As a professional adviser, whether or not the scope of your services includes the responsibility to actively manage and mitigate risks that your clients face, the simple fact is that your clients expect that you do exactly this.
Ponder this thought for a moment:
How often does a client hand you a detailed scope of required services, clearly defining exactly what it is that they want you to consider/analyse/produce/etc.?
There’s a very good reason that this hardly ever happens.
It’s because your client doesn’t actually know exactly what they want or need you to do.
They’re putting significant responsibilities in your hands, in relation to their financial, business and personal matters, that they probably don’t really understand all that well (hence why they’re paying you for your professional advice).
“That makes obvious sense”, I hear you say… So what’s my point here? We’re all professionals in our own specific fields, so when we’re asking questions, looking at data or doing research, we naturally do so using our own knowledge, skills and experience. But what about issues or risks beyond those which we understand, i.e. considering what we don’t know that we don’t know? Is there a risk that, in providing your professional advice, there may be an unintended consequence that comes about as a result of there being risk factors beyond your field of expertise that you’re simply not aware of – not because of any form of negligence – but simply because you’re not an expert in that field?
My bet is that, unless you always carry out a “round table” approach with your clients’ other advisers – so that everyone can put in their two cents as to what happens when one lever is pulled – this risk probably occurs more than you would like to think.
As debt capital advisers, we’ve seen many risk issues over the years (based solely upon our knowledge, skills and experience!), simply because the clients’ accounting, legal or other professionals simply didn’t realise that there was a potential problem. Here’s three questions that we recommend you keeping in mind when working with your clients…
1. Do you have sufficient Working Capital available, relative to your [accurate/conservative!] 3-Way Financial Forecasts?
(for the non-accountants, a 3-way is: (1) Profit & Loss, (2) Balance Sheet and, (3) Cash Flow statement)
Everyone knows that “Cash is King”. But what about “Growing Broke”? Ask any insolvency practitioner how many times they’ve seen a company go under whilst still making plenty of profit (they won’t be able to give you a number, the answer will be “a lot”). If you’re an accountant, you know this too well – “profit does NOT equal cash”. As a prime example, too many builders to count have gone under in the last couple of years, with a major contributor being their lack of understanding or management of cash flow, when taking on more and more jobs.
Too many businesses just do a P&L forecast; and then it’s often just something like “last year +10%” as a goal, with little substance behind it. If there’s no Balance Sheet to accompany it (and calculated properly!), then how will your client know where their assets & liabilities will end up if that P&L comes true? Oh, and that cash flow thing – will they actually have enough to pay their bills and keep the doors open?
Which is where the debt structures question comes in. Based upon that forecast (or forecasts, if it makes sense to run more than one, which it usually does), will their existing working capital facilities allow them to operate? Comfortably? We’ve seen too many businesses in our careers that fly by the seat of their pants, suddenly in a panic when they need money next week – which could have been averted with (1) a proper 3-way forecast and, (2) some forward planning for their working capital facilities, relative to the forecasts.
2. Is Everything with One Bank, with all Assets provided as Cross-Collateralised Securities?
(“cross-collateralised securities”, loosely related to the term “all monies mortgages”, basically means that the bank uses every one of the client’s assets as security in a pool, against all of the debt facilities)
Loyalty used to truly mean something in banking. It used to mean that you could get an approval for a deal that the bank wouldn’t do for an unknown client; it meant you could get things done quickly and at a discounted price.
But in the new world, where credit policies are much tighter than they used to be, bankers and credit managers often less flexible, and variances between policies and appetites at each bank can vary materially, there can be some real risks in having everything with just one bank. Even worse, the one bank having every asset as security for every loan or facility.
Why? We just posted a short story about this – click here to read it – talking about how the best structures setup by accountants and lawyers, can be made completely useless by a client providing everything as security to one bank. In the worst case, a client with many assets and a strong net position, can be completely wiped out in a short space as a result of one little thing going wrong, snowballing into a disaster.
Asset protection MUST also include protection from the bank (or banks!).
3. When are your Facilities due for Renewal & Expiry?
Too many people wouldn’t have a clue – they just wait for their banker to tell them they’re coming due in a couple of months, and provide the financials and anything else that is requested, expecting that everything will just get rolled over, just as it has in years gone by.
But is that a safe assumption to make, particularly in a post-Royal Commission world?
The simple fact is that when facilities are due for renewal or expiry, the bank is usually within its rights to effectively say “we’re not going to renew, you need to pay out the facilities”. Which, if that were to happen, these days usually takes longer than 30-60 days to arrange; which could therefore leave your client in a very difficult position. Ok, so that’s the extreme end of the scale – but what if they just:
- Suddenly convert an Interest Only loan to a 5 year Principle & Interest loan? On a $1m loan at say 6%, this would go from $5,000 per month to about $19,300 per month – how many could quickly adjust to a change like this?
- Reduce an Overdraft Facility Limit, because the bank considers that there is too much “unused limit” (i.e. not using enough of the facility)?
- Demand additional security (which simply doesn’t exist), because a property’s value has declined – either because of the market (think Sydney & Melbourne house values right now) or say, because a lease on a commercial property is close to expiry but hasn’t yet been renewed?
The above are all things that banks can and do demand when facilities come up for renewal or expiry. So at very least, you want to get wind of this with plenty of time up your sleeve, so that there is time to make alternative plans or negotiate a better outcome.
IN THE END…
These are all very real and present risks, so they should be on your mind when working with clients.
If any of this has rung any alarm bells for you – whether for yourself or your clients – get in touch and we’ll be happy to give you our thoughts on specific risks and whether there may be a way to mitigate the risks or improve the position.