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Monday, August 15, 2016

Dealing With Banks - The Agonizing Process

Earlier this month, I met with my local account manager at my bank to discuss applying for a mortgage to buy a property in New Brunswick. Our reasons for making this move are good, solid business reasons that make a lot of sense and demonstrate that we are prepared to make a lifestyle change in order to ensure that we protect the best interests of all our stakeholders:

  • The business ultimately pays for everything and it costs twice as much to live here in Toronto as it does to live in New Brunswick. These first few years of the business life cycle are the most critical to its development and ultimate health and success. So drawing out a salary that is twice as high as it needs to be is not in the best interests of the company. 
  • Our customers are located all over the world and receive their stamps by mail, so they do not care where we live. 
  • If we acquire the house as a business premises and rent the residential portion, the company will have an opportunity to build equity in a real property. Many will argue that real estate in New Brunswick is a poor investment, but I would beg to differ. For one, the price disparities in this country are so glaring now that New Brunswick cannot be this inexpensive forever, especially since there are plenty of businesses whose location is not important and whose owners, like us are prepared to make sacrifices to ensure the health of their businesses. As this happens, more amenities will emerge to satisfy the lifestyle demands of the entrepreneurs who relocate there and prices will rise. 
  • Even if that doesn't happen, the property's value can be viewed as being worth at least the present value of the cash flow savings that accrue from not having to live here, which is considerable. Right now we are paying $2,400 a month in rent and we could easily be paying $1,400 in new Brunswick for mortgage, property taxes and utilities, which represents a monthly savings of $1,000. Thus over a 5 year period, that represents a savings of $60,000. So even if we cannot resell the house for the $190,000 we are seeking to pay, as long as we get at least say $150,000 for it we are ahead of the game. Although capital losses are not allowed on personally held residential property, they are allowed if the company owns the property. 
  • The critical challenge we face is to get the inventory that we have properly listed and described on E-bay and our website before our cash reserves run out. We already know that sales rise in direct proportion to the amount of inventory we have listed. Right now, except for these two slow summer months, our average monthly sales are around $3,000 and these sales are being generated by approximately 20% of the inventory on hand. So as long as we can get all the material listed within the next two years, it is completely reasonable to project that sales should rise to about $15,000 a month once we are all done listing. From that point on, the business can pay a reasonable salary to Steph and I without hurting the organization's growth potential, or its ability to pay returns to investors. Our focus can shift from setting up the business, to maintaining and growing the business.
  • We are due to receive additional funding from investors, which we can make last for two years if we move, whereas it will all run out within a year if we stay here and then we will have to take a salary here which would rob the business of monies needed to finance growth. 
  • Finally, there are several government incentives available to businesses that provide jobs in New Brunswick, that are not available here. 
This all sounds like a pretty good plan no? But the bank doesn't seem to be so convinced. They haven't turned us down yet, but they sure are taking their time to make a decision. 

A lot of people get very emotional and angry with the decisions made by banks when it comes to loans and mortgages. Much of this anger comes from not understanding how banks work and taking their decisions personally. Banks exist to make money, but they also have a fiduciary duty to their depositors to safeguard their funds. The Bank of Canada also mandates restrictions on the supply of money made available by banks as a way of controlling inflation and other economic indicators. Because of this they are required to follow very strict rules in assessing risk and managing it. 

The problem is, most of their risk assessment looks at purely quantitative factors and fails to take other important qualitative  factors into account. For example, if I were employed as a staff accountant at a medium sized Toronto firm making $150K I would have no problem qualifying for a $500,000 mortgage, which would buy me a place in the lower-end of the now overpriced market in Toronto. The banks would evaluate me as a low-risk borrower, even though:

  • There is no guarantee that my income level would remain at that level for 25 years. Accounting firms seek to cut costs all the time and replacing senior staff, who are more expensive, with junior staff, as short-sighted as that is, is a decision that I have actually seen made many times in my 21 year career. The only way to guard against it is to continually develop one's skill sets. The banks I have dealt with over the years make no attempt to determine if I am the type of employee who protects his earning power in this way.
  • Toronto and Vancouver are both in a market bubble. I have read multiple accounts that refute this assertion because it hasn't popped yet. But I know my history and if you know what happened in Europe in the 1600's with tulips or the Wall Street Crash of 1929, and you compare it to what is happening in these markets now, the similarities are far too glaring to ignore. So from my perspective the banks are taking huge risks in writing mortgages for more than 50% of the value of properties located in these markets. 
On the other hand, we are having trouble qualifying for a business loan to buy a $190,000 house in New Brunswick, even though:

  • We have inventory with a liquidation value that can be objectively verified that is more than double the amount that we are seeking to borrow. 
  • Our business is profitable. The sales are low, but not significantly lower than what the original business plan projected. 
  • Our reasons for making the move show that we are managing the business in a financially prudent manner, which should lower the perception of risk. 
  • I am a Chartered Accountant with 21 years of professional experience and almost 40 years of philatelic experience, so the chances of the business not being successful are well below average, and even if the business did fail, I have a track record of being able to easily earn enough to handle the payments, even though I do not currently have that income now. 
  • They will have the property itself as security. 
  • It is highly unlikely that I would ever let things get to a point where the bank would have to repossess and liquidate anything. However, if they did have to do that, there is more than enough value to cover any loan they could advance. 
  • We have both been customers of the bank for years and I had a mortgage with them in the past with no defaults on record. 
Because we are self-employed, which means we are self-starters, and not employees and the bank doesn't understand our business, even though I have explained it to the gentleman I met with, it is very likely that we will be seen as too risky and turned down. 

However, all is not lost. One of the best aspects to being a CA is not the amount of money you make, but rather all the connections that you form over the years you practice. This is often overlooked by many who work in the profession, and who fail to develop their relationships with their clients to the point that their clients trust them and believe in their general business acumen. One of the things that I always made sure that I did was go above and beyond the call of duty for my clients. I also never made any secret about my interest in stamps or my history with it. I didn't do this with any kind of agenda - I did it because I cared about my clients and wanted to connect with them on a genuinely personal level. However, now that I am out of the profession, I am finding that there are several former clients who have expressed interest in becoming investors. They trust me, they see the soundness of our business plan and they have the money to invest and are keen to earn a good return on it. I have several meetings lined up over the next two weeks to pursue private financing opportunities. 

So the point of this post is to try not to put all your financing eggs in one basket. If you deal with a bank as a start-up business, be fully prepared to be rejected, as lending to start-ups is not usually within the mandate of most banks. Look at all your business contacts and try to identify people that:

  • You have known for at least 2 or 3 years; 
  • Who trust you;
  • Who know your skills;
  • Who have money they can afford to risk.
I'm confident that if you do this diligently you can probably find at least a few people you know who meet all four of these criteria. Even if you relationships are weak on the first two criteria, you can look for ways to strengthen those relationships. The best way to do this is by staying in contact and offering to help in any way you can, or simply by staying in touch and showing an interest in them, while being open about what you are doing, but not asking them for help. My experience is that if someone wants to invest and they know you need investment capital, they will offer to invest if they are sufficiently comfortable with you. 

If this fails, then the Business Development Bank of Canada is an option that you should look seriously into. It is a lot of work to qualify, as they will want to see a solid business plan, but as long as you have a good one, you should be able to qualify. 

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