Episode Transcript
[00:00:00] Speaker A: Welcome to the Independence by Design podcast where we discuss what it means to be a business owner and ways to get unstuck from the day to day so we can design a business that gives us a life of independence.
What's the best way to flip the power dynamic with your commercial banking relationship and your commercial bank? We are going to be unpacking that topic today. I've got Luke Moppin on the show. He's been a dear friend for almost 10 years. I've watched him in and out of different banks and he is the best business owner advocate in the commercial banking system. I absolutely love his approach on transparency. In today's episode, we're going to unpack how banks work, how they think about risk, how they think about personal guarantees, how they think about covenants, and then what you can do to flip the entire dynamic so that way you are partners with them and you can go to them as a growth partner and say, how do we actually get to our five year goal? And then here's the type of relationship that I need and here's how I see the technology that I need from a bank as well as the different types of debt structuring and how it's going to accomplish the growth goals for the equity as well as allow the bank to make a return. So that way you become part of the 1% of their client base that is actually helping them see where they're going to get their return. So that way you can get what you want. You're in for a real treat today. I know it's going to be a slog because it's almost a two hour episode, but I can tell you what, this is going to demystify how commercial banks work. So that way as you're going out and interviewing commercial banks, you can be sitting in the driver's seat and you can go get what you want and find a good, a good growth partner that can help you actually have an enjoyable journey as a business owner instead of have the bank that wants to pull the umbrella from you right when it starts to rain. So I hope you enjoy the podcast with Luke Maupin. Well, Luke, I'm excited for this, buddy.
[00:01:51] Speaker B: Same.
You've been asking me for a little bit to do.
[00:01:57] Speaker A: Kicking and screaming. And what I find interesting is, you know, you've been on multiple of my workshop panels. We've been friends now, what, for almost a decade. And I find it fascinating that you're, it's really interesting watching you come to realize how your expertise in banking is actually extremely Valuable to the people that are going to be listening to this. So, you know, people don't want to hear this. I'm like, yes they do actually.
So you've got a bunch of guitars in the background. Why don't you give everybody like the story arc of Luke Map and you went from in a band to being a commercial banker. So what the hell dude?
[00:02:30] Speaker B: Yeah, you know, basically the, your standard run of the mill career path. I got out of college and you know, I was an entrepreneurship finance major at St. Thomas and I wasn't ready to settle down, I guess you could say. But I chased the dreams for a little bit. I like to look at myself as an entrepreneur at heart. I just never had the guts to really go out there and do it myself.
So I played music, toured the country, met a lot of really great people, a lot of really shitty people.
[00:03:00] Speaker A: What were you playing again?
[00:03:02] Speaker B: Played guitar primarily, then a few other instruments I dabble in, but played guitar for a rock band and had a lot of fun for about a year and a half and then decided it was time to, time to settle down and, and move into the banking force. No, I, I started off actually in commercial real estate. So commercial real estate in 2009 was fun stuff, fun time, but it really cut my teeth in sales and learned a lot very quickly. Had to. But one thing I quickly realized was that no matter what the state of the economy, everybody still needs a bank.
And so I, I went over to US bank and worked in their commercial real estate department for number of years and that's what launched my, my banking career. I've worked for the big bank.
[00:03:47] Speaker A: When you were at US Bank, I.
[00:03:49] Speaker B: Think maybe towards the tail end.
Wells Fargo. Yes, yes, because you.
That's correct, yeah.
[00:04:00] Speaker A: Crazy.
[00:04:00] Speaker B: So we met, right? Right, yeah, it was a long, long time ago but it's been great perspective wise to be a part of big banks, be a part of small banks. I helped open a de novo or a loan production office for Cal bank that you know, they eventually sold to one of the bigs. So that was experience all on its own, trying to go ground up with a team and, and deal with people more. So yeah, it was, it's been, it's been a good run.
[00:04:29] Speaker A: I am excited to have this conversation because what I think you have a unique position to give us a lens into is the banking system and here's why Luke is.
And then we can kind of put a container on like what we want to cover for, for the listeners. But the, you have you know, over your Career, been in and out of lots of banks, like you just said. And you have a huge heart out for the owner who's trying to grow their company. And what I mean, as I've been following you across the banks like you just recently got over to Choice, like, I don't care what bank you're at, because you are the advocate for the owner inside the system that they need to utilize. And I think that is the bridge that so many people don't have view into because they're getting some bullshit answer from an underwriter. They're getting some. Something from the credit department and something from a totally a salesperson. And so many times people just take the immediate answer that they get as gospel. And it's like, I learned the hard way. And you've heard my story about my banking experience, you know, at the family business. But you have this whole like underpinning of like you've been in and out, seeing it all and then communicating to people what they should expect from a partner at a bank to help them first, not from a salesperson's perspective. So that's kind of the liftoff point. Is like why I'm excited to have this conversation.
[00:05:50] Speaker B: Yeah, I couldn't, I couldn't agree more. I think just from a transparency perspective, I realized more recently in my career, I guess, that what business owners want to know is what's behind the curtain, what really makes a bank operate, why are they making the decisions they're making?
And honestly, it's not rocket science to me to tell you what's going on behind closed doors that you should be able to know that, to make your own decisions. How are you to make an educated decision if you don't know why someone's telling you yes or no? You should be asking the same questions to your bank that your bank is asking you. And that's something that, and it's rarely done. I mean, I couldn't tell you the last time I had a meeting. They, they started off by asking, well, I'd like to take a look at your balance sheet. Why don't you explain to me xyz? There's a million questions that I think are very relevant to your bank, to your prospective bank, whatever it might be. So that's right there, I think.
[00:06:45] Speaker A: Oh, and I get so excited. The what? What? I've watched you do a good job on, on, you know, the workshops, the client conversations is flipping that power dynamic so that way the owner can feel empowered to like, you have to go like, just like they would shop out A CPA firm or a wealth manager or a marketing agency. A bank is a bank and you can go find someone else. And like, in that I've got a very biased perspective of my own unique experience, but I feel like other owners have too. Where like the patronizing bullshit that comes from banks of like, you should be lucky that we are giving you money. And like, and because so many of the owners that we work with didn't come from finance, so they don't understand this stuff. And most financial literacy to owner operators, and especially in bank lingo, which is different than finances, is about me. About is equivalent to me trying to play that guitar. I have no freaking clue what I would have to do in order to actually make that thing work. And so you from a point of wanting to help, say, hey, here's how it all works. Because there are a lot of options now for banks, banking for the client. So you have had some unique experiences that I've watched. You were like, you've actually, you know, because you're always out there trying to help the owner, the bank may or may not even be able to allow you to help the owner.
So even though you're trying to help them, like there was one of the banks in the past where they're like, luke, go home because we can't lend anymore. And you're like, what?
So maybe explain when you mean like the health of a bank, let's empower people to say like, here's how a bank works, here's how a bank is healthy or not. Because when you landed at choice, you were like, I looked at like 10, 15 banks in the, in Minnesota because you wanted to land at someone that could help you help the owner.
[00:08:37] Speaker B: Absolutely. And I don't want to jump into, you know, the economic side just yet, but I think it's really relevant to look at what's happening in the marketplace and how your bank's health is going to impact their decisioning, impact their rate more than what we just read about what the Fed's going to decide. So to dial it back, I think it would make sense to talk a little bit about how bank operates and that banks are still a business and there's some, you know, there's well run businesses and there's poorly run businesses and banks are, you know, no anomaly to that by any means. So I think something that is worth pointing out is baseline. How do we look at a credit, how do we look at a company when they first come in the door? We're peeling through the numbers. What do we look at as a bank and how do we decide whether we're going to give somebody $20 million or $1 million?
What's the difference? Is it, you know, we see a lot of companies pushing for that top line revenue growth with a lot of the things that you're building and the building blocks you create for business owners is understanding cash flow. And that's really at the heart of banking. Banking is typically, every bank is different. Sure. But it's going to come down to cash flow and measuring that and a lot of other, you know, minutiae around and other ratios that we're going to look at. But it boils down to can you pay this debt back?
If it was all based on collateral, then you'd be with an ABL or a factoring facility. And, and that's, you know, has its place. Absolutely. But if we're going to look at conventional banking and how risk rating is handled, that's, that's where we should start. So banks review credit and assign their own risk rating.
So an internal risk rating model varies bank to bank. It's typically written by chief credit officer, maybe some of the leadership, it's reviewed by the board. And we all have to live by a certain set of guidelines. Yes. You know, community bank versus big bank.
Big bank, you have the Basel III standards that you have to live by. That's pretty much carved out. And, and the lower you get, smaller banks have a little bit looser regulations. And this is worth pointing out as well. Sure. We're all writing our own version of a risk rating model. And, and risk rating bank to bank typically are, you know, there's a lot of similarities.
But if you're going from a big bank living by a Basel 3, three pillars versus a small.
[00:11:00] Speaker A: You want to explain the Basel 3 just a little bit, just real quick.
[00:11:02] Speaker B: Yeah, yeah. So this was after 2008. Sorry, my, my history might be off, but somewhere right after 2008, you know, the Fed decided essentially we need to dictate some common banking regulatory guidelines. So there are three pillars of the Basel III standards, which is essentially a guideline, guidelines that were written on how banks should operate. Your first and foremost, it's going to be capital requirements, liquidity ratios that banks have to hold.
Secondly, there's going to be. Second one is supervisory review. So it's going to involve regulatory review and oversight over how a bank is operating. And lastly, the third pillar I believe comes down to community involvement and how they are transparent with investors. So it depends on ownership and that's why? Typically a true Basel III guidelines are going to impact the larger banks more than smaller banks. Just because it's typically a publicly traded.
[00:11:59] Speaker A: Bank and it's based on just setting up standards of like how you run a. Because and I know you're going, maybe you're going to tie a couple of these topics together is how they're viewing risk for the owners who are borrowing from them. But that relates to their regulatory compliance and their ability to make money and how they're.
Is that kind of where you're going to be balancing both these two?
[00:12:23] Speaker B: Thank you. Thanks for tying that back together. But regardless of what your risk rating model is, depending on how you risk rate a company that changes the capital allocations that that bank has to set aside for that debt. So a riskier company doesn't mean that a high risk rating is something that a bank can't lend on. Now we typically all have a number to where we consider that a problem. Credit, it's something that's heavily watched. It could move towards something in defaults. But again a bank can choose where they want to lend and where they don't want to lend and in a lot of ways. But again they have to assign a higher amount of equity. Bank equity has to be on reserve, the higher the risk. So naturally we want the lower risk deal so we have more of our equity. And that's where the business mindset comes in for a bank. If we have to operate like a business and somebody were to tell a business owner, sure, you could take on that customer but it's going to cost you more capital to do so you're going to think harder about whether or not you bring in that customer.
