7A Loan Program information

Section 7(a) of the Small Business Act, authorizing the SBA to provide loans to domestic small businesses.

• The SBA does not make loans, but instead guarantees a portion of loans made and administered by commercial lending institutions.
• For example, you can apply for an SBA loan at bank; you would fill out the bank's loan application, the bank would make the loan and manage the loan. The SBA will be partially on the hook for the loan, so will you. If your parents ever co-signed a car or mortgage for you, this is kind of like that except the government helps co-sign in this case.
• This is the SBA's primary program to help start-up and existing small businesses obtain financing for those businesses that might not otherwise be credit worthy through the traditional small business loan process.
• SBA loans generally have a higher interest rate than a traditional loan because the companies that need them are generally riskier than larger, existing Borrowers. However, SBA loans are typically much cheaper than using a credit card, etc.
• 7(a) loans can be guaranteed for many loan types including working capital lines of credit, machinery & equipment, FF&E, land & building, leasehold improvement, and debt refinancing.
• Loan maturity is generally up to 10 years for working capital loans (lines of credit) and generally up to 25 years for fixed assets (term loans).
• The SBA does not fully guarantee the loans, the lender and SBA share risk that the borrower will not be able to repay the loan in full.

Acceleration

Legal definition: Following an Event of Default in the credit agreement, a Lender has declared that the loans are immediately due and payable. Bankruptcy and insolvency Events of Default automatically lead to Acceleration

Practical definition: Your remaining loan balance is due now.

Why it matters: The bank wants all of its money back now and will pursue legal recourse if you don't find a way to repay them quickly.

Accounts Receivable Aging Report

The detailed list of all trade receivables owed to the company, primarily including:

1. amount owed in aggregate,
2. amounts 30,60,90, and >90 days past due,
3. customer name, and often times
4. customer contact information including address and phone number.

Banks use this for many reasons, but primarily to

1. understand how much of a Company's A/R is current,
2. determine if there are any customer concentrations, and
3. have a list of people to call and money to chase if the company goes defunct.

Accounts Payable Turnover Days or "A/P Days"

Calculation: (Accounts Payable/COGS)*365

Practical definition: The average number of days it takes you to pay an invoice after you purchase inventory.

Why it matters: If you are paying your payables slower than 30 days, or generally past due, this is an indication of potential cash flow issues. Lenders generally prefer to see A/P days roughly equal to A/R days to ensure cash is being generated from operations versus being generated from slow-paying vendors.

Accounts Receivable Turnover Days or "A/R Days"

Calculation: (Accounts Receivable/Sales)*365

Practical definition: The average number of days each customer takes to pay an invoice after the sale is made.

Why it matters: Similar to A/P Days, A/R Days is a reflection of how well the company manages its working capital, and is also a barometer of the health of your customers. If you're paying your payables late, it's probably due to cash flow problems. Similarly, if your customers are paying you late, they are probably having cash flow problems.

Accounts Receivable (A/R)

Accounting definition: An amount due from a customer, typically sent via invoice from a supplier, that will be repaid by the customer with cash within 90 days in exchange for a supplier providing various products and/or services.

Practical definition: The cash you are owed from your customers for the services rendered and/or products they purchased from you.

Why it matters: A/R is one of the most important pieces of collateral to Lenders because it's very close to cash in the sales cycle (Inventory eventually turns into a sale, which eventually turns into A/R, which eventually turns into cash). As a result, A/R receives the highest Advance Rate versus any other piece of collateral (except for Liquid Collateral). Thus, Lenders will spend the most amount of time diligencing the Company's A/R.

Advance Rate

Definition: the amount of credit a bank will give you for each dollar of collateral. For example, if a bank has an Advance Rate of 85% against A/R and if you have $1.0MM of A/R, than the bank will give you up to $850k of debt.

Why it matters: Advance Rates are the key components in an Asset Based Loan, in which case a Lender agrees to grant you as much debt as the advance rates provide, up to a loan limit. For example, if the bank gives you a $1.0MM Asset Based Loan with advance rates of 85% against A/R and 50% against inventory, and if you have $1MM of A/R and $200k of inventory, than the Lender will give you up to $950k of debt. You can never go over the $1MM loan limit, but you might get less than the limit due to advance rates and collateral amounts that might add up to less than $1.0MM.

Affiliate

Legal definition: A subsidiary, corporation, partnership, or other person controlling, controlled by or under common control with another entity.1

Practical definition: an entity that shares common ownership with the Borrower. For example, the individual that owns the Borrower might also own a small (or large) piece of another entity, which would be considered an Affiliate of the Borrower.

Why it matters: Lenders will typically require a corporate guarantee from all affiliates because they're potential recipients of the Borrower cash, which is the Lender's collateral. If you were the Lender, you'd care a lot less about the risk of a Borrower siphoning funds into another entity if you had the guarantee from that entity.

Amortization (for goodwill, not Loans)

Accounting definition: The allocation of a cost or charge to gradually reduce the book value of an intangible asset.

Practical definition: The amount by which the Borrower's intangibles decline in value each period (month, quarter, year, etc.)

Why it matters: Amortization is the "A" in the EBITDA calculation. Similar to Depreciation, Amortization is a "non-cash" expense meaning it reduces net income but it doesn't use company cash to do so, it's just an accounting thing. Above all, Lenders want to calculate how much cash a Borrower can generate to service its debt. As a result, it will add Amortization and other non-cash expenses to that pool of cash, commonly referred to as "EBITDA."

Amortization (for a loan, not for goodwill)

Accounting Definition: The scheduled payments, generally monthly or quarterly, that are required to repay a loan.

Practical definition: the monthly/quarterly payment for a term loan, similar to a mortgage payment on a house. Amortization on commercial term loans differs from mortgage-style amortization in that commercial loan amortization generally has fixed (level) principal payments; mortgage-style loans, however, pay more interest upfront relative to the total payment.

Why it matters: The Amortization schedule illustrates the amount of principal you have to pay each year. The annual Amortization also represents the "Current Portion Long Term Debt" portion of the Fixed Charge Coverage Ratio; the lower your CPLTD, the higher the probability that your cash flows will be sufficient to service your debt & expense.

Asset Based Loan

Legal Definition: Unlike a cash flow loan, which provides the borrower with a line of credit in a fixed amount that can be borrowed at anytime, an Asset Based Loan limits the line of credit to the lesser of (i) a fixed amount and (ii) a percentage of the value of a certain set of assets (typically account receivable and inventory). This is often referred to as a Borrowing Base.

Practical definition: A revolving facility where the total amount that can be borrowed fluctuates based upon the value of the borrower's assets. A typical Borrowing Base formula might be to advance 80% against accounts receivable and 50% against inventory.

