For many companies, the primary source of funds for working capital is a credit arrangement with one or more commercial lenders. When the company is small, it will deal with a single lender, typically a local bank, and the documentation associated with the loan will be relatively straightforward. For example, the president and/or chief financial officer will discuss the terms of the loan with one of the bank’s loan officers, and the parties will reach agreement on a short summary of terms of the proposed loan before entering into a formal loan agreement accompanied by a promissory note and security agreement. The documentation will be based largely on the bank’s standard forms with few, if any, changes; and the closing of the transaction normally occurs fairly quickly. As the company grows, however, its capital requirements may expand significantly and exceed the amount that any single bank is willing to lend on its own to a single borrower. At that point, the company will be faced with seeking a loan from a syndicate of banks who combine their financial resources to extend the necessary credit to the company. It should come as no surprise that the syndication process may be lengthy and that the documentation involved increases significantly.
The first step in the process is locating and interviewing prospect candidates to serve as the "lead bank," which is the bank that will be responsible for making sure the loan syndicate is formed and that will be most involved on a day-to-day basis with the company once the loan has been funded. If the company already has an existing banking relationship, it may be appropriate for that bank to serve as the lead bank assuming that the company is satisfied with the service that it is receiving and the bank is able and willing to complete the syndication process. This type of arrangement may be necessary when the capital requirements of the company outgrow the credit limits that the bank is willing to offer to a single customer. In some cases, the company may seek a different bank to lead the syndication if it believes that other banks are better positioned to meet the needs of the company in the future. For example, a change may be warranted if other banks offer more sophisticated technology or the ability to make and service loans in foreign countries in which the company intends to expand its business. If a change in lead bank is made, the existing bank may nonetheless continue to work with the company as a member of the syndicate, although its role will be much more passive.
Even if the company intends to stay with its existing bank, it should generally take the time to interview at least three or four candidates to get some idea of the prevailing economic terms in the marketplace and have an opportunity to get to know the personnel who would be responsible for the relationship with the company. In most cases, the company can use this period to negotiate specific terms of the loan, such as the interest rate structure and the covenants, and may want to elicit proposals from several banks that can be used to improve the terms offered by the preferred bank. At the end of the process, a bank will be selected; and the focus of attention then turns to the syndication process. At that point, the bank will bring in a team from its syndication department that specializes in carrying out the various tasks associated with putting together a bank group, and the company will find itself doing many of the things that might be expected of a company looking to sell securities to the public or to sophisticated private investors. It is a time-consuming process that requires the attention of the company’s finance and legal groups and participation from other members of the senior management team who will be called on to explain their roles and the outlook for the company’s business to prospective members of the loan syndicate. In my next post I’ll discuss drafting the engagement letter with the lead bank.
The content in this post has been adapted from material that appeared in Business Counsel Update (October 2006) and is presented with permission of Thomson/West. Copyright 2008 Thomson/West. For more information or to order call 1-800-762-5272.