And that's, that's just common business. That's that that applies to anybody and banks.
[00:13:31] Speaker A: I think it's such an important note Luke. Like business, banks are businesses and you got like, I mean normal owners they can resonate with the asshole tax. Like hey that person, that client's just a jerk, you're going to charge more or like you know, if the client asks for a one off and it's a manufacturing firm and they can't just build a whole, you know, piece of machinery for that one part. I mean it's like all of these things have to do with then the risk. Like the bank has a profitability for cash flow and equity ratios that the bank has to adhere by in order to be solvent in a good bank. And maybe can you. Because I want to go in back into the risk rating and then how you you know, how the credit department helps analyze but on the health of the bank, then is that like helping us explain where the money comes from and then how they actually like, look if the bank's healthy or not?
[00:14:22] Speaker B: No, that's it. And I think you touched on it a little bit. Whether it's the liquidity versus solvency. There is a difference.
Maybe I'll start with how banks actually make money. Yeah, I think that's a relevant question because I would say a lot of my customers and business owners, I've lent money to people that look at, oh my, my revolver rate is six and a half percent. Well, you're making six percent and a half, six and a half percent on, on me as a customer. So I should be able to negotiate six and a half percent worth of margin. Right. But banks truly work off of a spread and controlling that spread is the number one source of bank profitability. We have to make money off of the margin between what we're paying for deposits and what we're lending on.
So that's the number one key component.
But beyond that, banks still have to worry about a lot of other costs and expenses. You know, there's notional equity that's kind of that unknown, undefined. Well, banking has a lot of undefined expenses. When we underwrite a deal, this the time it takes to underwrite a customer, bring them in the door. Every business owner struggles with the cost it takes to bring in a customer.
[00:15:36] Speaker A: Which is people and payroll and all those systems and stuff.
[00:15:39] Speaker B: Right, Exactly. I've seen banks tried, you know, different methods, have different numbers assigned to dial in. Their ROE is, it's all, it's all baked in there. But a lot of banks, just like business owners don't have a true understanding of what their cost of funds is. So you know, banks costs or operational costs truly boil down to what their cost of funds are. So we're working off of a set margin we want to hit. A lot of banks want to get around the 3% margin.
They don't really want to go less than 2%.
But with that they need to bake in, you know, those expenses that are costs involved in getting the deal done.
And with that, some of it's unknown, some of it's hard to boil down. But truly that cost of funds, the better you have clarity on that. And that's, this is where banks will hire consulting firms and people that there's systems that banks will add in really to just dig into what our true cost of funds are. And that lets us make better Decisioning based on lending. And next I'll move into some ancillary things.
[00:16:45] Speaker A: Before we do that, I think it just kind of connecting it to what I know the language that owners understand cost of funds is their cost of goods, right?
I mean, and so the, I mean, you guys sell money.
That's your inventory, right? Like, people might, listening in, might be selling people's time.
They might be selling other pieces of, you know, parts because they're a distributor or manufacturer, but you guys sell money. And so can you explain? Cause I just. Business owners are so savvy when they understand how to make money. But they, you know, that's why I think connecting the jargon is helpful. Because then, like, once I started learning this stuff, Luke, I'm like, if I can understand this, I mean, I think other people are as well. And so when you say deposits versus lending, so they're, you know, you have. I think people can understand the overhead of payroll and subscriptions and different, like regulatory compliance and all that stuff that adds to the cost of fund.
But maybe walk through how the deposits versus the lending ratios, because I think that's a super interesting dynamic that people don't probably understand enough.
[00:17:46] Speaker B: Well, I truly think that's most relevant right now. If you're out selecting a bank, talking to a bank.
Let's go back to Silicon Valley. Silicon Valley going down was a pretty big event.
A lot of people just saw a bank going down, question the, the security of their deposits, where they have it, is it insured? How much is insured? All that came into question frantically overnight. Obviously, the, you know, there's a bailout. So I think some of that pressure was taken off because at the end of the day, no one really lost, you know, deposits because they came in.
[00:18:21] Speaker A: And plugged a hole with money printing.
[00:18:22] Speaker B: But again, so without getting into that, I don't want to get sidetracked there.
[00:18:27] Speaker A: But I promised you.
[00:18:28] Speaker B: I promised you. This began a movement, you know, that we. It's twofold. First people started really questioning, I have $300 million sitting in the bank and how much is FDIC insurance? So there's a few products out there like ICS accounts. Essentially, that's a product. There's other service companies that offer service that does it. They'll band together as many banks as they can to take advantage of the FDIC coverage. And so you can get up to around 130 million in deposits insured for tax ID through an ICS account. So that was overnight. Everybody wanted all their money market funds in an ICS account. But with that there's a margin. So this company that sells ICS accounts or sells this product charges a margin to the banks that use this product to sell this product. And people wanted it overnight and they wanted the banks to pay a premium. I don't care if you're paying a fee. I want 4.5% of my deposits because I have $300 million sitting with you. Well, the treasury market obviously started looking really good when all your money is secured and as we're as treasury, you know, the rates go up, going up, rates go up. People saw that as an opportunity. So a lot of the money just left the banking system because Silicon Valley shined a light on something. There was a good old fashioned bank run on a bank. Somebody with 800 million said I'm out. Then the next person was the next biggest depositor. And it happened so quickly that this is when people started, or in my opinion should have started questioning their bank's position.
All of a sudden a lot of banks that operated with a loan to deposit margin that they operated off of and I think a lot has changed. This is a little into the weeds. But banks used to operate in that 80 to 90% loan to deposit ratio as kind of an efficient standpoint where we want to get to 90% loan or deposit because then we're making efficient use of our money. I think that number has changed, especially in the community bank.
What happened?
[00:20:27] Speaker A: Okay, sorry to interrupt.
So loan deposit at your way of saying fractional bank reserve, where you get a dollar in and then you can loan out $9.
[00:20:36] Speaker B: In some ways, yes.
It is by no means a true measurement of bank liquidity. Strength. If, you know, if somebody were really dig into the CFO of a bank was listening to this, they would jump out of their chair and say that's by no means a measurement of a bank's liquidity position.
But part of that is because banks have a lot of levers they can pull by design because believe it or not, the government does not want banks to fail. So let's say that you're in trouble. You're over 100% owner deposit more than what you want. You can go out and buy broker deposits.
[00:21:10] Speaker A: Well, that's the Fed the repo market is from, right?
And again, we don't have to get too much into the reason. I guess where I was going to this and, and, and for any banking professional listening in, this is for my clients and the owners who have a trades background or they started their business and they didn't have a Finance degree. So this is our disclosure that this is not a finance mba. So, but I think, you know, what we're trying to pull through is the concepts for people to understand the banking business model where. So let me know if I've got this right or wrong or if you want to modify it. So if someone has a, if a bank has $10 of deposits they can give out, what would that be? Is it $90? Or what would be the ratio there? $90 in loans.
But there's that relationship between the deposits and the loans that they can make out. So if the $10 goes down to $1, that becomes a very bad problem because it's a pyramid. It's an inverted pyramid, right? Fractional banking reserves. So you pull out the bottom and then the whole pyramid collapses. So then there's this, the importance of deposits. And so when I heard what you said and like, and I was reading one of the articles, Luke, about the SVB is. And by the way, I interviewed the Signature bank founder, like, years ago, and I was like, when that whole thing went down, I was like, oh, I want that one banking guy. I should have him back on the podcast and see what he thinks. And I'm like, oh, he's part of this. It's insane. I was like, oh, that guy's not taking any interviews. But what, what I, the article that I read was because the money was moving so fast, because of the technology, space, versus like, in the 1920s, like, a bank would go from fine to completely illiquid with that ratio in like seconds, which is a problem. Just in general. Is that a fair.
Am I on track? Off track?
[00:23:00] Speaker B: Absolutely on track. And thank you. I was getting in the weeds and there are, there are cushions, there are margins. Your Fed line doesn't really get shut off till typically around 115% loan or deposit. So again, that's why you're right for a banking professional.
Or you could argue that that's not a really relevant liquidity measurement. But for a business owner, I think right now it's a very relevant question. It's an easy question that a bank should know the answer to. And it's going to give you a good answer of are you really hungry for loans or are you completely hungry for deposits? And are you going to have to bring in for every dollar you're lending me, am I going to have to deposit a dollar and a quarter, get you back on track? Because most borrowers that come to me don't have a dollar and a quarter deposits for every dollar that I'm lending. That's, that's such a great business.
[00:23:50] Speaker A: It's because it's just one of those KPIs that like, it's just a quick one. It's. Yes. It's not an ultimate like. And that's why I'm just having these asterisks. But it, but like that's how the system works. And then one more part of this, I mean maybe a two part question, Luke, on just how banks operate to lend out the money because the money is the inventory that they're lending out. Then we can get into like credit and how you guys analyze it. But yeah, so few people understand that.
So you. Every bank gets the money from other sources. So maybe question one is where the money comes from to set up a bank or to like, you know, because like there's a bank that I've come, you know, there's egg banks that want to get into, you know, other.
There's a diversification play in general. And like is it Fidelity or Scale bank that came from the Opus family? So question one is like where does that pool of money come from to begin with? And the second part, Luke, is this.
There's this graph that I'm picturing that floats around X all the time of how illiquid. Not illiquid. Maybe that'd be the right. Wrong term. If so, you know, there's a bank here in town, they will not be named, but I had a little interesting skiff with them at one point. But they had a lot of 30 year mortgages that they consumed that they had on their balance sheet. And the moment that the rates went up, if they sold them, they'd have to sell them at a discount.
So how the inventory of money, of loans impacts. Because my analogy there would be is people having inflated inventory on their books.
And no bank wants that, but the banking system does the same freaking thing. So two questions of the pool of money, where it comes from and then how you guys measure the equity or the health of the balance sheet of the bank.
[00:25:32] Speaker B: Yeah. So I mean the pool of money where a bank to start a bank. I think that's, that's one topic. I think what you're getting at is a little bit more of where does the money come from that a bank is lending out. And there are a few different measurements that I think are important. One being what they call what banks call core deposits. So that's you and I have an account. A business owner has an account. It's in, you know, a dda. It's moving it's non interest bearing it's or even, even if it is interest bearing, it's money that is there, it's not purchased broker deposits. So broker deposits are something where there's a company going out and essentially selling deposits to a bank saying hey, we have a billion dollars worth of municipal funds we manage. We need to get X number of this return on it. I want 5% but I could wire you 10, $100 billion, whatever you need based on what you're willing to pay for that. And now that's considered essentially hot money for a bank. And so the amount you're able to lend off of hot money versus core money is very different.
[00:26:32] Speaker A: Is hot money because it can disappear tomorrow kind of thing?
