Flush with cash from a new loan, some small business owners may find it hard to resist the temptation to spend the proceeds quickly and liberally. But this can result in unnecessary expenditures. Your bank can help instill fiscal discipline with four steps.
- Establish expectations early
Before your borrower applies for a loan, discuss your bank’s approach to monitoring how borrowers spend loan proceeds. For example, share how often you expect to talk with the business owner during the life of the loan, the type of documents you might wish to review on a periodic basis — and for revolving debt facilities, the mechanisms you have in place to monitor usage.
Your discussion will raise the “perception of detection.” This refers to the borrower’s belief that, in the event they squander the loan proceeds, your bank possesses the means to detect such activity quickly.
- Pay attention to the details
Send a strong signal to would-be borrowers about your willingness to oversee their loans by asking detailed questions about how they plan to spend the money, and over what period of time they plan to spend it.
For example, if a borrower plans to make a significant, one-time purchase of equipment or a commercial vehicle, ask for documentation relating to the purchase. Also, inquire about efforts to locate the most cost-effective item. But sometimes the cheapest option isn’t necessarily the most functional or reliable one.
- Conduct a site visit
If a loan funds the purchase of a physical asset, consider inspecting it at the company’s facilities. Ask to see the purchase order, invoices and payments to the vendor to confirm the terms of the purchase.
- Schedule periodic check-ins
Maintain customer oversight by setting up regular meetings — either digitally or in person — to review the business’s performance and how it’s benefited from the loan proceeds. Before each meeting, review the borrower’s business and personal accounts and loan activity for red flags. These might include transactions involving questionable vendors, transfers to personal accounts, cash transactions or compliance with loan covenants, should they exist.
In extreme cases, a business owner may use loan proceeds to make purchases unrelated to the business or fund personal expenses. Lenders can benefit from paying close attention to borrowers’ spending habits.