forecasts is because a lender’s willingness to do the loan is sometimes dependent on a positive outlook.
Bullish models show lenders the potential of additional credit facility and loan needs in the future as well as a potential increase in credit strength, a signal that the lender will need to reserve less capital on its balance sheet, which in turn makes lending to that borrower more profitable.
The temptation to go bearish
Some companies like to be conservative with their forecasts because a loan structure is often done around their forecasted expectations. If they get the loans under these conservative forecasts, then the borrowers will have more cushion in hitting their actual predicted financial performance. This will give the company CFO a reduced risk of violating loan covenants and other provisions within the loan agreement.
When I was a lender, I received a company’s forecast showing deteriorating cash flows over the coming nine months, but then a predicted turnaround starting in the tenth month with a full return to growth within 24 months. Unfortunately, that borrower’s financial model suggested them violating covenants in the upcoming two quarters.
When asked if this was accurate, the company said they adopted a very conservative model to ensure that they would clear their targets by a wide margin, and then be able to reinstate confidence among investors and lenders.
However, the borrower didn’t realize that such a conservative model accidentally put them in default by forecasting a violation of upcoming covenants, which technically triggered a default provision in the loan agreement. As such the company incurred fees, had to go into a forbearance agreement, and was cut off from borrowing additional funds even though they had additional availability.
As a result of submitting an overly bearish model, the business owners were forced to infuse cash into the company to fund working capital. Had that company submitted a forecast that was accurate, they would have shown the ability to pass their covenants, and their line of credit would have remained available.
Credit search process
Whether to lean bullish or bearish when preparing your financial model, borrowers, especially courting new lenders, should provide a model that is as accurate as possible but still optimistic enough to be enticing for lenders to explore.
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The world of middle-market lending has changed. Before COVID-19, traditional lenders showed flexibility as they worked to expand their books of business.
Increase the Chances of Closing a Loan
Significant disruptions to the lending landscape in the past four months have left corporate borrowers scrambling to stay on top of changing requirements
CFOs need to be constantly aware of how their company’s financial performance and market shifts affect its debt capacity, which is the best measure of your business’ ability to borrow.