[00:26:36] Speaker B: Well, not necessarily. I mean yes, it can disappear tomorrow and also. And for that reason. Yes, so you bring up a good point. So after SVB went down, some banks started really looking at their deposits and saying okay, who's a really big depositor? That could leave us and put us in a tough position before. I mean FCB had those large deposits. That's, that's part of the problem. They didn't care that somebody had 300 million in one account that could leave tomorrow. So banks did start looking at that. The hot money is, is twofold. A regulatory compliance will dictate certain things as, as hot money or broker deposits. And some banks will kind of have this category of their own where we're saying yeah, whether that's technically brokered or not, we might be able to lend off that as core deposits but we're going to dictate it as hot money that can be.
And so there are a few different buckets of deposits and I think that kind of gets into your answer some of your first question. And that's something where if you're looking at a bank's balance sheet which by the way we'll get into this later but every all banks financials are public.
Uniform bank performance report is something that every business owner should know where to find. If you have not looked at your bank's P L balance sheet Uniform bank performance report or UVPR, you can find it. It's the ffiec.gov I believe is the website that will post any any bank it has to be public. This is no matter what bank ownership, whether it's owned by a private, you know, a family of billionaires or it's public bank, it all has to be published and you can see how much brokered money or hot money a bank holds right on their report.
So without knowing much about to your point, you know, true measurements of what you know, a banking professional might consider a measurement.
A business owner with a few good questions can figure out pretty quickly how much appetite their bank has for lending.
[00:28:37] Speaker A: And just like I don't know if it were me, I would probably just go to that website, hit control P, get a PDF, put it into GPT and say what's going on here?
I can't read and understand any of this stuff.
[00:28:47] Speaker B: Please tell me, give me five questions. Yeah, give me five questions they asked my banker right now because that's, I think that's very relevant right now. Now two years ago it might not have been as relevant two years from now, it might not be right now. That's one of the first things that I would tell a business owner to look at, to ask. And a lot of bankers could argue yeah you know, we might have an elevated loan to deposit ratio right now, but everybody does. Things are changing. We can go out and buy broker deposits. We could, they could give you a lot of reasons why they're not closed for business or not, you know, putting the pencils down on lending. But I think there's still really good indicators and it also has a good control not only on risk appetite but also on pricing. They're not going to slash margins if they're really not hungry for new business.
[00:29:37] Speaker A: No one's pricing and interest rates, terms, conditions, personal guarantees like all the and we'll get where we'll save. I'm saving the juice for the the because that's where a lot of people want to get to but I think that, I don't know, I'm just such a proponent on the context and I think the last part on this and then we can move on Luke is the like there's this chart on actually like how much of the banking system is underwater. So for the listeners in it's Mark to market is a fancy word of saying we're lying about how much your inventory is worth. So that way we can keep our equity in a ratio that makes sense. And like when I, I look at the banking system and that's what happened with one of the local banks here is they when the Fed rate is at four and a half percent and all of their, the Treasuries that a bank might own is at two and a half, they would have to discount those to sell them. And it's like the same thing if my clients got, you know, a bunch of clothes that no one wants, you have to discount it to sell them and so can you explain a little bit of like how that bank balance sheet looks outside of the hot money and like how that mark to market works? And again, I, I don't know if that's possible to find that on that website either and because I think that will impact the appetite of a bank to loan because of their exposure to commercial real estate that's going on right now or the old treasury or the, the Treasuries at a low interest rate.
[00:31:00] Speaker B: Right, Absolutely. And I think probably what's the most important thing to look at and the most relevant to what you're asking is a bank because bank's loan portfolio is essentially their, you know, their inventory. And you're right, if you have a huge concentration within your inventory, that's a concerning factor. So something that, yes, you can find on a bank's balance sheet, you're not going to get a ton of granularity. I'm trying to think last time I looked at it, but you can go in and see where the concentration within the bank's loans are. So if a bank is 90% of their lending portfolio is all in commercial real estate, I think you should ask yourself a couple questions. A, is that, is that a good thing because that's all they want to do, or B, is my loan maybe going to be what tips the scale or overflows that bucket? They obviously are going to have a bigger appetite to diversify their portfolio. They're going to lower margins, they're going to be more aggressive to grow loans in other areas.
So I do think that's very, very relevant.
[00:32:04] Speaker A: Is that what is because, like, how does that, I, I really don't know how that works where like, you know, you might have a bank, like there's a one out of North Dakota that's doing, that's getting into the Twin Cities here, that's doing some ridiculous things to like their structure because they're trying to diversify outside of egg and fracking. But then like in the commercial real estate, like, is there a general, like every bank should have a portfolio allocation like, like, you know, everybody can probably picture the 60, 40, a diversified portfolio looking like a, you know, colorful, you know, Charles Schweib or is it like, is there flexibility and, you know, niches that certain banks are going after? That's okay. But then the only risk is if something happens that one industry, they run the risk or like, how does it work?
[00:32:48] Speaker B: Well, first of all, I'll say a lot of banks that wanted to grow quickly found a way to grow in that in commercial real estate. That's every bank that I've worked at, they look at commercial real estate as almost a faucet. There's an influx of commercial real estate. If you want to go out and cut your margins, you can get commercial real estate loans pretty quickly. You can get big loans quickly, but you're not going to get a lot of deposits. You're getting debt that's going to amortize off slowly and for a lot of reasons. Sure, it's quick balance sheet growth for a bank, but it can get, get you in trouble with concentration and then obviously the market is going to impact things. So you're dead on with that and that depending on market movement, sure, it might have been fine. Some banks really specialize in commercial real estate. They do it well. They make sure that they're balancing their portfolio in different areas of commercial real estate. They're making sure that their loan maturities are balanced properly. Even though it's amortizing off slowly, there's still going to be a renewal at a, you know, a five year mark or a three year mark. They're maybe balancing it out with the derivatives like a swap product. But, but that being said, one market turn, any company, regardless of banking or not, doesn't want concentration. Right? I mean that's, you look at any valuation metric, any risk metric, concentration is bad. So no different for same thing that.
[00:34:10] Speaker A: You look at with your clients is the same thing that goes. I mean that's what I mean. It's like, I think it might tell us a bank is a business.
That's.
[00:34:16] Speaker B: Yeah, it's, it's. So, you know, this is why sometimes if you didn't know what to ask your bank, maybe just go and ask them the same questions they're asking you. And just because to be honest, there's, you know, they're going to point to your concentration. Ask them about their concentration. I, it's a really relevant, you know, bank that's stable and well diversified, is going to be proud of it and they're going to talk about that. I know when I meet, you know, I've worked for a number of different banks. I landed where I am today because I wanted to be able to sit down and hand over a quarterly performance report or a balance sheet and say, look how diversified our portfolio is. And this means we want loans in every bucket. We want, and we want loans in general because we have liquidity. I mean that's, that's another thing that I think is a big, a big topic right now that's important, but hopefully that answers.
[00:35:12] Speaker A: It does. No, it's, it's.
I think all of that context is relevant because when an owner is sitting across from someone and they get the no and they think it's, I did something wrong, my business isn't pretty, why don't I get the line? Like it's, it.
There's so many reasons that it's like. And I.
As long as we can empower people to go, okay, here's how, like here's how it works so you can start thinking and then you can have more conversations. Also they have the option to have choices to like, like I was on a call with a client this morning, Luke, and we've, we've got their three statement model. They've been working on their forecast, their five year plan. They got their strategies, they got a growth plan that's either buy, it's literally buy or build.
And like we can see exactly how much debt we're going to be able to take on. What we need is the line of credit, how it's going to be able to cash flow and like. And I said to him, like, now it's time for bank shopping because money is a commodity in this situation. We want a partner that can lean into this five year growth plan. So like it's just flipping the power dynamic to say like it's not like an act of God. Like you know, your, your parent anointed you with the ability to have, you know, a night out with your friends because the bank gave you a loan. It's like, no, this is a reasonable request. Just like you need a cpa, you can go to other banks and shop them out.
And that's what we're just trying. I just the context I think, thank you very much. Because it seems maybe boring for you but it's helpful for the people to understand behind the scenes.
So then we can move into then as that context is behind the scenes, how the banks make money then.
And then how they like, what are the products and services that you guys sell to make money on? And then what are the different ways then how that ties into, like what kind of.
And then maybe we can get into the analysis of the client health of how much debt you'll give them in the product, how it kind of translates from you and then to the client's balance sheet.
[00:37:10] Speaker B: Yeah. And we touched on it a little bit in the beginning as it relates to risk rating and equity allocation. However, I think it's worth noting again to your point, how banks make money, the deposit Margins are not an area of banks making a lot of money right now, obviously. So it's lending margin, then there's fee income. A lot of times if you're going and getting a loan from a bank, you're going to pay some sort of origination fee. So fee income is another big one from lending. And then treasury management is something that I'm very passionate about because I feel banks need to diversify and give more solutions and efficiencies back to their company, their clients.
[00:37:51] Speaker A: Can you explain what treasury management is?
[00:37:53] Speaker B: Yeah. So treasury management are going to be any banking service or tools and somebody actually explained this to me recently that I thought was a genius way of explaining it back to my customers is that banks offer different products or services, kind of like an app store.
We all have a platform we subscribe to, whether it's FIS or fiserv or Jack Henry. There's, you know, our core banking platform. When you log into your bank and put in your name, password, you want to go look at your accounts, move money, all that, that's. There's a platform, sure. There's no overlay. Everything's white labeled nowadays. That's no different in the banking world. If anything, maybe it's heavier in the banking space. And I've worked for banks that have tried to be software companies and tried to build their own platform. It just, it does not work. Banks should not ever try to be software companies.
So with that they go out to the market and let's say you, your bank utilizes fas. We're going to go out to the FIS marketplace, we're going to grab your bank will pay for integrated receivables, integrated payables, you know, different services or automation tools that they can essentially purchase and provide to their customers. The treasury management is any, any service involved in automation moving money different ways. And a lot of people will look at it as just a way. Fraud prevention is obviously a big one, maybe number one. But a lot of people look at that as a way for a bank just to sell more and try to make money. And they're not all wrong. Yes, that, that is a, it's a big income producer because once it's in place and you pay for your service as a bank, then once you get past your expense, it's not, If I have 10 customers using it, I'm not paying anymore. If I have a thousand customers using it.
[00:39:35] Speaker A: Dude, this is a total ridiculous this comment. So we just went out to dinner with a college couple of our, our friends and she married this guy super, super good dude. And he works at the largest fraud protection company that sells to banks. You would know you. He said the name of it and he's like, it's the biggest company, you've never heard of it. And so every bank uses his company and that's what he does for a living, is sell that. My God. So you can only imagine our fund coverage. It's just like, oh my God, who would have thought? But like he was saying like that, like it's ridiculous that every bank and everybody is using that fraud protection. So obviously you need it. But then you're like this app management I think is an interesting way of tying it all together. Like because it's payables, receivables, all the moving money around, all of the administrators, registration, overhead, BS that people's finance departments have to do anyways, right?