Why it matters: If you're given a $1MM Asset-Based line of credit but you only have $400k of eligible collateral per the Borrowing Base, than you'll only have $400k of availability. Asset Based Lending is a way for companies to meet their short term cash needs by borrowing against their shot term assets at favorable rates. Asset Based loans are particularly popular among retailers and other businesses with large amount of accounts receivable and inventory. 1

Backlog Report

Definition: A backlog report means different things for different industries, but generally represents a report illustrating the amount of revenue that the company expects to receive from contracts/customers over the next several months. The revenue can sometimes represent contractual revenue from customers, but can also represent verbal non-binding commitments from customers (after trade shows, etc.).

Why it matters: A company's historical ability to accurately project revenue and profitability for products/contracts, is a strong indicator whether or not it can deliver expected results in the future. A bank will want to see this to gain visibility into a company's revenue and to help substantiate the company's projections. Some banks will want to see a detailed backlog report that illustrates how much a company's backlog projected for the year with respect to revenue and profitability, versus the actual amount of revenue and profitability that was generated by specific customers & contracts. This level of detail is most prevalent with contractors, who bid on projects and estimate profitability.

Basis Point (commonly referred to as a BP "bip" or BPS "bips")

Accounting/practical definition: One one-hundreth of a %. (e.g., 50 Basis Points equals 0.50%)

Why it matters: With respect to term sheets and legal documents, the Borrower's fees and interest rates are typically described by Lenders in the context of "bips" instead of dollars or percentages.

Blacklist (Bank Blacklist)

Definition: list of the banks that the Borrower does not want to work with.

Why it matters: we only want to match you with banks acceptable to you.

Borrowing Base

A formula used to govern the availability of an Asset Based Loan, typically a line of credit. A quick and dirty, rule-of-thumb borrowing base formula is to advance 80% against Eligible Accounts Receivables and 50% against Eligible Inventory. The sum of these numbers generally governs the limit for your line of credit.

Breakup Fee

Legal definition: in an M&A transaction, a fee the seller must pay to the original buyer if the seller ends up selling to a different buyer.

Practical definition: the financial penalty one party must pay to the other as a result of walking away from a deal.

Why it matters: Breakup Fees create incentive to follow through and close a pre-negotiated transaction. It's a penalty for walking away and costing the other side time/money/resources. The fee is partially based on time/$ recovery cost and partially based on creating sufficient financial incentive to get a deal closed. For example, a groom might not be as willing to run away at the altar if the bride's father made the groom sign a Breakup Fee agreement before a wedding!

Bridge Loan

Legal definition: short term loans that typically (but not always) provide a bidder with sufficient financing to acquire a business in case alternative financing cannot be consummated prior to closing the acquisition.

Practical definition: A short term (typically less than 12 month) loan given to the buyer to prove to the seller they have enough money to close the acquisition.

Why it matters: Financing an acquisition with debt can be a long, unpredictable process. In the case of an acquisition, the seller in particular wants certainty that the buyer will have enough cash at the finish line to pay the agreed upon price. If the financing takes longer than expected, some Lenders will provide a short term bridge loan to bridge the time gap between closing and when the alternative financing will be completed. Bridge loans are not exclusively for acquisition financing, but that is their most common use.

Capital Expenditures ("Capex")

Definition: Line item found on the Company's cash flow statement. Capex is generally broken into two categories:

• Maintenance Capex: The amount of cash the company must spend to keep the business running to maintain the current capacity of operations.
• Growth Capex: The amount of discretionary cash the company spends to grow the business and expand operations beyond the current capacity/necessity.

Capital Structure

Legal definition: a term referring to the overall structure of the company's debt & equity. A company's capital structure is generally divided into several distinct buckets, such as senior debt, senior subordinated debt, preferred stock, and common equity.

Practical definition: a snapshot of the debt & equity portion of the company's balance sheet.

Why it matters: The capital structure spells out the order of who would first receive proceeds from the sale/liquidation of the company. For example, if the company sold all of its assets than it would generally have to pay the senior debt lenders before it pays the equity holders because the senior debt lenders are "higher on the capital structure". A company's balance sheet generally lists the items that are closest to cash at the top, and those that are the furthest away from cash at the bottom; hence, senior lenders would be repaid before common stock holders.

Cash Flow Statement

Accounting definition: The financial statement that illustrates what caused the change in the company's cash balance between periods.

Practical definition: shows how cash is being generated and where it's being spent.

Why it matters: If you're seeking a cash flow loan, the lender will review this statement carefully to ensure the company is generating enough cash from operations to repay the loan. Taking a step back, each Lender views the company as a pool of cash, and uses covenants and other mechanisms to plug the holes of outgoing cash flow and keep as much cash as possible available to repay the bank debt. In addition to the Net Cash From Operations amount, lenders will also be concerned with Capital Expenditures ("Capex") on the cash flow statement .

Closing Fee (Success Fee)

Definition: a fee payable by the Borrower to the Lender when the deal closes, expressed as a percentage of the principal amount of such Lender's loan and is payable from the proceeds of such loan as and when funded on the Closing Date.

Why it matters: when considering which Lender to choose, it is critical for the Borrower to consider the closing fee (in addition to other key terms such as interest rate, covenants, etc.). This is somewhat similar to the percentage points you might have to pay on a home mortgage.

Cost of Goods Sold ("COGS")

Definition: the $ cost a business has to pay for the products it sells to customers. This is generally separate from the salaries and administrative expenses required to run the business (SG&A). A good rule of thumb in deciding between classifying an expenses as a COG or as SG&A is that an expense is typically included in COGS if it increase or decrease as the number of products made by the business changes. SG&A expenses generally shouldn't change based upon an incremental change in the number of products made.

Why it matters: COGS is a key component of the gross profit margin ratio and the working capital turnover ratios�if the amount of COGS is relatively close to the amount of Revenue, the gross profit margin will be tight, which means there's not a lot of room for the company to absorb additional/unexpected costs. This is particularly important in commodity-like businesses where a price war between competitors could take the high cost company out of business.

Collateral

Legal definition: assets of a Borrower and any Guarantors that secure the Borrowers and guarantors obligation under the applicable credit documents in a secured debt financing.

Practical definition: The assets of both the company and the guarantors that could be liquidated by the lender to repay a loan.

Why it matters: All lenders want collateral - comfort there's a secondary source of repayment, if the cash flow alone becomes insufficient to repay the debt. Collateral can come in many forms, but typically refers to the non-cash assets of the business. The collateral for each loan generally includes the assets that are purchased with the loan's proceeds. For example, accounts receivable and inventory generally represents the collateral for a working capital loan. Real estate and equipment generally represent the collateral for terms loans. And so on. Some collateral has much stronger value than others in the eyes of the bank. For example, real estate in a normal economy is viewed as relatively safe collateral because it's a tangible asset that generally appreciates over time. Jewelry, however, is not viewed as favorable collateral due to the ease with which it could disappear after a borrower defaults on a loan. Accounts receivable is another strong source of collateral because it represents contractual, recurring sources of cash. Some lenders like A/R due from the government because the government isn't going out of business any time soon (we hope). On the other hand, many lenders avoid governmental A/R because, it's a bureaucratic process - more difficult for a bank to take ownership of this kind of A/R (collectability is impaired because some banks cannot perfect a lien on municipal A/R).

