Almost every Bank has a loan policy or lending culture that is more conservative than the Small Business Administration’s (SBA) Standard Operating Procedure (SOP). This makes selecting a Bank for business acquisition financing to be of the utmost importance.
When the acquisition of a business is being financed, the SBA SOP allows for an equity injection (down payment) to be as small as 10%. It is important to note that the SBA SOP uses the term “project costs.” This means that the buyer of the business can also finance the expenses incurred to acquire the loan. Examples of project costs that can be financed include the bank’s attorney fees, appraisal fees, SBA fees, and lien searches. The cost of the bank’s attorney and appraisal will depend on the particular situation, but these fees will total several thousand dollars in all cases.
The SBA SOP states that a collateral shortfall is not a reason to decline a loan. Most banks prefer providing loans that are secured with hard collateral, such as real estate or equipment. They are not comfortable will intangible assets such as goodwill. All business acquisitions, by their nature, have goodwill. This is why many banks shy away from business acquisition loans.
The SBA SOP allows business acquisition loans to be repaid over a 10-year period. The longer repayment period reduces the monthly payment and improves the business’s cash flow. Many banks have a shorter repayment period.
The SBA SOP allows banks to include working capital in business acquisition loans. SCORE, affiliated with the SBA, states that cash flow is the number one reason businesses fail. https://www.score.org/resource/blog-post/1-reason-small-businesses-fail-and-how-avoid-it Banks comfortable financing business acquisitions will provide the borrower with a loan to assist with working capital.
The SBA guarantee will cover loans up to $5,000,000. Allen Business Advisors has relationships with Banks that will provide loans over the $5,000,000 guarantee.
When selecting a bank for financing, you should ask these four questions:
- Does the bank’s loan policy closely align with the SBA’s SOP?
- What is the bank’s minimum cash injection (down payment) requirement for a business acquisition?
- Does the bank provide loans to assist with working capital?
- What is the maximum repayment period for an SBA business acquisition loan?
The SBA 7(a) loan program is designed to assist with business acquisitions. But unfortunately, they get overlooked due to misperceptions, especially when borrowers turn to banks who don’t understand their complexities or specialize in this type of loan funding.
Some people do not know that the SBA loan programs are designed to be borrower friendly. Compared to conventional loans, SBA loans are generally more flexible with equity and collateral requirements, have longer repayment terms, and do not have balloon payments.
Small business owners mistakenly assume that the SBA is a direct lender of funds. The reality is that the SBA guarantee is to the bank to cover a percentage of their loss, if necessary, not the borrowers. Typically, the SBA guarantee is around 70%, but it changes from time to time based on government incentives. The guarantee allows banks to extend credit beyond their normal limits and offer favorable terms which may be difficult or impossible for borrowers to find elsewhere. Even with the SBA guarantee, some preferred SBA lenders are more conservative than other preferred SBA lenders.
The bank will perform a significant amount of due diligence, similar to any commercial loan. As a buyer, your interests and the bank’s interests align. For instance, the bank will hire a third party to value the business. You also benefit from having this information. The bank will search for any liens on the business’s assets to ensure that all titles are clear. This also helps the buyer.
Typical documents required include federal tax returns of the borrower and the business, year-to-date income statements, balance sheets, account receivable agings, account payable agings, resumes of the buyers, business licenses, and leases. For a more comprehensive list, go to https://www.sba.gov/funding-programs/loans/7a-loans
John Allen is a former Commercial Loan Officer, Mergers & Acquisition Advisor, and President of Allen Business Advisors, a firm that specializes in selling architectural, engineering businesses, and land surveying businesses. You may reach him at 781-443-4874 or John@AllenBusinessAdvisors.com.