[00:40:25] Speaker B: Yeah, they have to be. And I feel like I'm, I'm jumping out of context a little bit here, but I think it's really relevant when you're talking to or shopping for a bank, deciding what, what you, it's, it's what value they can provide other than, like you said, we sell money.
So we sell money and can we sell it cheaper than the next bank is really what it boils down to. There's, that's the commodity component of banking. But if we can go to a CFO and say you need a payable clerk, you can't find anybody because everybody's looking for a payable clerk. We can automate your payable process enough to save you hours and shed that much time and it's going to cost you X. And ultimately we're not looking to replace Jobs by this. But I do think that there's a lot of banking, there's a lot of technology out there and if banks don't figure it out, Amazon and Apple are going to for them and pretty soon Amazon's just going to be a bank and provide those services. Because banks have struggled for years with technology, there's still banks out there that utilize screen scraping when it comes to some of their treasury management services, which, you know, again, don't want to get into that, that's a tangent, but I will say it's really relevant. I've worked for a lot of banks that have done looked at technology in different ways. They've taken a different approach to treasury management and how they're going to automate some of them again, try to go ground up, try to be a software company, it's disastrous. Others just say, you know, this is a service we're going to give away. It's carrot on a stick, we'll give this away.
Anything that you're giving away is never something that you're truly putting value on, in my opinion. And then where I'm at currently is a way to shine a light on what I think is the best use case is when we're going to take a bank will actually take a white glove approach and have in house engineers that will write and customize something for your company. Instead of saying here's we bought this app, it's really cool, use it, download it, pay me money for it and your text, you're going to have to do the work to make sure that you can comply with the, you know, this app's needs and integrated payables. Sure, they're great, but your fi, your, your XML or CSE file is going to have to match with this apps or this product's guidelines. Otherwise it's not going to work.
[00:42:39] Speaker A: Receivables and stuff like that is it? Just integrating into the accounting system. So then you're doing all the coding and you're able to just categorize everything and then track everything with like dashboards of the cash conversion cycle essentially, or.
[00:42:51] Speaker B: Yeah, yes, yes and yes, basically.
So there's a few different layers you can start with. You know, like I said, some banks will go out and just screen scrape data, take that, batch it out and submit your ACH for you. Then there's FTP or SFTP batching, which is, you know, the next level, much more secure. And this is, you know, your data that's moving. So again, the screen scraping thing, you know, I think that was, there was a privacy bill that was supposed to put a kibosh on that, but we'll see if that happens or not. Then APIs are kind of next in line where everything's hardwired, that data is moving back and forth and that's where most banks are looking. There's some banks, some of the bigs that I won't name that have moved even beyond that and are actually building out products and services within your erp. Typically that's on the large scale, like within Oracle, within netsuite, some of the bigs. But look at it, I mean there's 3,000 plus ERPs out there. Not everybody wants to go out and buy an Oracle. And I think who we're speaking to today is, is that middle market company, that company that's, you know, looking for answers in their bank because they're kind of Falling into a black hole is how it might feel. You're moving from what banks would call business banking into a middle market segment. And so the rules kind of change, the products and services change. So what we're talking about, some of these automation tools are more when you have enough, you know, payables, receivables that it matters.
[00:44:19] Speaker A: Can you explain the business banking versus the middle market? Because every bank has their different groups and I think a lot of owners don't realize that there are different groups that banks are targeting.
[00:44:34] Speaker B: It's one of those, another one of those kind of best kept bank secrets I feel that I love to shine light on because it's by design, it has to be done. Big banks I've worked for where they need to have customer segmentation and some of that is because they want to truly provide specialization and silos. Whether it's, you know, food and beverage, healthcare, manufacturing. At some level that does make sense.
But when it comes to size of a company, this is where it really hurts a business owner, in my opinion. When you have a large bank with a business banking unit that says we get to service any company that's 2 million in top line revenue to 10 million in top line revenue, and then your next segment is commercial banking and they service anything from 10 million to 100 million, well, naturally that line in the sand is always spot over and there's always, you know, someone from a business banking segment that wants to try to service a bigger company and maybe they don't have the tools and services, treasury management or credit analysts to support that. So there's a reason why banks want to segment it. But behind the scenes customer business owners don't know that. They don't know that you're a customer that some bankers are fighting over because one department wants the revenue over this department and who's going to hurt.
[00:45:56] Speaker A: The two banks that they're interviewing might have a different threshold. So like one bank might offer the middle market to the 10 million, the other one might not.
[00:46:03] Speaker B: And based on who you met, you know, what banker did you get referred to? Oh, well, he happens to be in the middle and you know, they'll call it different things. They'll, they'll, they'll change the definition of what constitutes business banking. Oh God.
[00:46:16] Speaker A: Well, we all know that everybody is the VP of commercial banking at every bank.
[00:46:20] Speaker B: Yeah. Yes, exactly.
You know, I couldn't even tell you what my, I don't even know what my title is. That choice, really, that's awesome.
Actually comes through. Just answer my phone. Call when I call you and do what you say you're going to do and I'll take care of the rest.
That's awesome.
[00:46:42] Speaker A: That's helpful because I mean all of this is just helpful to understand who they're talking to. And as we continue moving down the customer journey of then analyzing the credit, analyzing the structure, personal guarantees, like the different structures of debt and all that stuff, I think I was trying to figure out what would be the best bridge to all of those questions that I know everybody's salivating over is.
I was, I would love to hear from you, Luke, like, because you did as you explained the deposits fee income, the treasury management, like the just the partnership type style.
Do you have like a favorite story of like a client that partnered with you or maybe one from, from choice that you've heard where it's like someone that truly viewed and you as a partner of how to capture their growth and all of the different ways that you were able to help them?
I want to like maybe see if we can capture that and then we can talk about how the questioning that comes from a bank is trying to figure out how to put people into their business model but then to help them accomplish it. But do you have like a story or two that are your favorites?
[00:47:51] Speaker B: One of my favorite stories to tell really encompasses like you said, I've talked about what provides banks strength and, and not, not strength, Treasury Management Services. I, I have a, I'm passionate about that because, you know, I, my, my dad owned, he was a reseller for Microsoft in the ERP world. So I started working with Peachtree when I was, you know, 15 years old running, you know, sending invoices for his company. And since then I've partnered with a lot of resellers in town and I'm passionate in that area because I think it's an underserved area of banking.
But to tell a story that kind of encompasses a lot of. That goes back to a time when I had to give an honest answer to a tough question. And that's something a lot of banks and bankers in general aren't good at. You know, we're a commodity in a lot of ways. And you get a lot of bankers that want to be people pleasers. That's another reason why I see a lot of business owners have such animosity towards banks because they're never getting a clear cut answer. It's always today's, you know, today or tomorrow's bullshit. They're not actually being treated like a human being and said there's no genuine intent there to just tell them the truth of this is why we can or can't do it.
I was the only one in a room. There was a company that was growing. Hockey stick growth couldn't keep up with the amount of the influx of customers they had. And because of that, financing was an issue.
They're not alone. There's a lot of companies that see that extreme growth not producing the cash flow yet. They need a bank to bridge the gap. It's a classic. I mean, and every bank was in the door trying to figure out how to do it and talking about it and this and that. Well, what if we did this or that? No one just said the obvious, which you could tell within, you know, about 10 minutes of looking through the financials is, hey, this is, this is not a bank deal.
I'm not going to do this deal for you. Here's a solution. There are solutions out there. You might not love them, but you want to get from here to here.
Let's talk about how to get there and then how to get to the next step. And that's not going to be with a bank. You can try. And no one was willing to tell this CFO it was a very sophisticated CFO. They're growing from 70 million to about 120 million in top of the line revenue. And then from there they went to 200.
I mean just. It was incredible.
[00:50:11] Speaker A: For the listeners here. And here's what, yeah, what I curious on why you said that and what the solution was for them. Because like I had a very similar conversation with a client two years ago and the reason it's not a bank deal is because you can't take on an SBA loan or conventional loan or whatever and have fixed debt services when you're growing that fast because of the negative cash flow from operating activities. Right. So you need equity or some sort of bridge equity to get to a point where then you can service some sort of bank structured debt. Is that a fair. Is that what you was.
[00:50:47] Speaker B: That would.
[00:50:48] Speaker A: The solution was very similar.
[00:50:51] Speaker B: This one was more of, you know, they were going out and selling their product.
And a lot of business owners will look at it this way for the, for the right reasons. You're selling a product and you bring in a receivable and say, well look, I sold it. I have, I'm. This is an asset on my balance sheet. I'm old. This money, it's not cash flow yet, but I will. This money can you do. Banks will advance. It was a version of yeah. And I can see it in your face. But there are, there is a time, a time and place where I know.
[00:51:22] Speaker A: There is a time and place. If you got a financial forecast, then sure, yes. It's just. Here's the cocaine. It was just for tonight. No.
[00:51:31] Speaker B: This one was legit. It was, it was a short term. I was able to bring in a partner that said we're going to give you an early out because that's, I mean, you know, I don't need to tell you, you know, factoring ABL any of those collateral based solutions, they're going to try to make it tough to get out of there. But if it's the right maybe.
[00:51:48] Speaker A: And all joking aside and all joking aside, I mean if there is an actual. You said it's a sophisticated CFO is. And I want to go back to you kind of explaining how you like help them because if they can see the cash flow forecast, then any type of financing should provide a return on the equity that they're growing in their company. So whether it's asset based lending or if it's receivable or, you know, or some sort of machinery or whatever the hell it is, or even a short term like Patrick Donahue's got his like, you know, equity or the mez financing kicker with equity, like any of that stuff, that's bridge financing to get onto the other side where you're actually cash flowing.
I think what you and I both know is that what is it, less than 90% or 95%, they can't see the other side of that. So it's all hope and dreams. But if you can see the other side of that, that's where my joking will stop saying like anything is possible if it mathematically makes sense to get to the other side.
[00:52:45] Speaker B: This was legitimately a cash flow concern. They couldn't hit one to one from a cash flow perspective.
So they couldn't technically afford the debt at the time. So there had to be light at the end of the tunnel in the projections. And that was why it made sense. It was a one year play and it is somewhat of a bad example because it was a SaaS company.
