How to facilitate the granting of a loan?

Profitable project

Your company is considering tackling an investment with an interesting return. Specifically, you have calculated the ROI (Return On Investment) of the project and consider it more than reasonable. Specifically, the ROI shows the economic profitability of the business, relating the operating result to the average assets of the company: ROI = Operating result

Average assets On the other hand, partners only want to contribute 25% of the necessary funds for the business, as they want to maximize their profit: The project will generate enough cash flow to meet the outlays related to financing the remaining 75% (payment of interest and principal amortization).

 

External financing will increase profitability for partners. The ROE (Return On Equity) will grow exponentially thanks to leverage (the cost of bank debt is lower than the expected profit from the investment).

• ROE =

• Net profit after taxes Equity

For example, the project foresees a profit of 150, 000 euros (before interest and taxes) for a total investment of 1, 000, 000 (that is, an economic return of 15%). See how, indeed, the profitability for partners will increase as the proportion of external financing increases:

Net profit after taxes Equity

 

For example, the project foresees a profit of 150, 000 euros (before interest and taxes) for a total investment of 1, 000, 000 (that is, an economic return of 15%). See how, indeed, the profitability for the partners will increase as the proportion of external financing increases:

• Case 1: 75% equity, 25% external financing (with a cost of 6%).

• Case 2: 25% equity, 75% external financing (with the same cost of 6%).

 

Concept	Case 1	Case 2
Equity	750, 000	250, 000
External financing	250, 000	750, 000
Operating result	150, 000	150, 000
Less: Financial expenses (1)	–15, 000	–45, 000
Profit before Taxes	135, 000	105, 000
Less: Corporate Tax (25%)	–33, 750	–26, 250
Net profit	101, 250	78, 750
ROI (2)	15%	15%
ROE (3)	13. 50%	31. 50%

Case 1: 250, 000 × 6%. Case 2: 750, 000 × 6%.

Operating result/Average assets (equal to total liabilities).

Net profit/Equity.

 

This approach when addressing an investment is very common. Shareholders expect a high return, but at the same time, they do not want to provide personal guarantees for the necessary bank financing. How can this financing be facilitated without guarantees? Keep in mind that the higher the percentage of financing, the greater the risk for the company if the forecasts are not met, so the bank will be demanding!

 

Commitments of the shareholders

Well, negotiate with the bank some additional commitments from the shareholders that do not necessarily constitute a guarantee but serve a similar function.

First, explain to the bank that they will incorporate into the bylaws a commitment from the shareholders that they will contribute more funds to the company in case certain economic circumstances arise:

• The "ancillary benefits" can be provided as a grant, to account 118.

• The conditions under which such contribution will be required must be established (for example, not achieving a certain ROI or not reaching a certain cash flow volume).

• The bylaws must also establish the amount of the contribution (it is not enough to set a maximum) and the period during which this obligation will be valid (for example, five years).

• Once the partners assume this obligation to the company, the company will commit to ensuring that the funds received from the ancillary contribution are entirely used to reduce the requested debt. Compliance with this obligation –and with the partners' obligation to make the ancillary contribution to the company– can be reinforced by introducing a compensation for damages in case of non-compliance.

Continuing with the numbers stated above, they may establish a contribution from partners of 150, 000 euros in case the ROI falls below 10%. It is true that with this scenario (final contribution from partners of 400, 000 euros and ROI of 10%), the ROE decreases to 12%, but it remains positive and the banking risk is reduced by 20% (from 750, 000 to 600, 000 euros).

Secondly, partners may commit to not withdrawing dividends, or to only withdraw them up to a certain limit and only if profits exceed a certain threshold. This way, the company's equity is strengthened during the initial years of the bank debt.

To reinforce this commitment and ensure its compliance, the bylaws may provide for the mandatory allocation of part of the profits to a statutory reserve. They can establish the percentage of profit to be allocated to this reserve, its maximum limit, and its purpose (for example, it may be distributed once a certain period has elapsed during which the bank debt has been reduced).

And thirdly, they may add other commitments to facilitate financing. For example:

• The signing of shareholders' agreements among partners that obliges them to prioritize compliance with the company's obligations to the bank in any decision they make as partners or managers (with an economic penalty in favor of the company, which will in turn be allocated to the bank as an indirect beneficiary).

• They may also offer the pledging of the company's credit rights: rental income, receivables reflected in a contract (for example, a contract signed with a public administration that allows for income during this fiscal year and the next), etc. Likewise, they may pledge intangibles, such as patents or trademarks registered in the corresponding registry.

• Society can also commit to maintaining a certain level of operations with the bank (this always gives it confidence about its solvency and activity). The commitment to operate with that bank can also be assumed by the partners for their businesses or personal matters (committing to minimum periods of permanence and balances, but never guaranteeing the obligations of the company).

 

Offer additional commitments from partners in the form of ancillary benefits or limitation of dividends to avoid signing guarantees.