When Money Gets Expensive
A four-part series for founders and family business owners
Rates have moved, and the pressure is showing up in operating companies before it shows up in the headlines. Not as a crisis — as friction. The line renews on worse terms. A good customer starts paying in forty-five days instead of thirty. The buy-sell agreement everyone signed in 2016 suddenly describes a transaction the company cannot afford. Distributions get smaller, and the phone calls between owners get longer.
These four articles work through the documents behind each of those. They are written for the owner who wants to know what their own paperwork says before someone else explains it to them. Please forward any article to someone you think should read it.
1. The Line of Credit Renewal Nobody Prepares For
2. Getting Paid When Your Customers Start Stretching
3. Your Buy-Sell Was Priced in a Cheaper Decade
4. When the Distributions Stop
Your operating line renews once a year. For most of the last decade, renewal meant a signature page and a new rate sheet. This year it means a credit memo, a fresh set of covenants, and a banker who wants to walk your aging report line by line.
The rate increase is the part everybody sees, and it is the smallest part of the problem. Renewal is where the bank re-underwrites a loan it has carried for years, and in a tightening cycle the terms that come back are not the terms you have been living under. Advance rates get trimmed. Reserves get added. Covenant levels get reset against a forecast you did not prepare. And none of it is negotiable on the day the line matures, which is exactly when most owners first read it.
Your covenants can break without anything going wrong
Start with the arithmetic, because this surprises people who are running good companies.
A fixed charge coverage ratio divides cash available for debt service by your fixed charges — interest, scheduled principal, often rent, sometimes distributions and unfinanced capital expenditures. Interest sits in the denominator. When the rate on a floating-rate line goes up, the denominator grows while nothing about your operations changes. A company that covered at 1.45x on identical earnings can be under a 1.25x covenant two rate moves later.
The same mechanic runs through debt service coverage, through leverage ratios keyed to EBITDA, and through tangible net worth covenants that are quietly eroded by a year of thinner margins. You can run the business exactly as well as you ran it last year and still be in technical default.
Two things follow. First, covenant compliance is a forecasting exercise, not a reporting one — if you only learn your ratio when the quarterly certificate is due, you have given up the months in which you could have done something about it. Second, the levels in the renewal documents deserve as much attention as the rate. A covenant set with no headroom is a covenant you will breach, and the bank will know that when they set it.
The borrowing base: what you can actually draw
If your line advances against receivables and inventory, there is a second number that matters more than the commitment amount. Owners describe the line as “we have a two million dollar line.” It is a two million dollar ceiling over a floor that moves every month.
A formula line advances a percentage — call it eighty percent — against eligible accounts receivable. Eligible is defined in your loan agreement, not in your accounting system, and the standard carve-outs take a real bite: receivables past ninety days drop out; cross-aging rules pull an entire customer’s balance out of eligibility when part of it goes past due, current invoices included; customers above a concentration cap count only up to the cap; balances owed to a customer you also buy from get netted; and credits, returns and disputed invoices come out through a dilution reserve.
None of that is the bank behaving badly. But it means the number on your borrowing base certificate is meaningfully smaller than your aging total, and the gap widens exactly when business slows.
And here is the mechanic that gets missed. Your eligible receivables are, by definition, the good ones — current, undisputed, owed by customers who pay. Those are also the ones that collect first.
When a hundred thousand dollar eligible receivable pays, eighty thousand dollars of borrowing capacity goes with it. If the cash sweeps to the lender and pays the balance down dollar for dollar, you come out ahead. If it does not all reach the lender, you do not — and in many businesses it does not. Sales commissions are paid out of collections. Subcontractors and suppliers get paid when the customer pays. Sales tax billed on the invoice was never your money. Retainage, freight and warranty reserves come out of the same dollars.
So the hundred thousand comes in, thirty goes back out to a commission and a sub, seventy pays down the line — and the base dropped eighty. You just lost availability by collecting a receivable you were pleased to collect.
Run that for a quarter and what is left in the aging is the slow material: the disputed invoice, the customer who is stretching, the account about to cross ninety days and drag its current siblings out with it. The base erodes while the balance sits still, and eventually you are over-advanced — borrowed more than the formula permits — which the loan agreement says you cure in cash, now.
Profitable companies get there. Profit and availability are not the same thing.
The temptation, and the line it crosses
Whether the pressure comes from a covenant or an over-advance, the instinct is the same: make the number look right this month and fix it next month. That is where careful operators start doing things they would never otherwise do — invoicing before the work is finished, asking a friendly customer to pay ahead so the month-end certificate reads correctly, re-dating an aged invoice, deferring an expense past quarter-end to help a ratio, paying the line down on the thirtieth and redrawing on the second.
Each move buys a week and makes the following week worse, because it borrows from the next period to repair this one.
It is also worth being clear about what those documents are. The borrowing base certificate and the compliance certificate are representations to your lender, signed by an officer. Misstate one and you are not merely in default — you are in default with your signature on the misstatement, which moves the conversation out of workout territory and puts the liability protection you were counting on into play. Knowingly making a false statement to a federally insured lender to obtain or maintain credit is a federal offense in its own right, separate from the loan.
I raise it not because readers set out to do it, but because the pressure to make one month work is real and the distance between aggressive accounting and a false certificate is shorter than it looks at 4:45 on the last business day of the month. If the numbers do not work, the answer is a conversation with the bank before the certificate is due.
One default, five problems
Read the cross-default provisions in everything, not just the credit agreement. Equipment notes, vehicle loans, the building lease, equipment leases, a surety bond, a franchise agreement, a key supplier contract — many contain cross-default language, a material adverse change clause, or a financial condition covenant that is tripped by a default elsewhere.
The practical consequence is that a single covenant breach on the operating line can hand five counterparties a right to accelerate, suspend, or demand assurances in the same week, at the moment you have the least capacity to deal with any of them. Owners are usually aware of the bank. They are rarely aware of the other four.
If a forbearance is on the table
Understand what it costs. Most forbearance agreements include a release of any claims you may have against the lender, an acknowledgment that the debt is valid and undisputed — which forecloses defenses you may not know you have — additional collateral, tighter and more frequent reporting, sometimes a field exam or a consultant at your expense, milestones you must hit, and occasionally a guaranty from someone who never signed one before.
Some of that is the price of the extension. Some of it is negotiable. All of it is far more negotiable before a payment is missed than after, and the single most common mistake I see is waiting until the bank is the one setting the timetable.
What to do before renewal, not during
Forecast the covenants. Run your ratios forward four quarters under a rate scenario worse than you expect. Find the quarter that breaks first.
Model availability, not just cash. Build a rolling thirteen-week view of eligible receivables times the advance rate, less reserves, less the balance. Most companies forecast cash and get blindsided by availability.
Know your ineligibles cold, and trace where collected dollars actually go. If commissions, sub payments or sales tax come out of collections, that leakage belongs in the model.
Inventory your cross-defaults across every agreement the company has signed, not just the loan documents.
Start the renewal conversation a full quarter early. Banks reward borrowers who bring them a problem with a plan and penalize borrowers who bring them a surprise. That is not sentiment; it is how credit committees work.
The same analysis runs the other direction. If you are extending credit to a company with a formula line, or buying one, the borrowing base certificate and the covenant calculation tell you what that business actually has to work with — not the commitment amount, and not the income statement.
If you have not read your own credit agreement since the day you signed it, that is a well-spent hour with your CFO, your accountant or your attorney. Most of what is in this article is sitting in documents you already have.
Mike Lang is a transactional lawyer who writes weekly for founders and family business owners navigating the deals that define their companies. Questions or topics you want covered?