War Story: Don’t Be Too Eager With Your Lender

We started with a new client who was a bit antsy and anxious—which is typical for someone doing their first deal. We talked to him about how the Quality of Earnings (QoE) is a tool that provides the bank with a properly formatted set of financials. It helps the bank understand the business thoroughly. The purpose of the QoE is to provide a true picture of the company’s profit and cash flow. This analysis is more substantial and better supported than tax returns.

Our QoE process, which includes a Cash Proof, takes about four weeks because we analyze several different data sets that triangulate to a more reliable EBITDA and SDE including company financials, taxes, and bank accounts. Rather than following our recommendation of waiting until the QoE was finalized, this client sent the business’s tax returns to the lender right away. The banker then told him that the number he sees as profit is far lower than what was listed on the Confidential Information Memorandum. Unfortunately, the story does not end well.

Bankers typically focus on tax returns. They're usually lower in cash flow and profit relative to company financials and bank statements because business owners want to minimize their tax burden. This is the most conservative view. The QoE and other analyses are meant to provide a more accurate picture of profit and cash flow. One of the reasons a QoE is so important is that it takes into account personal expenses that owners run through the business and other items that don’t show up on taxes.

When buyers rush to share information with their bankers, they lose the opportunity to provide the most accurate view of profit and EBITDA and instead show a messy presentation of sub-optimal profit that limits the loan amount the bank can and will provide.

The client did not understand that once a banker gets ahold of the numbers, it’s very hard for them to adjust. Their hands get tied by internal stakeholders at their institution. After we finished our analysis, we had several calls with the banker. On the final call, this 25-year-plus veteran of SBA lending was yelling at my client about $100,000 of add-backs on a $700,000 SDE business! This level of personal expenses was reasonable given the size of the deal, but once the banker started yelling at my client, I knew the deal was likely dead.

The banker had already anchored onto the lower number not accounting for the add-backs that we found. He told his colleagues a lower number, and now that our analysis pointed to a higher number, the banker was unwilling to throw his credit behind the deal. He didn't buy that the increased number was more accurate and felt he shouldn’t underwrite based on the higher number.

In this case, the impatience of my client cost them their deal. Be careful when it comes to sharing information with your lender. Make sure you have all the information you need before sharing anything.