Current Assets

Calculation: Cash & Equivalents + Accounts Receivable + Inventory + All Other Current Assets

Practical definition: The things owned by a business that can generally be converted to cash in less than 12 months.

Why it matters: Current Assets are a key component of the company's liquidity calculation, which is critical for banks. The higher a company's Liquidity, the higher the company's ability to be able to pay its bills (including repaying bank debt).

Current Ratio

Calculation: Current Assets/Current Liabilities.

Practical definition: If a company has to be liquidated, this ratio represents the amount of proceeds immediately available for each dollar of short term liabilities owed by the company. In other words, for every dollar of short term debt the company owes, it might have $3 of current assets, which means there could be significant cash leftover to repay long term debt.

Why it matters: gives lenders a sense of how quickly your company's assets could be converted into cash after paying off your short term liabilities either through the normal course of operations or through a liquidation scenario. The leftover amount is what the lender deems to be available to repay the long term debt.

Deposit Account Control Agreement ("DACA")

Legal definition: The document used to obtain a first lien perfected security interest in a deposit or securities account. This DACA is between the Borrower, Lender, and whichever institution holds the Borrower's cash collateral.

Practical definition: An agreement between (i) the bank where your operating account is held and (ii) your lender. The DACA verifies the company's cash is part of the Lender's collateral pool.

Why it matters: A DACA gives the bank the right to sweep all the cash in your bank accounts if you default on the loan. This is similar to a landlord signing a landlord waiver agreement � yes the assets might be held under their roof, but it should be understood the senior lenders have the first right to that collateral because they have a first lien on ALL assets, including cash accounts (and inventory).

Debt-to-Net Worth

Calculation: [Total Bank Debt / Equity]

Practical definition: For each $1 of equity, there is $_ of debt that needs to be repaid.

Why it matters: Estimates the amount of cushion a company has in a downside scenario before the amount of liabilities exceeds the value of the company's assets. Lender generally consider a 4:1 Debt-to-Equity ratio to be high.

Debt-to-Tangible-Net Worth

Calculation: [Total Bank Debt / (Equity - intangible assets)]

Practical definition: Similar to Debt-to-Net Worth except the Company's intangible assets are excluded from calculation. Represents the amount of equity that is relatively tangible and can be reasonably expected to generate value in a liquidation scenario.

Why it matters: Companies with a significant amount of intangibles (loans to affiliates, goodwill, etc.) will have significantly lower Tangible Net Worth than it will Total Net Worth because the bank won't put much value in the intangible assets. For example, in a liquidation scenario, the bank won't count on the affiliated loans to be repaid and won't count on the good will and intellectual property to generate meaningful value (particularly if the company ever reached the liquidation scenario).

Depreciation

Accounting definition: An accounting charge to income to allow for the wearing out of the worth of certain assets, such as machinery, buildings & trucks.3

Practical definition: The amount by which the Borrower's fixed assets decline in value on the company books each period (month, quarter, year, etc.).

Why it matters: Depreciation is the "D" in the EBITDA calculation. Depreciation is a non-cash expense meaning it reduces net income but it doesn't use company cash to do so, it's just an accounting thing. Above all, Lenders want to calculate how much cash a Borrower can generate to service its debt. As a result, it will add Depreciation and other non-cash expenses to that pool of cash, commonly referred to as EBITDA.

DIP Loan

Legal Definition: Debtor in Possession Loan

Practical definition: New loan facility done during or shortly before a company files for bankruptcy to ensure the Company has adequate liquidity to cover all short term expenses and bankruptcy costs, which can be extraordinarily high.

Why it matters: Lenders are sometimes uncomfortable with DIP loans because they typically take 1st priority over all existing debt. This is commonly known as a "priming facility". The borrower tends to like these facilities because they provide additional liquidity for the company in order to (i) help pay extraordinary bankruptcy-related costs, and (ii) signal to customers and vendors that, despite bankruptcy, the company will still have sufficient liquidity. DIP loans tend to be well in excess of what is required in order to create optical benefits (window dressing). The nuance with these facilities is that they are generally less risky than the existing debt facilities because DIP loans generally have priority over all other debt claims, yet the interest rate is typically high because the company is still in bankruptcy, which scares a lot of lenders. DIP loans don't automatically receive priority status, it must be granted by a majority of the existing senior lenders. But if the lenders want to get any of their money back, they need the company to survive. In order for the company to survive bankruptcy, it will need a DIP loan.

Dividends

Accounting definition: A cash payment by a company to its shareholders.

Practical definition: Not only the one Monopoly card that really confused you as a kid, but also the amount of cash that business owners pull out of the Company that isn't captured on the Income Statement. Dividends are particularly relevant in S-Corporations, which typically distribute cash to owners in order to pay taxes.

Why it matters: Dividends are important to banks because they represent another drain on the company's pool of cash available to service debt. Dividends are expected for S-Corps, but lenders will generally try to prevent excessive distributions with creative covenants.

EBIT

Accounting definition: the acronym for "Earnings Before Interest and Taxes".

Practical definition: The income the company generates from ongoing operations.

Why it matters: Representing the cash available to service the Company's debt before adding back non-cash items such as Depreciation & Amortization. For companies that require a significant amount of capex, some Lenders believe EBIT is a better proxy than EBITDA for the cash available to service the Company's debt.

EBITDA

Calculation: Net Income + Interest Expense + Taxes + Depreciation + Amortization. Net income is synonymous with Earnings (the "E" in EBITDA).

Practical definition: The amount of cash the company generates from ordinary operations.

Why it matters: Represents the amount of cash available to service the company's debt. Although intuition would say net income or cash on hand is the best measure of how much cash is available to service debt, EBITDA is the best measure of how much cash the company will be able to service in a normalized environment. Cash on hand could be increased by simply not paying vendors for a while, but that's obviously not sustainable. Net income includes the impact of asset sales, interest income, and other miscellaneous non-operating items. If you're applying for a working capital line of credit or for an M&A-related loan, the lenders main focus will be EBITDA. As a litmus test, EBITDA should be reasonably close to the Operating Income line found on the income statement.

EBITDA Margin

Calculation: [EBITDA / Revenue]

Practical definition: The amount of EBITDA generated by each $1 of revenue

Why it matters: Reflects the profitability of the business; the higher the EBITDA margin, the more cushion the company has if costs rise or sales fall unexpectedly. The higher the EBITDA margin, the higher likelihood the company will be able to generate sufficient cash to service its debt.

EBITDAR

Calculation: [Net Income + Interest Expense + Taxes + Depreciation + Amortization + Rent Expense].

