Borrowing to Fund Business Growth Presented by: Ken Rosenberg, Vice President Jamila Braithwaite, Vice President

Capital One Bank Today, Capital One Bank is one of the top 10 banks in the country, with a network of more than 1,000 branch locations across NY, NJ, CT, TX, LA, DC, MA and VA

Objectives Identify and explain key aspects of debt financing Understand the key elements of successful borrowing Discuss the key aspects of evaluating a company’s creditworthiness Review financial ratios

Growth: The Increasing Demands for Cash Working capital needs Expansion of facilities and equipment Work force and other investments As businesses shift their focus on growth, their needs for cash will likely increase. Among the key needs for cash are the following: Working capital – this is particularly true for business with long/extended cash conversion cycles Expansion – this encompasses a broad array of cash outlays, from purchase of new equipment, enlarging facilities as well as investing in new information systems all of which are often integral to business growth Work Force and other – additional employees often increase cash needs in terms of office equipment, funding initial investments in training, etc.

Cash Flow Is the Gas in the Engine That Powers an Entity’s Growth $ $ $ $ $ $ Profitable operations are a key source of a company’s cash flow … … however, operating cash flow may not be sufficient to fund the investments needed to fuel growth Thus, many businesses will/should seek external sources of funding to accelerate and support growth while maintaining a solid financial position enabling them to sustain normal business risk/downturns that may occur in the future Business growth funded by operating cash flow Business growth funded by external sources of capital External sources of capital often accelerate and support growth

Primary Sources of External Capital Debt Financing Varied options that can fulfill specific objectives of a business Best suited to fund specific needs of an established business where likelihood of repayment is high Ownership is not diluted and management retains business control Cost of capital is low, and the process of obtaining debt financing is usually faster than obtaining equity financing Equity Financing Often used when operating cash flows are negative or insufficient to fulfill the company’s requirements for the foreseeable future Often associated with start-up situations where the risks are high Ownership is diluted, and the investor often has a role in oversight and management of the entity Cost of capital is high, and the process of obtaining funds is extensive and usually spans a significant period of time The two alternatives for obtaining external capital include Debt Equity Both have their advantages and disadvantages. Established businesses with cash flows that can fund debt repayments seek debt financing – its cheaper, it results in no dilution in ownership and control. Businesses with no or limited operating history or those with exceptionally high capital needs may best to seek equity financing The key attributes are outlined on the slide The remainder of this course will focus on debt financing.

TYPES & KEY ASPECTS OF FINANCING Matching Offerings to the Needs of the Business TYPES & KEY ASPECTS OF FINANCING

Debt Financing Options Bank Financing Line of Credit Term Debt Leasing Interest Rate Management There are various types of debt financing options. It is important to consider what the needs of the business are and which option(s) best suit the company’s needs

Debt Financing Options Line of Credit • Facility available as needed over the term of the agreement • Often variable rates charged • Repayment is interest only or interest plus principal • Frequently used to fund short-term working capital needs and unexpected expenditures

Debt Financing Options - continued Term-Debt • Loan for a fixed amount with specific repayment terms • Interest rates may be fixed or variable • Generally does not provide for borrowing beyond the initial amount • Frequently used to fund asset (facility and equipment) purchases

• Requires payments over the term of the arrangement Debt Financing Options - continued Leasing • Financing arrangement providing the right to use an asset over a period of time • Requires payments over the term of the arrangement • May or may not transfer ownership of the asset at the end of the lease term • Used by companies to fulfill their asset needs without significant upfront investments inherent in purchase transactions

KEYS TO SUCCESSFUL BORROWING Optimizing the Chances of a Desired Outcome Like anything else, some planning and getting started early will pay dividends and increase the likelihood of a successful borrowing effort. Remember, a potential lender should be viewed as an important business partner. Developing and maintaining an open, honest and direct dialogue will optimize a businesses chances of success and broaden its options in terms of funding alternatives available to it. KEYS TO SUCCESSFUL BORROWING

5 Cs of Credit Character Capacity Conditions Capital Collateral Does the borrower demonstrate a commitment to honor his or her transactions and keep promises even under adverse circumstances? Character Does the business demonstrate the capacity to apply the loan funds? Does management have a business plan? Are the plant and equipment sufficient? Are marketing and product delivery well developed? Capacity What are the economic and market conditions that could impair the company’s ability to service the debt and repay the loan? Does the company recognize these risks and have plans to mitigate them? Conditions Capital Does the company have sufficient net worth to absorb normal business risk? Is the collateral sufficient as a secondary source of repayment? If the collateral must be liquidated, is the realizable value enough to repay principal and outstanding interest, and cover the bank’s administrative costs of liquidation? Collateral

Be Prepared Evaluate your business by considering the following: Strengths and opportunities Weaknesses and challenges Current financial situation and needs going forward; be realistic and try to avoid subsequent unplanned credit request that can jeopardize credit standing and overall relationship Develop information that can be shared with prospective lenders. Your client’s should take stock of their current situation and its future plans. Developing and sharing information with prospective/existing lenders helps them understand your situation and needs and how they can best assist you achieve your objectives.