It doesn't always happen that way. To your point where there's true legitimacy in the projections and there is an end goal. But I brought it up as a story because I raised my hand and gave them an answer they didn't want to hear. No one else wanted to give it to them and the CFO was so happy that I gave them that answer. And then we Proceeded to implement a lot of those technology and efficiencies that I talked about earlier took a lot of time, but it saved them a ton of money and allowed their money. The flow of money is really what it's all about. If we can get you to collect your money faster and try to delay you sending money, it's basic knack and math and improving working capital here. But there are banking tools out there that I know a lot of business owners might roll their eyes and say, sure, we've heard that. Everybody says, you know, use this tool or that tool and it's going to increase your cash position. But there are some legitimacies to that statement and this one was a short term. We looked at the projections, we said, okay, and that's where having a banker that can sit down and talk with you about let's look at your projections and say when are you going to be above a 1 to 1.
Let's actually look at how we measure it as a bank.
It doesn't have to be any different than you're measuring it in some regards because math is math at the end of the day. And we can share a formula that you can do as easily as a bank can. And let's see when you're targeting to hit that. And then that's when we're going to convert it to a bank though.
So the reason I use that story is because it is a little bit of an anomaly. But the reason it worked was because of the planning and the approach and I provided clarity around here's how we're doing the math and why we can't do it today, but why we could do it tomorrow. And that, that is why I should have maybe led with that statement.
[00:55:00] Speaker A: That is why it's awesome and it makes a ton of sense. That and I think that's a good bridge into I'd love to hear how you analyze a client and et cetera. But what you just said is like why I am such an advocate of like the planning that my clients are doing. And like even a couple weeks ago I had like I put out a podcast about the three statement models. Like if you can do this, like your bank is actually capable of being your partner instead of your adversarial adversary because you're showing them what your planning on doing and to get people on the same page, then, then everything else becomes easier. But I think I want to hear a comment and then we can go into it is like how many people actually in your career have a three statement projection?
Like we talk about.
[00:56:00] Speaker B: Without trying to put a number on it, say that very, very few, whether they have quality financials or not, let's say they have moved, you know, have audited statements and all that having a true understanding of cash flows is, is the biggest hurdle I see when in business owners obtaining financing and the financing they want and need.
And so I, without putting a number on it, let's just say a majority in a lot of ways. And I've dealt with some really sophisticated CFOs that they have a handle on it. They, you know, they may understand it, but there is a very, very common theme with business owners not truly having an understanding of, of cash flow.
[00:56:48] Speaker A: And then that's, that's probably historical like let alone forecast because like in order to forecast out cash we have to forecast out the balance sheet mathematically time all together. I mean like, like my data points are Luke out of 3,000 people from the vistage workshops that I've done, yeah, 1 or 2%.
And they're generally private equity banks, you know, because they have to or you know, or VC back.
[00:57:13] Speaker B: So like absolutely.
It's also to your point, it's few and you're allowing business owners to be a proponent of themselves in a lot of ways. I look at it and say in some ways it keeps bankers in a job because a good banker is truly just a storyteller for a company and wants to listen to their story and then a good banker will then say how directly that impacts their cash flow or could impact their cash flow and then goes and takes that to the credit approvers. And I do want to get into that in a little bit because I think that is some of the juice that credit decisioning is very important. But you know, bankers are essentially storytellers. Otherwise the bank would think would just be a building full of credit approvers and you would just show up and you would say I want this money. And here's why you would do it yourself, otherwise you wouldn't need a banker.
[00:58:09] Speaker A: So in some way it's really interesting that you say that. Luke, my buddy who owns a billion dollar family office, so he manages like $30 billion and he's got clients with $200 million net income. So he's a good friend of mine and he's like Ryan, if they did what you guys do, we wouldn't be needed as a family office. He's like, we got clients that don't know where millions of dollars are. It's in checking accounts all over the place. And, and it's Just odd how few people have it. Like, it's just fascinating. But like. And I think even though that you just said that it wouldn't. It keeps you in the job. Like, the people that I love, watching them, like, work with someone like you is we have growth plans. And here's exactly like, Luke, Ari, like, when, when and how can we go from like. And maybe when you're talking about. We go from the underwriting and how you analyze it.
So maybe I'll. Let me back up and maybe frame it up like this. Luke is like, let's say someone comes to you and says, here's what I. Here's what my plan is.
Like, here's my growth plan. Here's what I want. Like, their questions, like my clients questions are, where does the bank fit in? So let's kind of. But I think we covered treasury management, and I think now we're focusing on, like, debt structures. So lines of credit, SBA loans, conventional loans. How do you match up the debt structure with the growth structure?
And how do you analyze, like, balance sheet health, what they can take on, how they can cash? Because I think that whole jigsaw puzzle is very confusing to people, like, what structures get offered up to them. If there's a different way you would want to handle this kind of process of like, helping people think through this or the.
Or the customer journey, I'm happy to it, but that's what. I just know that a lot of the clients are wondering.
[00:59:52] Speaker B: Yeah, can I dial it back a little bit and talk about the credit approval process?
[00:59:58] Speaker A: Absolutely.
[00:59:59] Speaker B: Important first, I think. And the reason I think that's relevant is because I think it's important for business owners to understand, regardless of risk rating model we talked about, regardless of analysis and approach, they need to understand who's actually sign. Who's actually saying, yes, the wizard of.
[01:00:16] Speaker A: Oz behind the curtain. Right.
[01:00:17] Speaker B: It's not a. Yeah, yeah, yeah. It's not. It's definitely not a computer. Otherwise, then definitely wouldn't have a job here. So every bank is slightly different in their credit approval process. But typically there's people that hold. Hold pens, you know, of approval weight. This is, you know, I have a pen, they have a pen. And sometimes you can get collectively a couple approvers Together, add a $2 million pen with a $5 million pen, and as long as your credit is within that, you could essentially get those two credit approvers to approve your credit. A lot of community banks, which, you know, there's. This is the Midwest, is Atlanta community banks, there are more community banks here than I worked for that bank from the west coast. And they just, they did not understand how many banks we have in the Midwest. But most community banks will have a committee.
If a deal is of certain size and complexity, you're going to go to an executive committee and you present that credit and that credit is then voted on. We still do have a chief credit officer, chief risk officer, chief. You know, there's still titles that, you know, they're looked at to kind of give some guidance and they can throw weight around. But that being said, I think that's why it's important to understand not only who your banker is, but who's going to be making that final decision. Do you have access as a business owner to help tell your story and state your case to that credit officer or executive that's making the market president, whoever. Depending on the bank size and structure, it's worth at least asking who's making the decision on my credit and what's the process?
[01:01:53] Speaker A: Right, because let me walk you through my couple of my experiences and you can maybe fill in some gaps for people from your experience of the different banks.
What I noticed through how many banks I've interviewed for myself and for clients, it's like there's a wild variation of how many people are just salespeople. Like some people like you and I know who have. Yeah, your goal is to go drink with people on the golf course.
And then there's so, and then there's so like I, I've seen sales only people. And then I saw people who have like a portfolio where they have a quota of like $30 million in loans origination. Plus you also have a clientele that you're also the portfolio manager of.
And then there's like the credit people behind that would come out like the sales engineer.
And then so that's kind of like the front of the house is what I've seen. A huge sliding scale depending on the size of the bank. And then there's the credit approval process which could be in that location, it could go from that location, then go up based on size, based on geography, but like all the way to that final pen.
And like what happened with me, Luke and my dad with Northeast bank is Larry, who's passed away unfortunately.
He like the FDIC came in because they had a bunch of shitloans and then Larry had zero authority.
And then when we were going through our some that we didn't know that was sitting in a high tower of some glass building, wouldn't talk to us and like for 17 years, years, we never missed a payment. And then all of a sudden their, their credit approval of their bad stuff from 2009 all ran downhill to us. And like, we couldn't, had, we couldn't. It's like, it's like calling the IRS and trying to talk to someone.
It was impossible.
So there, and there's a huge spectrum of experience that could be possible in what I just described. But like. Yeah, just understanding that. Right. Is the important part. Like anything that I, you would add to that or change.
[01:03:50] Speaker B: No, I, I, you're absolutely right. You, you need to get along with those, front of those, those, those people that are, you're going to be dealing with day in, day out. You need to know that you have a trustworthy banker and team that are going to pick up the phone. They're gonna, you know, but to your point, at the end of the day, if they don't have any say or decisioning or know how, how are they going to be an advocate for you? And even if they aren't advocate for you, if, if everything's up to one person and that one person happens to have a memory of their biggest credit loss ever in their career being in your industry. And you're going to, no matter what, you're going to be lumped into that because, you know, that's, it's a real thing. I don't care.
You know, a lot of bank credit officers would argue with this. Sure. But there's just no possible way that you went through a really difficult time in your career and that's not going to impact your decision making going forward.
You get scarred by specific deals, business owners, whatever it might be. And that's part of being a banker is not all risk ratings. Risk rating systems will have this built in, but a lot of them do. Where there's a management capacity component, let's say 20 of the risk rating or tempo, whatever it might be, there is a management capacity.
Does your business owner, as a, you know, me as my customer, business owner, cfo, they have the capacity to run that business to. That's the judgment.
[01:05:24] Speaker A: That's the judgment weight. Right. Like, we like Luke, we don't like Luke. He's capable, not capable.
[01:05:30] Speaker B: It's a real thing. And I mean, not all, you know, the bank of that now doesn't have that in, you know, in our risk rating system per se, or grid, but it's a component. It's definitely something that's talked about. You know, there's something that banks have, it's on the five C's of credit. You know, it's, there's, there's those character components and management components that are definitely evaluated. And part of that is going to be quality financial statements. You show up with a set of tax returns or, you know, P and L where, you know, your biggest line item is other.
It's, you know, it's basically lines up with the tax return.
What are we supposed to, you know, how are we supposed to.
[01:06:10] Speaker A: What are we doing here?
[01:06:10] Speaker B: Yeah, yeah, exactly. So, you know, that's, that's, you know, something you typically see in the, you know, more of the business banking sector. The, you know, couple million to about 10, 20 billion revenue. But the sooner that you can collect those sophisticated financial statements, understanding cash flow to, you know, what you're doing, that's what's going to get you.
[01:06:32] Speaker A: I was going to say that just matches up exactly what I was thinking where.
What I have been trying to get across and I've is if we are clear on what we want, we have our financial model and forecast that reflects our strategic plan.
We can hand it to Luke, if Luke is our advocate and Luke can tell a freaking story to.
I don't. And at this point, like, it's almost irrelevant to me whether it's Luke and then one underwriter and analyst or Luke and then four levels. I mean, like, we would want to know that chain, obviously. But if everyone's capable of telling that story because the material's clean, that then proves the capacity of the management team. And I mean, if we're all just people and someone's sitting there going, this person's an idiot. No thanks. Versus like, the story makes sense. And that's really what we're doing. When we sell a company to an investor who's got to buy it with debt and equity to. Because they need to believe the future cash flows. It's all the same material, which is we're telling a story. How well can we predict the future and can everybody understand the story so we can all just move along and actually start working instead of having all of this inner conflict? And so it just. To your point, whether it's the management rating or the credit rating or the storytelling or the different levels of credit analysis, like it's all about, do we all believe what's going on here?