Why it matters: It's basically EBITDA plus rent expense. Some lenders care more about EBITDAR than EBITDA when looking at various transactions, primarily real estate, because sometimes the company is paying rent for a building it owns, thus the rent is 100% discretionary and can be added back to that pool of cash available to service debt.

Excess Cash Flow Sweep

Legal definition: a provision in the Credit Agreement that requires the Borrower to prepay loans in an amount equal to a specified percentage of the Borrower's Excess Cash Flow.

Practical definition: the % of your ECF that a Lender requires you to prepay each year.

Why it matters: If a Borrower generates tight cash flow a Lender may elect to reduce the scheduled Amortization in exchange for requiring an Excess Cash Flow Sweep. This is generally an attractive but less common alternative to high, fixed scheduled Amortization payments; if the company blows away the budget, the Lender gets some upside because it will get a % of the large ECF. And if the company underperforms it's less likely to incur a payment default.

Excess Cash Flow ("ECF")

Calculation: Typically calculated as [EBITDA - Capex - CPLTD - interest expense - cash taxes]. Definition may be tweaked for each borrower, typically as illustrated in the Excess Cash Flow Sweep exhibit in the back of a credit agreement (potentially found in the definitions section)

Practical Definition: The amount of cash available after the Borrower has made its operating and debt obligations ("fixed charges") and is available to service additional debt.

Why it matters: ECF represents the cushion between the company's cash flow and its obligations. ECF can be calculated by taking the numerator in the FCCR minus the denominator; ECF and FCCR essentially illustrate the same thing but in a different manner ($ vs. %). This is somewhat analogous to someone figuring out how much is available to make a "13th payment" on a mortgage, cash leftover to make an extra loan payment.

ELA

plura acronym for "Electronic Loan Application".

This is the application each Borrower must fill out to enable Lenders to make an informed decision.

ESOP (or ESOT)

Legal definition: Employee Stock Option Plan/Trust. A government-backed program under which a corporation may elect to set aside profits or shares of its stock for the benefit of employees. In the case of a qualified plan, the directors can declare such an allocation under a trust arrangement that is tax deductible to the corporation and on which taxes are deferred until an employee's share is distributed to him. Not only can employees be rewarded, but corporate management can buy shares of stock outstanding with untaxed income; in effect they can fund a pension plan with no cash outlay.

Practical definition: Facility set up to allow employees to buy ownership in the company in a tax efficient way.

Why it matters: an ESOP is an effective way for employees to increase their control in their company, typically financed by a lender; the primary risk is that ESOPs tend to hurt the equity of the business at close because the loan proceeds aren't really being used to grow the business, but the ESOP loan is being repaid through the company's cash flow, benefiting the Owners of the business more than business itself.

Fixed Charge Coverage Ratio

Calculation: [Net Cash Flow / (Current Portion Long Term Debt + Interest Expense + Cash Taxes + Dividends)]

Practical definition: The amount of cash the company has to service its debt after making the necessary expenditures to maintain the sustainability of the operations.

Why it matters: Reflects how many times over the company's cash generated from operations can service its debt. This is the single most important ratio for cash flow loans. This calculation is similar to the interest coverage ratio except it includes the impact of amortization, taxes, and dividends.

Floating Rate

Legal definition: an interest rate that periodically adjusts based on a market index rate, such as the Base Rate or LIBOR.

Practical definition: An interest rate that changes over time, as apposed to a fixed rate that stays the same over the life of the loan.

Why it matters: depending on what happens to the market index rates (e.g. Libor, Prime, etc.) over time, a Floating Rate might generate significantly more (or less) interest expense over time. For example, LIBOR is currently low relative to historical standards; it might appear to be attractive to get a Floating Rate based upon LIBOR. However, one must consider the probability of the Libor (and Prime) rates increasing back to normal levels. Lenders are generally adverse to providing fixed-rate commercial loans, so don't be surprised if a fixed rate option is unavailable.

Grid Based Pricing

Accounting definition: pricing based on a tiered grid whereby each change in the underlying metric results in an incremental change in pricing.

Practical definition: as a Borrower does better or worse, the pricing increases or decreases based upon a pre-arranged pricing schedule.

Why it matters: Adds a level of uncertainty to future pricing. Grid Based Pricing is "fair" because it ensures the interest rate appropriately matches the current risk profile of the business. This concept is more common in middle market deals than it is in smaller deals.

Gross Margin

Accounting definition: the % ratio of [Gross Profit / Sales]

Practical definition: How much gross profit is generated for each $1 of revenue.

Why it matters: There is perhaps no better indication of a company's ability to generate and sustain profitability than gross profit margin. The higher the gross profit margin, the more likely a company is to manage competitive pricing pressures, generate EBITDA, and of course repay debt. Company's with low gross profit margins have little room for error; if a bigger competitor were to suddenly drop prices, a low-margin business would be in trouble. High gross profit is also an indication of value relative to competitors. If your business can generate higher gross profit margin than competitors, you probably have a better product, better service, and/or better management. It's important to remember that Gross margin is a % ratio, while gross profit is a $ amount. A larger competitor will usually have more gross profit, but does it have a higher gross margin? Banks will almost always ask what's driving any historical change in your gross margin. A good reason would be a shift towards more profitable products. The worst answer is "I don't know". It is very important to understand what your gross margin is and why it's changing.

Gross Profit

Accounting definition: The difference between Revenue and the Cost of Goods Sold.

Practical definition: The amount of cash left over, after paying for the cost to make/buy the product, available to pay the selling, general, and other administrative expenses.

Why it matters: the higher the Gross Profit, the larger the cushion the company has to manage an unexpected spike in raw material costs.

Guarantor/Guarantee

Legal definition: subsidiaries or patent entities that Guarantee the debt incurred by the Borrower. A Guarantee is a promise by an entity that is not the direct obligor of the debt to be responsible for that debt.

Practical definition: A person or business entity that �s on the hook to repay all or a portion of the debt if the underlying company goes defunct. An analogy would be if your parents co-sign your first house, they'd acting as Guarantors and you're the Borrower. Individuals that guarantee a loan represent Personal Guarantors. Corporate entities would be Corporate Guarantors.

Why it matters: Giving a bank your guarantee creates more risk for you personally, but it will likely be required, and will likely reduce your rate. Lenders typically require guarantees from all related entities and each person that owns >10% (often times 25%) of the company. This is typically is to align everyone's interest in getting the loan repaid. Again, this is an important concept as Lenders will consistently require corporate and personal guarantees from each person and each entity that have a significant stake (typically >20%) in the business. A personal guarantee will probably result in a lower interest rate for the loan because it decreases the risk of the bank losing money on the loan.

Insolvency

Legal/Practical definition: When the company's cash flow becomes inadequate to pay its bills. Insolvency is a zone (subjective), not an exact number.

Why it Matters: This is the financial condition Borrowers have shortly before entering bankruptcy. Once a court deems a Borrower to be within the zone of insolvency, the Borrower's fiduciary duty begins to include repaying the Lenders as a priority because they're the defacto owners of the now-insolvent business. Obviously, getting close to being within the zone of the insolvency is not good.