Build an Effective Dialogue Build an open and honest dialogue: Provide an understanding of the company’s current state and vision for the future Discuss key objectives, acknowledging key risks and related remediation plans Gain an understanding of the lender’s loan products or alternative solutions and related requirements Start early: It usually takes one meeting to get the best borrowing solution. Like many other things in business, relationships and good communication are critical. Don’t wait to the moment you need the funds to get started. Some up front investment in relationship building will go a long way in the long term and optimize a business’ ability to raise capital when/if needed

The Loan Application Ensure that the loan application is complete and accurate Core loan application information often includes: Historical business financial information (2 years) Business and owner’s personal tax returns (2 Years) Personal Financial Statement Interim financial statements of the business and its owner for the current & prior year, along with accounts receivable and payable aging reports Maintain open, balanced and responsive communication throughout the process The extent and nature of information needed for the loan application varies by loan type and amount Often, 3 years of historical financial information is needed Financial information of the owner(s) is needed for small businesses and those closely held by one or few shareholders Also, open and candid discussion of a businesses challenges and risk is important for banks to better understand these issues and avoids surprises that can be damaging going forward

Sources of Repayment Cash Flow From Operations Guarantor Support Banks typically rely on three main sources of repayment Cash Flow From Operations Guarantor Support Collateral / Security Cash Flow from Operations. This is the primary source of repayment. The question: is the company making enough money to repay its debts? must be answered satisfactorily to obtain approval. Guarantor Support. This is the secondary source of repayment. The questions: does the borrower have enough capital to support their business? And does the borrower have other sources of income to support the business? must be answered satisfactorily to obtain approval. Collateral / Security. This is the tertiary source of repayment which the bank would look to in a worst case scenario. The question: would the bank be able to liquidate enough collateral to cover its position? must also be answered satisfactorily to obtain approval. 17

Cash Flow From Operations - Questions to Consider Industry Dynamics Is the applicant’s industry stable, or does it have a history of volatility and high credit risks? What is the applicant’s competitive positioning relative to its peers in the industry? Financial Condition Are the business’s profitability and cash flow sufficient to fund debt service? What is the business’s current level of debt, and will the additional borrowing stay within reasonable debt to equity/leverage norms? Is there sufficient liquidity in the business to sustain it through normal business cycles? Management & Maturity of Business What is the stability and quality of the management team, and have they demonstrated an ability to develop and implement business strategies and achieve desired results? Has the business been operating for a reasonable period (i.e., three or more years)? These are representative questions that lenders consider when assessing the applicant’s ability to generate/maintain cash flows sufficient to repay borrowings.

Guarantor Support & Collateral/Security - Questions to Consider What is the financial condition of the guarantor? Does the guarantor have a track record of fulfilling his or her financial obligations? Collateral/ Security Is the collateral a building or physical asset that is easy to control, and is there an established market to liquidate this asset with minimal costs? Is the collateral occupied by or used in the business of the borrower? Other Is the amount requested by the applicant within the bank’s preferred lending parameters? Does the company have ready access to reputable professional support (CPA, attorney, financial advisor, etc.)? Does/Will the borrower have an established or full relationship with the bank? These are representative questions that lenders consider when assessing the guarantor's financial condition along with the adequacy and accessibility of collateral/support that an applicant will pledge.

KEY RATIOS & RELATED GUIDELINES The Importance of Metrics in the Application Process KEY RATIOS & RELATED GUIDELINES

Key Ratios Lenders typically look at ratios, focusing on the sufficiency of cash flow to fund debt service as well as the overall level of debt relative to invested capital (equity) Business Debt Service Coverage Ratio of cash flow to annual debt obligations Business Leverage Ratio of debt to equity (including subordinated debt) Personal Debt to Income Ratio of personal annual debt obligations to annual income

Business Debt Service Coverage Ratio Cash Flow Debt Service Cash Flow Debt Service Total Sources of Cash Net profit (loss) Depreciation & amortization Interest expense Other (i.e., rent expense if swapping rental for ownership) Total Debt Service (interest & principal; existing debt plus requested amount) Mortgage Auto loans/leases Term loans Lines of credit Business Debt Service Coverage Ratio is a measurement of an entity's ability to produce cash to cover its debt payments; a higher ratio suggests the business is better able to fund additional debt obligations

Business Leverage Ratio Total Liabilities Equity + Sub’d Debt Total Liabilities Equity + Subordinated Debt Total Liabilities Liabilities minus subordinated debt Equity Equity plus subordinated debt Business Leverage Ratio is an indicator of the level of investments made by the business owner(s) versus lenders; a lower ratio generally indicates lower level of default risk

Personal Debt to Income Ratio Personal Income Personal Debt Personal Income Total Debt Service (interest & principal) Mortgage Auto loans/leases Notes payable/term loans Lines of credit & revolving charge obligations Other debt Total Sources of Income Wages, salaries, etc. Interest & dividends Pensions & annuities Rental income Other Personal Debt to Income Ratio is a measurement of the sufficiency of an individual's ability to fund its existing debt payments; a lower ratio suggests the individual is better able to fund additional debt obligations

Ratio Guidelines Thresholds for ratios vary by lender; the nature, type and amount of financing requested; the level of collateral/security provided; and the industry of the applicant. Typical minimum levels are: Note: An applicant’s low Personal Debt to Income ratio may be taken into consideration when considering business-related ratios (Debt Service & Leverage) Business Debt Service Coverage 1.25 to 1.4 Business Leverage 3x or less Personal Debt to Income 40% to 50% Note: the guidelines outlined herein are illustrative and vary by lender and the type/amount of borrowings.

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