Term Loan – An Exit Strategy

By April 2, 1999August 31st, 2019Succession Planning

When Bob Steadman started his manufacturing business 22 years ago, he had never heard of mission statements. However, from the beginning he operated his company with a few simple guiding principles: work hard, work smart, treat customers and employees fairly, and reinvest the profits back into the business.

Bob’s informal mission statement worked well. His company prospered. Annual sales peaked last year at just over $15 million. Although the balance sheet did not reflect huge cash balances, it did reflect sizeable assets, little debt, and a significant net worth.

Now, looking back, Bob wondered if he did the right thing. Because he consistently reinvested the profits back into the business, the company built a significant net worth, yet Bob accumulated very little in the way of personal assets to show for his 22 years of hard work. Frustrated, Bob contacted his banker and his CPA to see if they had any advice.

Bob explained to his advisors that he wanted to accomplish the following three goals:

Transfer some of the wealth from his company into more liquid, personal assets.

Retain his current ownership position.

Not endanger the ongoing viability of the company for his son.

Bob’s son was active in the business, and Bob wanted to maintain the integrity of the company for future generations.

Several options were considered, but most required Bob to give up part or all of his ownership in the business. He ruled these out. In the end, Bob decided that the best option would be for the bank to make a sizeable term loan to the company and allow the proceeds to be distributed to himself.

Bob’s banker knew this might be a difficult loan request to get approved. Since the proceeds are not used to purchase any assets that will generate new cash flow to repay the loan, banks traditionally view this type of loan as “unproductive”.

Furthermore, the banker knew that others in the bank had become accustomed to the company’s strong balance sheet. The requested loan and subsequent distribution could weaken the balance sheet in the following ways: liabilities would go up, and net worth would go down. Leverage would increase significantly.

His banker, however, was willing to recommend the loan request, which was subsequently approved, for several reasons:

  • The banker and Bob had a long term relationship and the banker believed that Bob would continue to dedicate himself to operating the company profitably after he received the cash distribution.
  • Although the banker did not know Bob’s son as well, the banker believed the son was capable of successfully managing the company.
  • The company’s historical cash flow demonstrated the capacity to repay the loan. The repayment term of the loan was set to coincide with Bob’s anticipated retirement, so that his son would not be burdened with its repayment.
  • Because Bob had not borrowed heavily against the company’s assets in the past, they provided sufficient collateral coverage.
  • Bob was willing to both pledge a life insurance policy and to personally guaranty the loan.

Not much has changed since the loan was made. Bob still doesn’t know much about mission statements, and he works just as hard and just as smart as ever. He treats his customers and employees fairly, and he reinvests the profits back into the business. The difference is that Bob and his family are now enjoying some of the financial rewards of his labor. He can now look forward to retirement knowing that, if all goes according to plan, he will leave his son with a strong and healthy business.

Mike Meredith is a relationship manager with BankOne. Contact Mike at mike_meredith@mail.bankone.com

Follow Us for Updates