Intangibles

Accounting definition: non-tangible assets, including goodwill, trademarks, patents & copyrights, customer lists, brands, formulas, franchise rights, and accumulated amortization.

Practical definition: the company's non-operating assets that you can't physically touch but add value to your firm.

Why it matters: Banks often have a "Tangible Net Worth" covenant that excludes Intangibles from the Company's Net Worth calculation. Company's might think they have significant equity by taking a glance at the Equity line on the balance sheet, but if there's a significant amount of Intangibles, it's likely there's a limited amount of Tangible Net Worth, which is what Lenders really care about.

Interest Coverage Ratio

Accounting definition: EBITDA/Interest Expense

Practical definition: how many times over your annual cash flow can pay the company's annual cash interest expense.

Why it matters: If for some reason your cash flow gets tight and you're unable to repay your scheduled amortization payments, the bank wants to that, at a minimum, you could always pay your interest expense. This is critically important for many banks that have to write off a loan as a loss if a borrower is >[90] days late on paying its interest expense. Banks generally like to see an interest coverage ratio of 2x which means there's $2 of cash flow for each $1 of interest expense.

Interest Expense

The annual amount of interest you pay the bank for the loans you borrow. For example, if you borrow $100,000 and have a 7% interest rate, your annual Interest Expense would be ~$7,000.

Internally Financed Capital Expenditures

Definition: The amount of Capital Expenditures that are purchased with Company cash, instead of financed with bank debt.

Why it matters: Some banks include Internally Financed Capital Expenditures into the FCCR calculation because it's a drain on the pool of cash available to service debt. Capex acquired with debt financing, however, is generally repaid over time with loan payments thus captured in the CPLTD portion of the FCCR.

Inventory Turnover Days

Accounting definition: [(Inventory / COGS)*365]

Practical definition: How many days, on average, a piece of inventory sit in your possession before it's sold to a customer.

Why it matters: Inventory Turn matters to lenders because it's an indication of potential product obsolescence. If you've historically been "turning" your inventory every 25 days and suddenly you're only turning it 60 days, there's likely a problem - either you've changed your product line, your customers went JIT, or your products are less desirable. In any case, any meaningful change in Inventory days will raise a question.

Letter of Credit ("LC" or "L/C")

Legal definition: Acts essentially as a Guarantee by a Lender that kicks in if the Borrower does not meet an obligation to a third party (the "beneficiary").

Practical definition: A money-backed promise from a third party that all your obligations to pay certain vendors/contracts will be met.

Why it matters: Acts as insurance, a reliable mechanism to provide everyone involved certainty that the payments will be made. LCs are granted not only to vendors that require assurance of invoice payment, but are also required by Lenders who want to be absolutely certain that you'll make good on your loan payments. An increasingly popular strategy for Lenders managing distressed loans (defaulting borrowers) is to require the borrower to issue an LC such that if Borrower does not meet [X] hurdle by [Y] date, than the LC must be drawn in X amount with the proceeds going to the Lender to prepay the loan.

Leverage (Equity based)

Accounting definition: [Total bank debt / Tangible Net Worth]

Practical definition: The number of times over you'll have to generate the current amount of equity to cover the current amount of debt.

Why it matters: If the Leverage is, say, 4x than that means the equity would have to grow 4x larger before it equals the amount of outstanding debt. This is also an indication of residual value in a liquidation scenario. A company is believed to be "highly levered" if there is more debt than equity on its balance sheet.

Leveraged Buyout ("LBO")

Legal definition: a transaction in which one firm uses debt to buy another company. The secured portion of the debt is secured exclusively by the stock and assets of the target company and any Guarantors.

Practical definition: Primarily using debt to buy a company (as opposed to equity or company cash).

Why it matters: LBO is among the riskiest loans for Lenders to make; the additional debt certainly increases the debt burden, but the cash flow from the acquired company is uncertain. As a result, pricing for LBO debt facilities will be higher than a traditional loan facility.

LIBOR Floor

Legal definition: a concept in a credit facility that prevents LIBOR, for purposes of the credit facility, from falling below a certain threshold-even if actual LIBOR does drop below that threshold.

Practical definition: the lowest possible rate that a Borrower will be charged for LIBOR.

Why it matters: if your interest rate is LIBOR + 200bps, if LIBOR is 50bps, and if your LIBOR floor is 300bps, than you will not be permitted to pay less than 5.0% interest (200bps spread + 300bps LIBOR floor). This is a common provision because of the way banks obtain the funds they use to lend to Borrowers; they cannot afford to loan out funds for a lesser rate than they pay.

LIBOR

Accounting definition: The London Interbank Offered Rate

Practical definition: The interest rate that banks charge eachother to borrow money in the London bank market.

Why it matters: LIBOR is one of the most popular interest index rates charged by Borrowers; it's highly likely your Lender will charge you "LIBOR" plus some TBD spread as your interest rate.

Line of Credit

Legal definition: a short term credit facility extended from a Lender to a Borrower primarily to be used for short term working capital purposes.

Practical definition: a credit card with a really big limit, but without the plastic card and hopefully with a better interest rate than a traditional credit card.

Why it matters: A Line of Credit, not to be confused with a Letter of Credit, typically provides Borrowers with the life blood to operate their business. A line of credit is generally favorable to a term loan because a Line of Credit doesn't have any scheduled amortization (principal) repayment requirements. However, a line of credit should be used for short term (less than 12 month) investments/expenses. Lines of credit generally finance the time gap between (i) the time the Borrower shells out cash for the raw materials used to make the finished product and, (ii) the time it takes to collect the cash from the sale of the finished product. If you try to buy a long term asset, like real estate, with your line of credit then your Lender will likely convert the line of credit to a term loan.

Liquid Collateral

Definition: Cash, stocks, bonds, and other liquid assets that secure a loan.

Why it matters: Banks will typically require "liquid collateral" from the owners of the Company when the assets of the Company alone are insufficient to repay the loan in a liquidation scenario. For example, a consulting company might have strong cash flow, but no collateral. To ensure a strong secondary source of repayment, a bank may require Liquid Collateral. A bank may also require liquid collateral if they simply don't understand the business or think the business is too risky to stand on its own. Liquid collateral basically means the loan has very low risk of loss for the Lender, and typically entails the lowest possible rate and most favorable terms for the borrower.

Liquidity

Accounting definition: Unencumbered cash + revolver availability

Practical definition: the amount of cash and cash equivalents immediately available to the company

Why it matters: this is one of the most important calculations banks will want to see when they're monitoring your loan. If Liquidity drops below a certain threshold (e.g. the amount required for payroll or amortization), than there could be an imminent cash problem that someone will have to solve in order to keep the business alive.

Long Term Debt

Accounting Definition: Debt obligations due and payable that mature greater than 12 months

.Practical Definition: Bank debt that that matures after a year.

