How to Deliver Bad News to Your Banker

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Banking relationships, like personal ones, take time to develop. Neither are built on one-time interactions, they both require work, and they're both based on trust. If difficulties arise and things don't go as you plan, a strong relationship will get you through it. A poor relationship can easily seal your fate.

For example, don’t expect any sympathy from your banker if you under-report your cash income. The only thing that will make bankers unhappier is if you have a second, better-looking version of your tax return. The IRS and the bank will discover your scheme. Your lawyers have to keep anything you tell them confidential, but your banker doesn't.

But even if you're honest, sooner or later your plans may not go as expected. What then?

Start by being honest and open. A phone call is probably sufficient if the problem is relatively minor and temporary, but a face-to-face, honest discussion is best if you have bad news. If you’re delivering poor year-end numbers or worse news, don’t underestimate the value of a meeting. How you deliver the news is almost as important as the news itself.

Prepare an analysis to explain the problem and its impact on your past performance and future outlook. Your presentation should:

• Show that you understand the problem and are taking it seriously
   
• Describe the steps you've already taken to correct the problem (e.g. layoffs, pay cuts, expense cuts, tighter policies, trade concessions, etc.)
   
• Explain the steps you’re prepared to take in the future if the situation doesn't improve and what events will trigger those plans
   
• Remind the bank why you continue to be a good credit risk
   
• Demonstrate any recent improvements (interim performance; evidence of backlog)

Lenders have to tread carefully when a borrower has a problem. If they overreact by calling the loan or refusing to allow you room to maneuver, or if they’re too intimately involved in your management decisions, they could be seen by courts as investors, not lenders. A lender-liability suit can ruin a banker's day, so expect banks to handle the situation very formally and by the book. You should follow their lead and be sure everything is in writing and properly documented.

If you get to this point, you’re probably teetering on the edge of voluntary or involuntary liquidation, so be sure you have an attorney who’s been down this road before.

When banks are really spooked, they’ll invite their "loan work-out group" to the party. And make no mistake, their job is to get a bank’s money back any way they can. They probably won’t be introduced as such, but if your lender tells you a new loan officer will be taking over your account, there’s a good chance it’s a get-out, er, work-out specialist.

Assume the worst. The bank may demand full payment of your loan within thirty days, or it may take immediate steps to liquidate your collateral.

If it does reach this point, there’s not much you can do to make the lender change its mind. The best you can do is to buy time.

For example, if you have to find another lender, you'll need interim financial statements first. These will obviously take some time to prepare. It would be reasonable, if this is the case, to counter their thirty days with a request for ninety days. Give them good reasons for the extension and convince them that their risk will be no greater as a result of the delay.

In the meantime, keep the lender informed of your progress, both in terms of replacement financing and your business.

And don’t ever, ever, let them hear bad news from anyone other than you. If they do, the trust will be gone, and the gloves will be off.