[01:07:59] Speaker B: Yeah. Banks are in the business of risk. I was just talking with one of my, my senior analysts the other day, and, you know, he made the comment that no matter how you approach, you know, risk evaluation, risk rating, no matter the industry, there's always something that could come in and just blow up that, that company. There's always that, that's, that's part of why a business owner needs to be who, who they are to run a business. Because it's not easy and that, that's a risk that they're willing to take head on. And, and banks are in the business of risk. And knowing that, sure, you want to try to measure as best you can, but there's, there's always that anomaly that can come out and get you. So your point? Yeah.
[01:08:43] Speaker A: Comment on that. Is the reason that senior debt is ahead of the equity in a bankruptcy is because you guys are taking less risk.
But the reason that equity gets a higher rate of return is because you're taking more risk. I mean, it's just that simple. But that's also why, if we have a clear line of sight of our growth path, and I can, because Luke, we're walking through where we can see the discounted cash flow. You look at the distributions and the future valuation, it's, who gives a shit if it's six and a half percent or 6.7%, I don't care. Because we can see like, well, we're going to get a 30% rate of return on our money.
And then like, then like the debt structure, then it becomes like, okay, how do we get creative on the debt structure? So let's go back to the underwriting and then we can get to the structures where it's like, as you're looking at a, at a business, how are you looking at their assets and how are you looking at their balance sheet and their future cash flows and how do you place weight on certain things?
[01:09:43] Speaker B: So I, I think I'm going to go just basic advance rates. This is pretty common amongst a lot of banks. If you're in the commercial banking space, you know, we talked about kind of bank segmentation and that exists. And the reason I wanted to throw it out there is depending on who's listening and what category you might be in, it's just important to know that that exists. And you need to know where you fall within your bank. And ask them, say, you know, do you, do you take a scored lending model approach where my FICO score is impacting the decisioning and it's, it's, or are we in commercial banking and you know, there's going to be a set of spreads and we're looking at cash flow coverage, we're going to leverage, we're going to, you know, quick and current ratios or are you moving towards a fixed, fixed charge coverage metric which you know, the bigger you go it's that's, that's typically what a banks will lean on is, is a fixed charge approach over a global debt service. So without getting into.
[01:10:43] Speaker A: I wouldn't mind if you actually like, like would you mind just doing a quick like one or two sentence summary of each of those? I think that because like if, if people take this transcript, plug it into GPT what you're answering. Because there was some of my clients question how are you looking at that? But what I heard was it's different depending on the bank. So the question is the most important part because it depends.
[01:11:06] Speaker B: Yes, exactly. And I think it's not as much saying okay there's small business and business banking where some banks will take what's called a scored model where they're taking you know your, your gross number, your gross revenue, a net income figure, a fico, you know some, some key metrics they're punching it in based on your industry, industry scoring and a bunch of other things. They spit out a number is that number above or below where we want to hit? Okay. You're either approved or not. There's no, there's no actual like decisioning.
[01:11:39] Speaker A: In that smaller type business banking clients or something like that.
[01:11:42] Speaker B: Yeah. Okay. Yep. And then you know once you get into more advanced commercial banking there's typically at least just a global debt service approach. You know we're taking a net income and you know there's going to be a depreciation and interest expense add back. But we're you know we want to know can you afford your debt? So that's going to you know, then over your interest payments sometimes banks will stress so it's not just going to be dedicated plus add backs over debt service. There's going to be time periods.
[01:12:12] Speaker A: Here's where, here's what I'm interested. Like are you looking at this year, last three years, how many people even have forecasts?
[01:12:22] Speaker B: Not many. On the forecast I would say in my, based on who I talk to and who I target, you know I tend to find people that are growth oriented. I would say 30% of my customers will come to me with a forecast maybe up to 50% now. But the quality of that, you know, are you plugging in a 10% growth number and just everything.
[01:12:46] Speaker A: Is it just the income statement?
[01:12:47] Speaker B: Usually yes, yes. It's typically. So I, I should, I should step back real quick and say you know there are pro formas out there. But then the, you know the Quick question is. Yeah. Is this just a, a build out model with 10 growth on the income side? And yeah, there's no actual scenarios around here. So it is rare.
We do look at typically, you know, two to three years depending on the size of the credit. But a lot of times banks want to look at the past three years if it's a large credit. And interim statements are very important.
We're going to want to look at something current period within maybe 60 days. You know, obviously it's not going to be current current but whenever the books are closed and it's within the last 90 days, we want to look at that. And I would always ask for a year over year comparable. So let's look at this snapshot of the year. How does that compare to last year? And I mean with really cyclical companies or you know, a business that sees drain or really heavy reliance on the revolver at certain points in time, getting a snapshot around that time is very important because you're in data is your end data. But if you can get a snapshot around, why there's, you know, a heavily impacted revolver at that point in time, we want to analyze that, that point in time, of course. So that's, I'm sorry if I'm not answering everything.
[01:14:12] Speaker A: You are because like, because this is like.
[01:14:16] Speaker B: Yeah.
[01:14:16] Speaker A: And all I can, because I picture my brain, Luke, is my three statement model template which is like all of those answers are so easy to see and I, and I am operating also under the awareness that very few, if anybody has that. So then it's like grab this PDF, go grab that spreadsheet. And that came from that. And then we're going to piss, you know, piece this together and then hopefully, because like what you're trying to see is like, hey, we're going to give someone a 10 million dollar loan, but holy, between May and September they burn cash and they're going to have to hit their line of credit for 5 million bucks. But you don't know that until you know that unless they tell you. Right. So you're trying to figure out that piece of the puzzle so you don't get screwed, right?
[01:14:56] Speaker B: Yep. And so depending on complexity, depending on the bank, depending on the size, there's going to be covenant monitoring. Right. So let's say that's, that's initial analysis. We're looking at the last three years plus, you know, or depending on where we're at in the year, interim statements year over year, we want to look at receivables and payables, you Know, aging reports.
The really important thing to understand from a banking perspective, I feel and why automation is key is how the money's really flowing and moving into cyclicality. So then we move into how many.
[01:15:28] Speaker A: People, how many people actually can go to you and say here's my cash conversion cycle, my working capital, my pay was receivables, inventory as a percentage of revenue.
[01:15:41] Speaker B: 25% maybe. Okay.
[01:15:43] Speaker A: Because that's what you're looking for. You're going okay, how much? As we grow, how much cash do we burn? Right. And then in the past.
Yeah, that's interesting.
[01:15:52] Speaker B: So yeah, there are, you know, I would say there's, there's some. If I'm dealing with a you know, sophisticated CFO that has a solid ERP system, you know, we're not talking and I've seen companies burn hundred, near 100 million on QuickBooks. It's, it's, it's wild what you can accomplish. And you know, they're throwing in, you know, square nine or this, you know, fathom and all these add ons. I mean there's so many add ons out there just to automate certain segments of your accounting that you could really run QuickBooks quite a while. But let's say somebody actually has something like a Sage product or a NetSuite or, and, and can get access to good data and then they understand it and how to ask the questions that you're, you know, but, but I, I would say, you know, a lot of people don't want to spend that money and that's why you see those companies that are 75 million and running QuickBooks and having access to that data is a lot more difficult when you. Yeah, yeah.
[01:16:48] Speaker A: You know, so you're, so you're going into. Then that's why I was. Because you're talking about working covenants of how the money's coming in.
[01:16:54] Speaker B: Yeah.
[01:16:55] Speaker A: And then how you're looking at. So I don't know if you were going to Covenants and I don't know if you were something between you were going to.
[01:17:02] Speaker B: Yeah. I just thought it was worth stating how you know something that banks use to monitor ongoing credit and this is where is another area where I think it's important to question your bank. A lot of CFOs and business owners will go into negotiation with the bank and the bank will say okay, here's I to want propose a 10 million dollar revolving facility based on standard advance rates. We're going to advance 80% of receivables, 50% of inventory. Anything that's stale, dated or you know, past due.
A lot of banks will discount that entire customer. There's some, you know, there's some metrics within a borrowing base which is your advance rates on inventory and NAR that are things that you should understand. Don't just say, okay, is it 80% of all receivables or. Yeah, what, what kind of discounts?
[01:17:50] Speaker A: So what are the things that they should be thinking about there?
[01:17:53] Speaker B: Well, I, I think the, the discounts are a big one. If let's say we have 90 day terms with the customer and they get to, but they're a big customer and they get to 92 days is, you know, are all our receivables of that customer then discounted from our borrowing base the minute that they're late on one bill or not?
[01:18:15] Speaker A: So it's not just that the $10,000 that's over 90 days, it's the whole.
[01:18:19] Speaker B: Invoice or is the whole. Yeah, I mean typically that's a gotcha. Typically you wouldn't see that. But I have seen banks take that approach where they say, okay, this customer, that's a warning sign. They're two days late on. I don't care if it's 10,000 bill and they got 2 million outstandings, boom, that's off your borrowing base and all of a sudden your advance rate on your line of credit is impacted.
Buy that much? Yeah, yeah, yeah, yeah. You know, heavily concept.
[01:18:44] Speaker A: It's just the gotchas that you're looking out for.
[01:18:46] Speaker B: Yep, yep, yeah, look for that. And the reason I say it is because it's part of this, you know, asking questions back. Does it have to be that way? Same with covenants, you know, are we going to take.
Typically there's a cash flow covenant, a debt service, fixed charge, interest cover, whatever.
[01:19:03] Speaker A: This is something that I would love for you to pay some, you know, go through with some details and then how these covenants probably roll into personal guarantees.
Because covenants I've got clients that have been in, they've been tripping covenants, very understandable reasons why.
And then they're having very fluid conversations how to get over. But like what are the, like maybe an inventory list of the types of covenants and why are those covenants placed and then how do you work through those and then how do you work through to the point where you don't need personal guarantees. So is there kind of like a natural progression of how you think about that?
[01:19:41] Speaker B: There's in my mind, sure, there's a natural progression. Is there a natural Progression in the banking system. No and this is where some of the frustration comes out right Is because you're going to be told five different things from five different banks or bankers in in when it comes to covenants. And that's why I just want to put the general statement out there of ask questions and know what's best for your business when you're.
This is why the three statement model is so important and this is my, you know my pitch to you. And knowing that and your projections on what you're going to need is so important when you're deciding your covenants. It's almost as important as shopping for that bank. Everybody thinks about rate. Is it rate or is it going to be access to capital down the road because or talk about distributions. What is what are the individuals the business owners family plans or succession plans or.