Why it matters: When a lender is trying to evaluate how much debt you can afford to pay back each year, it's important to understand how much debt is owed each year. The total amount of the loan is important , but the amount of the loan you're required to repay each year is the most important component for cash flow evaluation purposes. If you owe $10,000,000 of debt over the next 10 years, it's much less relevant than owing $10,000,000 of debt this year.

MD&A

Legal definition: Short for Management's Discussion and Analysis

Practical definition: Management's written commentary regarding the financial condition of the business.

Why it matters: MD&As are typically required to accompany and describe the monthly/quarterly financial statements. The better written and more detailed these are, the less time you'll have to spend explaining the changes in financial condition to your lender over the phone.

Negative Covenant

Legal definition: a contractual provision in the Credit Agreement that prohibits the Borrower from engaging in specified activities, such as making investments, incurring new debt or liens, selling assets, or making acquisitions.

Practical definition: The things the bank prohibits you from doing such as blocking loans to affiliates, excessive dividends, taking on more debt, etc. Whereas Affirmative covenants are the things that the bank requires you to do/achieve such as minimum FCCR, interest coverage, maximum leverage, etc.

Net Cash Flow

Accounting definition: EBITDA less (i) Current Portion Long Term Debt, (ii) Interest Expense, (iii) taxes, (iv) Dividends, and (v) Internally Financed Capital Expenditures.

Practical definition: The cash generated by operations left over after all required bank, government, and operational maintenance payment requirements have been made.

Why it matters: If the Company doesn't generate positive net cash flow, it's unable to service its key debt requirements; thus, a Lender would be unlikely to provide the requested loan amount in the absence of liquid collateral and/or strong personal guarantors.

Net Debt

Definition: the total outstanding bank debt less the company's cash on hand.

Why it matters: The leverage covenant may or may not include a "net debt" concept (outstanding debt, net of cash, divided by EBITDA), which is generally more favorable to Borrowers than a standard leverage calculation (outstanding debt divided by EBITDA) particularly if the business draws the revolver down to keep cash on hand.

Net Income

Accounting definition: The amount of profit that remains after subtracting from Revenue all cash items, both non-cash operating & non-operating expenses.

Practical definition: The amount of profit that remains after all expenses are paid. Even items such as depreciation & amortization that don't require actual cash are considered expenses that reduce the amount of a Company's net income.

Why it matters: Net Income is the strongest indicator of a company's ability to repay debt. The higher the amount of Net Income, the more cash is likely available to repay debt.

Net Operating Loss ("NOL")

Accounting definition: The loss generated when operating expenses exceed revenue.

Practical definition: The accrued (aggregated) net loss that the company is carrying, which can be used to offset taxable income in future years.

Why it matters: NOLs can effectively be a source of cash in the future because they reduce the taxes that the company would have to otherwise pay in the absence of NOLs. Less taxes increases the pool of cash available to service bank debt. Certain changes in company status, including a change of ownership, may reduce NOLs and every company should be mindful of the value of this tax asset.

Net Profit Margin

Accounting definition: [Net Income / Sales]

Practical definition: The amount of profit generated by each $1 of reveue.

Why it matters: The higher the net profit margin, the more cushion the company has to combat an economic downturn, competitive pricing pressures, raw material price increases, etc.

Net Worth

Accounting definition: The book value of a Company's common stock, surplus, and retained earnings.

Practical definition: The difference between the Company's assets and liabilities.

Why it matters: If the company was liquidated, this would equate to the amount leftover. If Net Worth is negative, this would mean its unlikely the bank will be able to recover all of its debt.

Notes Payable, Long Term

All bank debt obligations that are due after 12 months, typically includes term loans, net of Current Portion Long Term Debt.

Notes Payable, Short Term

Accounting definition: All bank debt obligations that are due within 12 months, typically includes line of credit balance and Current Portion of Long Term Debt.

Practical definition: The principal & interest you're required to repay to the bank over the next 12 months, hence "short term".

Why it matters: If the company suddenly runs into a cash crunch, a Lender will want to know how much cash is needed to service the short term debt with the hope that the company's financial position will improve next year.

Operating Cash Flow

Accounting definition: [EBITDA - Capital Expenditures]

Practical definition: Cash generated from continuing operations

Why it matters: represents the amount of sustainable cash available to service debt. Cash generated from non-operating activities such as asset sales and miscellaneous income are not necessarily sustainable.

Operating Income

Accounting definition: [Gross Profit - SG&A]

Practical definition: The amount of income generated from the ongoing operations of the business.

Why it matters: Ignores items such as taxes, extraordinary gains & loses, and other categories that could skew the profitability generated by the company's core operations. If it's a manufacturing company, a bank cannot rely on your asset sales and extraordinary income to repay loans.

Original Issue Discount ("OID")

Other Expenses

Definition: The non-operating expenses listed on the Company's income statement that are excluded from COGS and SG&A but reduce taxable income.

Why it matters: Often times companies will have extraordinary (one-time, non-recurring) expenses that aren't a part of their customary operations thus shouldn't be counted when trying to determine a company's expected, recurring cash flow available to service debt. Other Expenses can be helpful to reduce taxable income, but Lenders will typically ignore them for EBITDA (cash flow) purposes.

Pay-in-Kind ("PIK")

Legal definition: This feature allows a Borrower to pay interest (or dividends) in the form of additional Bonds (or shares of Preferred Stock) in lieu of paying in cash.

Practical definition: Adding to the principal balance of the loan the amount of interest expense that would've paid in cash.

Why it matters: PIK interest payment are less of a cash burden on the Borrower, instead of paying interest in cash, the amount of interest is just added to the outstanding loan balance. This is helpful to cash flow in the short run, but will reduce the proceeds available to equity holders when the debt is ultimately paid off because the ending loan balance will be much higher than the beginning loan balance.

Pari Passu

Definition: equal right of payment

Why it matters: indicates which entities have equal claim to each other with respect to the Borrower's payments/collateral. If, for example, a SWAP (hedging instrument) provider and a Lender are both "pari-passu", then they have the same right to the Borrower's collateral.

PIK Toggle

Legal definition: An interest rate feature that gives the Borrower the option to Pay-in-Kind all, part, or none of the interest for any period.

Practical definition: The option for the Borrower to decide if it wants to pay interest in cash or have it added to the outstanding loan balance for a given period(s).

Why it matters: The PIK Toggle option gives Borrowers maximum flexibility with respect to the interest payments. If future cash flows are expected to be uncertain and/or tight, a Lender may provide a Borrower with the PIK Toggle option. This option is VERY rare in the small business loan market so don't be surprised if it's unavailable to you.

Power of Attorney

Legal definition: an instrument permitting an individual to serve as the attorney or authorized agent of the grantor.

Practical definition: a provision that gives someone else the ability to sign/act as the attorney for the person who granted this ability (power).

