In all of the years that I was in commercial banking and there were many (30 years to be exact) one of the dumbest loan conditions I had to impose was that of the “30 day cleanup” with regards to a revolving line of credit. It made no sense to me then and it makes no sense to me now. There are still banks out their today that enforce this silly rule.
If you are a business owner out there considering applying for a revolving line of credit pay close attention as this short article will save you some time, money and stress.
First a little background as to the intellectual foundation of the “30 day cleanup.” When a business owner applies for a loan, bankers are trained, (some not very well) to classify your loan need as either short term or long term. Bankers are supposed to match the maturity of your loan with the need or purpose of your loan.
Short term purposes are supposed to be structured as lines of credit, (12 month maturity) and long term purposes are supposed to be structured as term loans, (maturities usually 3-5 years)
Examples of short term purposes/needs could include:
Take trade discounts
Make special inventory buys
Finance short term increases in inventory & AR caused by seasonal sales growth
Examples of long term purposes/needs could include:
Buy new equipment
Buy a new commercial building
Invest in leasehold improvements
Finance permanent increases in inventory & AR caused by long term sales growth
Still with me?
When a banker determines that your loan need is short term as was stated they will recommend a line of credit. If approved, the payment terms are almost always interest due monthly and principal payments at your discretion based on your cash flow. All outstanding principal is due at maturity. Your balance is paid off by your new line of credit if it is approved for another year.
Many banks will require that as a condition of the line of credit approval that you agree, (in writing) to pay your line of credit balance to zero for 30 consecutive days during the 12 month term of the line. After this 30 day period is up you can borrow up to the line limit the next month if you like. This is the “30 day cleanup” requirement.
What is the purpose of this rule? If you can manage to achieve the 30 day cleanup you will have prove to the banker that your loan need was indeed short term (or temporary) but if you can’t then your loan need was really long term and you should have received a term loan not a line of credit.
Two questions: Who’s cares?…. and who recommended the loan structure you or the banker? Whether you achieved the clean up or not you are still pledging the same collateral, providing the same personal guaranty and you are still knowledgeable about your industry and business. (I have seen owners comply with the 30 day rule by delaying payments to vendors by an additional 30 days to create the temporary cash to pay the bank line down to zero. What does this prove?)
But here is the rub … some bankers take this issue very serious. If you cannot achieve the cleanup for reasons other than operating losses, fraud or excessive owner compensation, like constant sales growth you will normally be chastised by your banker for violating the 30 day cleanup rule. I have seen instances where a banker has asked a client to find a new bank due to non-compliance with the 30 day cleanup covenant.
Simple fix to this potential dilemma if you are seeking a line of credit. Ask the banker if your line of credit carries the 30 day cleanup rule, if it doesn’t no worries. If it does and you feel you can accomplish the 30 day clean up again no worries.
However, if you believe that it could be problematic to achieve the 30 day cleanup ask your banker to structure a hybrid line of credit /term loan for you. Ask your banker to preapprove a term loan that kicks in after the initial 12 month revolving period. This term loan will be used to pay off the full balance of your line of credit, say over a three year period.
That way everybody is happy.