[01:20:34] Speaker A: That's exactly why I wanted to talk about this loop because my ownership operating system is about the owner taking after tax after working capital debt and tax owners distributions. But then in there we have usually senior debt we've got maybe some you know all the different banking products of debt and serve and but we still want access to those distributions. And I'm working on a couple client internal buyouts where the CEO is buying a large percentage of the business but then the owner so now we're going to have multiple partners.
So then it's like okay then how do you deal with the distributions and the debt when one of the partners doesn't have a job anymore? But we want distributions.
So that this is why the covenant is because you guys as a, as a not you guys but like the banking partner will have say on how all of this stuff works. So yeah let's walk through the covenants and then like the variation of the types of covenants not to say that like just kind of help people think about this.
[01:21:36] Speaker B: Yeah. And so to go back to you know it's global debt service fixed charge. I'm not going to get into accounting 101 here but those are easy things for somebody to punch into rock GPT and get an answer on. It's. It's pretty easy to see what's going to be best for your business based on you know certain businesses being allow. Being able to allow for secondary repayment sources in their, in their cash flow calculations are. That's where some of that. Can you explain that mobile versus fixed charge. Well let's say there's another company or an owner is guaranteeing debt and they have income from somewhere else. You know are we Are we looking at income from a global perspective?
And you know, is there a repayment source or there's deals where maybe somebody owns a company and they're not the operator. There's, there's cash flow that they have maybe from, you know, maybe it's, you know, a franchise deal, something along that lines. There's circumstances where, and you know, another source of cash flow should be considered in calculations where some banks, if you're going to take a fixed charge approach, you're looking to, you know, starting with EBITDA on that. And so it's just a different and depending on lease obligations, again, not going to get into accounting. But I think to your point about distributions and back to the topic. Sorry.
[01:22:52] Speaker A: No, this is good.
[01:22:53] Speaker B: A lot of banks are going to have you negotiate a pre distribution and a post distribution cash flow covenant regardless of the measurement you want to use. Whether it's a global or a fixed charge approach.
That's important, knowing what your needs are.
If some bank says we want a 1, 2, 5 pre distribution coverage covenant and then we want a 1.1 to 1 post distribution, that's, you know, you're leaving money in the company for sure then to hit that one one or are they allowing depending on what your plans are. Are you harvesting the company in some company, but the cash flow in some way for some activity or need then any sort of post distribution covenant measurement is probably going to be tripped depending on what your, what your goals are. So just, and this sounds stupid like.
[01:23:44] Speaker A: Pre and post versus what? Sorry, I, I might, I don't know.
[01:23:46] Speaker B: If I'm pre and post distribution.
So if you're measuring cash flow before any distributions.
[01:23:54] Speaker A: Okay.
No pre and post distribution metrics. Got it. Okay. I'm checking.
[01:24:00] Speaker B: Yes. Okay. Yep. So pre and post distribution metric, that's going to matter a lot depending on everything you're talking about. That post number is what business owners care about. And so you're, you're, you know, you're talking with a banker and looking at a term sheet and talking about numbers. Again, you know, it's not all about rate and not that everybody needs to hear this, but I think it's worth pointing out that those things can be negotiated. So there's typically that cash flow component and then there's going to be a leverage component. And this is another area where growth and planning matters. Do you know what kind of leverage you're going to have to hit to get to your five year or three year wherever it is? And is your, does your bank have an appetite for that. That's where some of that earlier conversation ties in. Now liquidity position, hold position. How much is your bank willing to hold in credit? You know, is this a $20 million deal and have you asked your banker how much in credit are you willing to hold at your bank?
You know, explain that.
Yeah, if this is a 20. So let's go to a bank size. Let's say it's a 5 billion dollar regional bank and they have a legal lending limit of $100 million. Just using some round numbers here, they can legally lend up to 100 million. Sure. But that's not, that's not what they're willing to hold per relationship.
You know, there's a good chance that that bank is really only going to want to hold 20 to 30 million dollars in total credit exposure per relationship.
And I mean there are options, don't get me wrong. I mean, but there just should be planning around it. Let's say you're coming into that bank and you're borrowing 20 million out of the gate. Well, what happens when you get your 25, 30 in then? Are you going to find another bank? Are they sophisticated enough to put together a club or syndication deal where you're adding some bench strength? You're still dealing with one bank, but you have a bench of banks behind. And the reason that really matters is when we're talking about acquisition growth, maybe you think as a business owner, oh I'm only going to need a $20 million revolver, I don't need debt beyond that. I'm not looking to buy any buildings or anything, any big capital needs.
But all of a sudden opportunity strikes and you could buy a company for a, it's a fifteen million dollar acquisition. You're going to need to finance a chunk of that. Your bank is pretty much tapped out and you need to make a quick decision.
That's not the time to be out shopping for banks.
[01:26:29] Speaker A: You covered it. And I think like the, the syndication I think is a really cool thing for people that it's, it's just you're subcontracting out to other banks. Like you're saying like we're at the point we're going to go grab another 20 million from someone else. But we're still project managing the whole thing.
And like, so as someone's going through and they're looking at their growth plan, how do you think about like how much leverage a company is willing to take on? And like what are like the red meters, like where they start to like how are you looking at the Leverage of a company. And how does that then impact the term?
The term and the structure and like the type of debt that they're taking on?
[01:27:10] Speaker B: Yeah, that one I could go a few different directions. So it's tough. I'm trying to figure out a good way to answer that from a high level. I mean a lot of banks will look at a general leverage debt to tangible net worth calculation is, is a common one and they don't want to seeming more than a three, three and a half. You know, there's, there's certain metrics in there that are common. Ish. But again to your point, what is the leverage?
What is the purpose of leverage? You know, are we talking equipment heavy company where you're a manufacturing firm and you have, you know, a five million dollar machine that's brand new on the floor and you know that that's solid collateral and sure the leverage might be high but that that thing's it's bolted to the concrete. It's not going anywhere. And that's, that's safe collateral quote unquote for a bank to look at in a lot of ways because it's a new machine. It's going to keep its value and things those, those impact to some of that.
[01:28:05] Speaker A: But one, that's why I see like yeah, I think you're getting to one of the points I was going to ask you about is the type of company in industry matters so much when you're looking at that leverage ratio because it has to do with collateral. Right. I mean it's how much do you have that's real that we could technically take in the situation that this goes under. And so equipment and then as any of those equipment financing or buildings or the receivables. Right. And anything that's a real asset. And this is where it's very interesting Luke. And I don't know how that as that conversation of that leverage as the assets go from tangible assets to future cash flow. Because the banking system since 1971 turned from cash flow lending to collateral lending. Yet there are still banks and people that like we're trying to grow and we've got cash flow here. But how do you like how does that change as you're looking at the mix of the balance sheet and the company growth?
[01:29:10] Speaker B: Well, I'd say what's most important is you touched on it really is when is that going to convert to cash? And do you know that really and planning for that that's what's truly most important.
I, I've had and I think that's where if I could look back into conversations that have gone the best, I'm sitting down and I'm handed a balance sheet and you know, I wouldn't say it's, it's always including a cash flow statement, but handed some financial statements in the meeting and said let's point to this, let's point to that and talk about it right out of the. I mean that some of the best and most productive meetings, if you're trying to figure out how to plan for a productive meeting with the bank, make best use of your time. I mean sure, let's make best use of the bankers time too, but let's be honest, it's the business owner's time that matters the most there. And I'm saying that as a banker coming with financials and knowing what you're asking about and why it matters when those assets are turning to cash and why you might be levered up beyond what a bank is maybe comfortable with today, but you can point to when that point is going to turn, when the cash flow is coming in. Then that's telling. You're giving the business owner the power of being their own advocate there and saying here's my story, but here's how it relates and translates to financials and numbers.
My story is now in numbers. I'm not just telling you words. Here's where that turning point is and then they can make decisions based on that. I'd say some of the best deals that most fun deals I've worked on are ones where somebody came to me with a problem.
One is a really seasonal company where they pre sell everything by March.
March they've got everything sold and it's contracts, no buyback, provisions and solid contracts, all pre sold. But then they have to order everything and they're not going to get paid for six to nine months.
So all of a sudden they have just a warehouse of inventory.
And most banks look at it as like okay, sure you're pre sold but these are these, we're not counting this as receivables yet because you're not getting paid on these until you know, September.
And you got to build all this stuff before you're shipping it all out within, you know, two weeks. And so we had to do a 90 advance rate or almost 100 advance rate on inventory and raw materials because that's what you know, they bought it all, they had it all in their warehouse. They were assembling and constructing everything there on site and then they sold. Then their line of credit would rest.
You Know, through their peak season, they sold down to, like, half a pallet of goods. I mean, they were. They were tight. They knew their business well. And when they sold it, they didn't manufacture anything more than they sold. Move on to the next year, hit reset. But most banks look at that and say, hell, no, I'm not gonna advance 90% of your inventory, much less raw materials. And.
[01:32:07] Speaker A: But it's the story that makes sense. And you got the data and it's the story.
[01:32:10] Speaker B: Yeah. They can point out exactly when that turned into revenue. Yeah, yeah.
[01:32:14] Speaker A: And. And I know we're probably getting to the tail end here. I'm having so much fun, and I, like, I've already got a couple ideas of having you back on. On how to prepare for, like, what does a banking meeting look like? And maybe we go over my financial model. We'll get you in on the group calls with my clients, too. Luke, I feel like this is kind of like the climax. You're like the personal guarantees.
So, like, I think all of this.
[01:32:40] Speaker B: We had an hour and 20 minutes.
[01:32:42] Speaker A: 30 minutes of context to get to the. Okay, so if we have all the story, we have all the information, we can see when the debt turns to cash and whether it's.
Maybe there's probably, like, the personal guarantees. And then maybe one other question I got on, like, the structures, but let's do the personal guarantees first. And then I'm curious about, like, how the conventional loans and the structure, because you have, like, some cool things about the cash sweep and stuff like that, but personal guarantees, like, how.
How do people get out of those? And when can a company bank itself where the owner is not sitting on the hook?
[01:33:18] Speaker B: Well, I'll try to get to the point as much as I can on that, because you're going to get a lot of different answers. But the shortest answer is, how do you get out of it to negotiate it? I once looked at a company that was recently acquired. We're looking at 13 times leverage.
And they went to a big bank that I won't name and said, we want this, and it means no recourse. And the leverage was dialing back quickly. There was a story there.
It was one of those on paper, I'm looking at like, you want what?
And I was at a competitive bank, and we were, you know, $5 billion, $6 billion in assets growing quickly. So I.