Why it matters: Power of Attorney will generally be granted to a trusted person, typically an investment advisor, that will be able to make decisions about your financials if you're deemed incompetent to do so (coma, debilitating heart attack, etc).

PP&E

Definition: The aggregate amount of property, plant, equipment, and other fixed assets listed on your balance sheet. These are generally found in the "non-current assets" portion of the company's balance sheet because they have a useful live of over one year.

Why it matters: PP&E is generally excluded from the collateral pool that banks will consider valuable collateral; PP&E depreciates in value over time making it difficult to determine their value in a liquidation scenario. Current assets, such as Accounts Receivable and Inventory, however, can typically converted quickly to cash which is more valuable for lenders that may need to quickly liquidate collateral if a borrower cannot afford to repay its loan.

Preferred Stock

Accounting definition: Capital stock with a claim to income or assets after bond holders but before common shares. Dividends on preferred shares are income distributions, no expenses.

Practical Definition: An asset class that sits in between debt and Common Stock in the capital structure. Preferred Stock has priority over Common Stock in a liquidation, generally pays a fixed dividend (the equivalent of the Interest paid on debt) and does not share in the upside to the same degree as common stock.

Why it matters: As a result of where it sits in the capital structure, Preferred Stock is generally less "expensive" than Common Stock and more "expensive" than debt. Investors that are more interested in the economic interest in the business, as opposed to voting control, will generally prefer Preferred Stock over Common Stock because Preferred is paid off before Equity. Equity investors almost always want to be first in line behind debt lenders in the capital structure so that they are paid off before any other equity investor.

Pro Forma

Legal/practical definition: Financial Statements calculated to reflect the impact of contemplated future events as if they had already occurred. The "as if" financials.

Why it matters: Lenders (and Borrowers) will want to know what the Borrower's cash flow would have looked like had certain events (e.g. new loan, acquisition, etc.) occurred in the past (as opposed to occurring now). For example, if a company is seeking its first loan, the bank will evaluate the company's historical ability to service the amount requested debt. Also, if the Borrower is seeking a loan to acquire a business, the Lender will re-run the Borrower's financials to see what the cash flow would have looked like with the additional EBITDA and the additional debt burden ("pro-forma for the acquisition" or "pro-form for the new debt")

Quick Ratio

Accounting definition: [(Unencumbered cash +Accounts Receivable)/Current Liabilities]

Practical definition: The amount of short term cash available to service the short term cash requirements.

Why it matters: Similar to Liquidity, the Quick Ratio helps determine the amount of cushion within the business. If the quick ratio is very small (tight) than any unexpected shortfall in cash receipts (customers paying late) could result in less cash than needed for payroll, vendor invoices, etc. Banks like to see cushion here.

Refinancing

Legal/practical definition: the repayment of existing debt with the proceeds of a new debt issuance.

Why it matters: it is generally easier to obtain a loan to refinance existing debt than to obtain debt for the very first time. Lenders will nearly always ask if the loan purpose is for new debt, or if it's to refinance existing debt. Borrowers should make this distinction clear in their loan application. Just like new businesses are more risky than established businesses, new borrowers are more risky than established borrowers.

Relationship Lender

Definition 1: A lender that is only interested in providing you a loan if you are interested in moving all of your other business accounts (e.g. checking account) to that bank.

Definition 2: A lender that will provide significant flexibility, even during down times, due to frequent interaction and the ability to "kick the tires" of the Borrower and "touch & feel" the business. Why it matters: Nearly every single lender will claim to be a "relationship lender"; however, sometimes the relationship will only be as good as the Borrower's financial performance. The more assets you hold at a bank, and the longer the track record you have with them, the more flexibility they will generally provide you. Small business loans are not particularly profitable for banks; if you do not have significant assets with the bank and if your company is not performing well then it's unlikely the Lender will provide significant flexibility. This is just our opinion, not fact. But when a lender claims to be a Relationship Lender, be sure to ask them to explain exactly what that means.

Representation and Warranty ("Reps & Warranties")

Legal definition: an assertion of fact in a contract (such as a Credit Agreement); the means by which one party to a contract tells the other party that something is true as of a particular date.

Practical definition: a statement by the Borrower (or contract signor) that certain items (listed in the contract) are true.

Why it matters: Requires the signor to illustrate in writing that certain things are true. This eliminates doubt/issues down the line about what the Borrower said/stated was true when the deal closed. Often times, a Borrower will have to Rep & Warranty that it's not in default each time it requests a draw on a line of credit. This representation gives the Lender comfort that Company is not operating in default of the credit agreement and should not be concerned about lending more money to the Borrower.

Required Lender Voting

Legal definition: Lenders holding more than 50% of the aggregate principal amount of outstanding loans and unfunded commitments under a Credit Agreement.

Practical definition: the required number or % of votes to effectuate a change in a loan agreement.

Why it matters: Commonly referred to as "numerosity" and generally representing 51% of the number of lenders in a bank group. In bankruptcy, however, Required Lender Voting automatically changes to (i) 51% in numerosity and (ii) 67% of the amount of debt held by the lenders. If/when you hear lawyers say "voting is half in number and two-thirds in amount", this is what they're talking about. For changes that adversely impact the bank group, a 100% vote is typically required. Outside of bankruptcy, only numerosity typically matters; but in bankruptcy both numerosity and amount are equally important. This distinction is important because, in bankruptcy one large lender holding 51% of the debt among 100 smaller lenders cannot by itself make a change to help itself and punish the others. As a practical matter, small business loans will never need to worry about Required Lender Voting because it's unusual for there to be more than 1 lender in each debt class. Just good food for thought as your business grows! For voting purposes, Lenders familiar with bankruptcy law will actually increase their amount shortly before bankruptcy by buying the position of other lenders (at a deep discount). Moral of the story borrowers - avoid bankruptcy!

Return on Assets (ROA)

Return on Equity (ROE)

Accounting definition: [Operating Income / Equity]

Practical definition: The amount of income generated by each $ 1 of equity.

Why it matters: Investors seek a good balance of risk and return. Since equity is the riskiest investment, the ROE should be relatively high. A good rule of thumb is that the ROE should be 2x-3x higher than the interest rate your bank charges you on your debt; if your line of credit pays 9%, the ROE should be 18%-27%. Reason being, the bank charges an interest rate based upon the probability you'll repay the loan (risk). Since debt has collateral, the unsecured equity investment is at least 2x-3x riskier than debt. An investor will expected to be compensated for that equity risk - and so should you.

Revenue

Definition: The amount of sales you've generated, the volume of units sold multiplied by the prices you've charged customers for them.

Why it matters: Revenue is the key driver of cash flow, and an indication of how important a company is; if a company generates significant recurring revenue, it clearly has a reason to exist and it would probably missed if it went away.

Revolver

Short for "Revolving Credit Facility", another word for a Line of Credit.

Sale Lease Back

Legal definition: a transaction where a company sells an asset (usually to a financial services company of some kind) and then immediately leases back that same asset.

