Mind the Gap: 10 Potential Warning Signs for Lenders

In a series of brief articles related to SMEs (Small-Medium Enterprises), we will examine common skill set gaps in management that will be important to recognize from the perspective of both the lender and the entrepreneur.  

Riders of public transit will be familiar with the warning sign “Mind the Gap”.  It warns passengers of potentially dangerous gaps that exist when boarding subway cars and other public vehicles.

Most entrepreneurs (borrowers) and lenders have a common goal – they want the business to succeed. After all, this is the purpose of developing a relationship in the first place. However, when performance disappoints, the relationship can turn sour.

We can learn much by understanding the most common reasons why businesses fail. In a Statistics Canada study entitled Failing Concerns: Business Bankruptcy in Canada, some common themes emerged.

• Almost 50% of the firms in Canada that go bankrupt do so primarily because of their own deficiencies rather than externally generated problems … the main reason for failure is inexperienced management
•  A second key deficiency occurs in the area of financial management … Some 71% of firms fail because of poor financial planning
•  Seeking the advice of outsiders is regarded as an important step in minimizing deficiencies on the part of management

Many years after the report was published, a consistent theme among struggling companies still appears to be poor planning and poor financial management – an identifiable skill set gap.

For example, in a 2014 BDC study entitled The Five DO’S and Five DON’TS of Successful Businesses, the following were the top five factors that contributed to borrowers being transferred to the bank’s special loan department. The DON’TS included:

• Don’t rely on too few customers—diversify.
• Don’t underestimate the importance of effective financial management.
• Don’t leave contingency planning until it’s too late.
• Don’t ignore what’s happening in your market.
• Don’t wait too long to get help

What Can We Learn?

The primary reasons for business failure in Canada appear to boil down to poor planning and poor financial management – a reflection of skill set gaps. Anecdotally, as an advisor and former lender over the past two decades, this is consistent with my own observations. 

Mind the GAP

This is not an exhaustive list, but the following may be warning signs or symptoms of potentially dangerous skill set gaps. While not necessarily fatal in isolation, the more questions answered unfavorably the greater the reason for concern:

1. Is the client in breach of or close to breaching covenants?
2. Do you receive timely and complete information?
3. Has the client consistently missed targets? 
4. Is management measuring progress against a strategic plan?
5. Do they have the skill set to build and use a robust financial model to plan for contingencies?
6. Is management proactive or reactive? Are you ever surprised?
7. Are you confident management has identified and mitigated risks, both internal and external?
8. Are they prepared for a potential economic slowdown?
9. Is cash flow tight?
10. Does management know how to access additional capital?

Fill the Gap

All is not lost. Entrepreneurs generally know their businesses well and can fill the gap by using experienced professional outside advice. After all, seeking the advice of outsiders is regarded as an important step in minimizing deficiencies in management.

Using a professional advisor may help to avoid or repair damaged lending relationships and better equip entrepreneurs for success. Entrepreneurs must realize it is not an admission of weakness to identify gaps. It is forward thinking and a best practice.

Lenders would be wise to mind the gap, assess any deficiencies in management skill sets and recommend their clients to seek outside help. Being proactive may just save the relationship!

#credit, #entrepreneurship, #restructuring, #lending, #creditrisk

David LaFrance, MBA, CPA, CMA, Managing Partner, DGL Consulting

--------------------------------------------------------------

About DGL Consulting:

Corporate finance professionals helping owners and mangers navigate through periods of transition. Specializing in small to mid-market businesses, providing flexible part time CFO advisory services and financing solutions to companies seeking capital.

Please visit: Dglconsulting.net