I had. There was a good company. So I kind of had the leeway to push for some things, and I offered a 25 recourse deal. And with a Burn off. I caught again, we can get into some of this but essentially I was saying, okay, hit these target metrics and you'll be into a non recourse note. I get a little skin in the game for year one.
Your recourse is 25% of the debt.
Thought that was a great deal and the big bank came out and said we want to buy this deal and they offered them no recourse right out of the gate. And it's the last bank in the world I thought would do that but they got it because they negotiated for it. So I won't say There's.
You hit 2 to 1 from collateral coverage.
If your collaterals to a certain point that you feel that your coverage is 200% you're going to ask for no recourse. Sure, there's some metrics you can point to and I could say you need to hit this metric and that metric to go and get that in the market. But I'm always surprised and it comes down to what's most important to you.
Is that recourse worth it enough for you to want to go and negotiate hard at a, you know, with banks and say I want out of this. And sometimes it's you know, just the size of the company or banks just aren't willing to let go of that piece until you're at a certain size. Sometimes it's history with the bank for.
[01:35:23] Speaker A: A long time or.
[01:35:25] Speaker B: Yeah, oh yeah. I just actually I just had a deal recently that I'll tell a quick, vague story because I can't give details but it was a deal that I felt was strong but didn't have a personal guarantee because the owner hasn't guaranteed debt in a few years.
And he didn't, you know, he's not looking to provide it now so it's hard to argue and he's not providing that at the current bank. I want the business. This is how.
And you know, my team didn't feel we were there yet and it's hard because I think if we had known them for a year or two it would have been a no brainer. But we weren't there and it was hard to make that leap. So it all comes down to negotiating what's most important. I think we could have improved on a lot of other things but we don't want to let go of that 100 on day one. Yeah, it kind of came down to meet in the middle and, and this. And that's another thing I'll point to is it doesn't have to be recourse, non recourse. If you talk, you know, talk to some attorneys about this, on what recourse means and what it means to have debt at a bank and not have recourse. And are you really, Are you. Is that really that valuable to you? Are you still in the clear? I mean, that business is everything to you? Is that really.
[01:36:37] Speaker A: What's the reality versus perception?
[01:36:40] Speaker B: I would say as a banker, it's one of the most difficult questions to get out of the gate because I just ask why? Why is that most important to you? If it is, I, you know, let's talk about it. And there's probably a reason where sometimes, yeah, yeah, you're fine. We don't.
[01:36:57] Speaker A: It's so interesting to me, Luke. It's like, But I just, you know, it's like the whole ism of like, once you see it, you can't unsee it. Like, when I think about business, all I picture is the three statement model and the forecast. And that's the only way that I want to make decisions. Because how the f do we know what we're doing if we don't know when we're going to turn our ideas and efforts into cash flow? And like, and I hear people go, I don't know if I want to take on debt. And I'm like, well, first of all, it's a terrible use of your equity, says every, every private equity firm on the planet and the entire fiat system.
So, like, it's actually a terrible use. But like, whether it's someone that says, I don't want to take on debt, I don't want my personal guarantees, or they're trying. And I, I do feel for you and your industry too, where it's like you're getting pushed back. Where it's like the person that's asking for the favor has no leg to stand on because they can't see the same shit. And like, what it's really. And it's the same way when we go sell a company, which is the moment that one of my people that I've worked with get to the point where they have all the shit that I'm talking about. There's no desire to sell it because you're like, I'm printing money.
So it's like, it's like, it's like I keep saying there is no easy button. The moment you get a sellable business is the moment you can go to a banker and get whatever the hell you want is the moment that you actually want to take on debt.
Is the moment that you get highest return on your equity. So it's all self reinforcing the same way. So to your point about personal guarantees, yeah, you can go negotiate them out but let's say we have a bunch of personal guarantees. Well, if I have a clear visibility of how all this debt is easily covered and paid, I don't have any concerns for myself, let alone the bank.
It all self reinforces up or it all self reinforces down is kind of what I've gathered.
[01:38:52] Speaker B: I agree. And I think it's something that if you feel is important, something you want to focus on.
My only my takeaway, I guess on it is this ties back to earlier statements on challenging your bank, asking your bank, getting to know your bank beyond the people. The people do matter. Yes, but you need to know that the people have the firepower behind them. They have that dollar to sell. They have the appetite to do your deal not today, but tomorrow when you really need them.
And if you want that guarantee gone, then challenge your bank. Say I believe in my business and I believe we're going to hit these numbers going to come back down to the cash flow, the three statement model, the projections that look at where I'm going to be next year. If I hit this number I want my guarantee down to 50% and the next year if I had this number, I want out of it completely.
I have a deal that I'm working on right now that will close in a couple years that I'm proposing a conditional guarantee where sometimes we can structure a guarantee where you're coming into the bank and you're guaranteeing your debt for the first year. But if you hit your metrics it'll die off and if there's defaults in any way it could dial back up.
But it makes you put your money where your mouth is and just wanting to point. My point is there are options beyond just a PG and a not pg. And I'm not talking, you know like a Laser Pro document, unlimited personal guarantee. That the language, if you read that thing, it sounds abrasive. It sounds like they own your ass. You know that's. Yep, that's what it looks like. The bank owns, you know, everything you could think of in that document. That's why a lot of, you know, commercial businesses are going to pay the extra for legal, legally prepared doc. They have a say in some of that a little bit more and it's not as abrasive. But then Laser Pro is free. So I get, I, you know what's.
[01:40:44] Speaker A: Important, knowing what you know, what you want. Negotiating with the bank, realizing the bank is a, the bank is a business, they need to make money, they're looking at risk. Everybody's looking at where's the future Cash on the last. Just random question because it's more for my, my interest is like.
So as we look at these middle market companies, call it like five to $10 million enterprise value.
[01:41:05] Speaker B: Luke.
[01:41:06] Speaker A: Internal buyouts are what a lot of people are wanting to be able to do. The SBA loan is a son of a. To work with sometimes, you know, from the internal person that doesn't have enough money to then like all the restrictions just. But what's very appeasing appealing about the SB loan is the 10 year structure.
And so like because you, you start getting to conventional at five years, it suffocates the cash flow. And like what I'm, what I am just personally seeing Luke, is that the million to $2 million normalized EBITDA companies which are the backbone of America have very little help from really good advisors because you have a normalized ebitda business of 2 million bucks. But like there's like 400 grand in cash or 500 grand in cash every year. And so like there's this big issue of the finance ability or if that's a word of the of so like 5 years versus 7 versus 10. So any, any thoughts about just that dynamic?
[01:42:04] Speaker B: It's a tough one. You're not, you're not wrong. A lot of banks struggle with that, that size.
It's difficult from a cash flow perspective. The model around conventional bank financing, some of the leveraged, leveraged lending metrics that banks have, even if it does cash flow very well, it's, it's stable and consistent and fits within those. Then oftentimes you run into a collateral issue, you know, if there's not enough receivables and you know, assets for the bank to back into, you know, a lot of the sponsor finance groups and that'll do leverage lending for PEs, you know, they're willing to dial it back to maybe 25%, 50% collateral coverage because you have, you know, a P is the buyer and there's just a lot of backing power. There's.
So that comes down to buyer strength, reliance, what, what is there on the bottom.
[01:42:57] Speaker A: You gotta have the money in order to get the money, which is just a tough dynamic.
[01:43:02] Speaker B: That's where the sba, that's why, why it exists in some ways. And I, I understand but that being said, there are some banks, you know, I'm just gonna tie a cell together with this answer and say the reason it matters the most. If you're really going to fight for it, it's going to start with quality financial statements and bringing those with the right answers to the right bank. Because there are always banks looking to grow and having that appetite if you know where to find them. Working in the banking system is hard enough and understanding and being able to move with what I call the almighty credit pendulum, it's always moving and I have to live with that every day at any bank I'm at. So if it's hard for me, it's got to be damn hard for a business owner to navigate all that. But hopefully some of the things that I pointed to today, looking at banks, liquidity position, asking the right questions about their diversification of their balance sheet and lending portfolio, looking up their UBPR report and comparing that side by side with a couple other banks you're looking at and you know, asking for help from the right people. You're going to find that bank that's hungry enough to do the deal that you know you want done. And maybe it's done creatively.
Maybe there's, you know, yeah, unique structure with equity rollover and cash sweeps and.
But if the deal's done, the deal's done and that's the bank that was able to stand up and do it for you. And that's only going to happen by asking the right question. So I think that does kind of tie in a lot of what we talked about today.
[01:44:37] Speaker A: I love it, Luke, because like I, I, I think it, you're an eyes the mission. It's like I am completely a believer if the person puts a plan together, puts it on paper and then a spreadsheet communicates it open and transparently. Like everyone mobilizes together to get the shit done.
Like all the adversarial relationships kind of dissipate and it's like we're all just trying to like you're going to your credit department, they're going to this and see everybody's working on, I mean like I've got multiple of these internal buyouts where they got valuation expectations that are aligned. Everybody's got the financials and everybody, like banker, buyer, internal person, everybody's on the same page. Like we're trying to just get a deal done based on how the world works. That's it.
[01:45:22] Speaker B: We're a business. Banks of business, in the end, they want to make money, they want to do deals. It's just a matter of Finding the way to communicate.
I understand the frustration. That's why it was a great opportunity to be here today and do this with you and kind of peel back that iron curtain a little bit and hopefully help some people understand what's happening behind the scenes.
[01:45:41] Speaker A: What gets you. Why do you love doing this instead of playing in a rock band?
[01:45:48] Speaker B: Well, you know, as. As cheesy as it may be, I. I do feel like I'm. I'm able to create a. Just a different perspective and those business owners that I'm working with and I'm able to find a solution that maybe they struggle to get elsewhere or sort of understand why, you know, a bank can be a partner. I just, I think that's a lot of fun and helping, you know, be a business, see business owner succeed when if I couldn't get there and be one myself, I get to at least every day see somebody do something new and help them get there and tell that story. It's pretty cool. And, and like, like I said on the technology and automation side, I just, I want to be first. I want to be first to know about something, how to do it, and bring it to a business owner and say, hey, this is really, really cool. Did you know about this? And I'm not just, you know, I don't want to be that, you know, salesperson that's selling a. An app. I'm. I legitimately want to find a way to make efficiencies, and I think that part's a lot of fun.
[01:46:50] Speaker A: That's awesome, dude. I appreciate your time. I appreciate you. It's been a lot of fun over the last decade. I will put your LinkedIn, LinkedIn in the show notes and hopefully people reach out, man.
[01:47:01] Speaker B: Cool. Appreciate it. It was a lot of fun.
[01:47:03] Speaker A: Merry Christmas, brother.
[01:47:03] Speaker B: Thanks so much. Merry Christmas.