Practical definition: selling real estate or equipment to a third party, then renting that very same real estate or equipment from the buyer.

Why it matters: provides a source of quick cash for Borrowers with tight cash flow. There are other reasons for sale leasebacks, including the desire to move a risky asset off its balance sheet. It's important to note that the rent payments that are made after the Sale Lease Back are generally classified as CPLTD, which reduces the company's Excess Cash Flow for covenant testing purposes. If you own real estate and need cash ASAP, a Sale Leaseback is worth looking into. But recognize that you will need to make rent payments, similar to loan amortization, going forward.

Securitization

Legal definition: a structured finance transaction in which a party owning a pool of cash-flow producing financial assets (the "originator") sells the assets to a Bankruptcy Remote vehicle (the "issuer") that then sells securities to investors that are secured by those assets.

Practical definition: Selling assets such as Accounts Receivable to a third party, generally sold at a discount to the amount of the Accounts Receivable due.

Why it matters: Securitization is a way to quickly generate cash for the (receivables) instead of waiting 30-60-90 days to collect them. There's a risk that not all of the Borrower's receivables will be collected by the issuer that bought the receivables; as a result, the issuer buys the receivables at a discount to whatever the book (invoiced) value is. Companies with significant receivables but tight cash flow typically evaluate securitizing its A/R or obtaining an Asset Based Loan facility.

Senior Leverage (EBITDA based)

Accounting definition: [Senior bank debt/EBITDA]

Practical definition: A reflection of how many years it could take for a borrower to repay the senior debt.

Why it matters: If you have a $1.0 million term loan and your company generates $250k of EBITDA per year, it will take at least 4 years for the cash flow generated by operations to repay the term loan. Since bank's prefer term loans of 4-5 years, it's rare they'll give you more than 4x the EBITDA generated by your business.

SG&A

Definition: Acronym for Selling, General, and Administrative Expenses. These are the Company's operating expenses, excluding Cost of Goods Sold.

Why it matters: To quickly calculate EBITDA (cash flow), most lenders subtract Gross Profit and SG&A from Revenue (then add back Depreciation & Amortization). As a result, they need to know the total amount of SG&A for cash flow evaluation purposes.

SIC Code

Definition: Standard Industrial Classification code

Why it matters: Lenders need to know what industry you operate in for many reasons; some industries are more risky than others, and the lender may try to increase or decrease their exposure in certain industries (e.g. speculative real estate). As a result, they need to know your SIC code, which can be found at http://www.sec.gov/info/edgar/siccodes.htm

Subrogation

Legal definition: the substitution of one party in the place of another party with respect to a claim by that other party against a third party, so that the substituted party succeeds to the rights of the other party with respect to such claim.1

Practical definition: the right for some other entity to step in to another's shoes with respect to rights, liens, etc.

Why it matters: Lenders want confidence that they'll always maintain their position with respect to liens, etc. A popular example is when an insurance provider pays a claim on behalf of the Borrower and subsequently steps into the shoes of the insured party. This process can compromise the Lender's collateral/position with respect to liquidation preference.

SWAP

Legal definition: an over the counter transaction in which the parties agree to exchange specified cash flow as at specified intervals.1

Practical definition: one party agrees it will sell to another party (the "counterparty") one rate or dollar amount in exchange for another for an agreed amount of time.

Why it matters: SWAPs are typically used by Borrowers that are required to pay a floating rate of interest, but would prefer to pay a predictable, fixed interest rate. In this example, a Borrower could "swap" with a 3rd party its floating rate for a fixed rate. Sometimes a Lender will require a Borrower to obtain a SWAP for [50%] of a term loan to prevent an increasing floating rate from causing cash flow concerns for the Borrower.

Synergies

Legal/practical definition: the cost savings and other efficiencies that are projected to materialize when two companies in the same industry are merged. Examples include reduced SG&A, increased purchasing power, more efficient utilization of factories, warehouses and distribution centers, and headcount reduction in the sales force.1

Why it matters: Particularly for LBO financing, Lenders will want to quantify and understand the synergies that are projected to be achieved. This will help substantiate the Pro-Forma financials that will be used to help evaluate the financing request.

Tangible Net Worth

Accounting definition: [Equity - intangibles]

Practical definition: The amount of assets left over after all the debt is repaid. Intangibles such as customer lists, goodwill, and affiliated loans are excluded because it's unlikely they'll generate any cash in a liquidation scenario. Why it matters: It's a reflection of how much cushion there is between the assets and liabilities. Where the "Net Worth" calculation includes intangibles, "Tangible Net Worth" is a more accurate gauge of how much the lenders might expect if the business were to be liquidated. The owner of the business might be able to sell its customer lists and recoup receivables from affiliated entities, but banks do not expect to be able to do so. When discussion leverage, certain lenders are referring to EBITDA-based leverage, while others might be referring to equity-based leverage. Small business loans tend to more concerned with equity-based leverage, while middle market and LBO financing is generally more concerned with EBITDA-based leverage (the equity is generally wiped out in an LBO).

Tax Expense

The amount of taxes you paid in a given year.

Term Loan

Definition: a long term (>12 month) loan to finance fixed assets, generally 5-7 years for equipment and up to 30 years for real estate.

Why it matters: term loans differ from lines of credit such that term loans are lump sum loans granted upfront to the Borrower and repaid over a fixed period of time with fixed principal payments, commonly referred to as Loan Amortization. Term Loans are substantially similar to mortgages except most Term Loans have "level principal payments" versus "mortgage style amortization".

Total Leverage (EBITDA based)

Accounting definition: [Total bank debt / EBITDA]

Practical definition: similar to Senior Leverage, except this calculation includes senior, junior, and unsecured debt.

Why it matters: You might have $2 million of debt, and high total leverage, but if all $2 million is a subordinated seller note, a bank knows it can put in senior debt ahead of the seller note. A senior lender primarily cares about the amount of senior debt and senior leverage because it will get all the liquidation proceeds before the junior lenders get a nickel.

Unused Fee

Legal /practical definition: the fee charged on the unused/available portion of the line of credit facility, generally expressed in Basis Points.

Why it matters: this is a legitimate request by Lenders because they sometimes have to earmark "reserves" (expenses) even for the unused portion of a line of credit. The unused fee is typically 50bps or less. This fee is important for Borrowers because it forces them to think more carefully about the size of the line of credit needed; if a Borrower obtains a $5MM line but only uses $1MM, than it might pay a 50bp unused fee each year on the $4MM unused portion of the line. There is a thin line between getting flexibility with a large line and paying for something you don't need.

Working capital

Accounting definition: [Current Assets - Current Liabilities]

Practical definition: The amount short term assets available to cover short term liabilities.

Why it matters: Similar to the quick ratio, reflects the cushion between the short term assets and liabilities. The higher the cushion, the less risk of a cash crunch.

Zone of Insolvency

see Insolvency