Ownership transitions (business acquisitions) have become very popular in recent times. A business owner looking to retire may want to sell the business to a family member or perhaps to a long-time, valued employee. A minority shareholder of a business may want to buyout other owners who might simply be passive investors. Or maybe a third party is looking to expand a current business or add a product line through an acquisition of a competitor or complementary business.
Financing these transactions through conventional means is not always the best option for the buyer. Typical roadblocks include higher cash equity requirements, shorter term/amortization of the loan and lack of appetite for conventional banks to lend against goodwill, which means being undercollateralized at closing. The seller may be open to providing a note to finance a portion or perhaps the entire transaction; however, if the seller is looking to “cash out”, this may not be an option.
The SBA 7a Program can be an attractive option for a potential buyer to consider when looking at a business acquisition. This program provides flexibility in the form of longer terms and amortization, thus reducing the monthly payment versus a conventional financing. In many cases, the loan term can be 10 years and may be a long as 25 years if real estate is involved in the acquisition. There are typically lower cash equity requirements when using the SBA 7a Program. Many times, 10-15% will be the required down payment at closing while conventional structures will start at 25-30%. Lastly, the SBA 7a Program allows for the financing of goodwill while most conventional structures will not. In other words, the SBA will consider transactions that might be undercollateralized, because an SBA loan is not declined based solely on a lack of sufficient collateral.
When considering an SBA 7a loan as a financing option, there are a few key points to consider that will play a role in how successful the buyer may be in obtaining an SBA loan. Having a solid purchase agreement early in the process is crucial as the allocations contained in this document will drive the overall structure of the transaction. The SBA allows up to 10 years when financing fixed assets such as machinery and equipment as well as inventory and goodwill. If real estate is part of the transaction, the SBA will allow up to 25 years. So, identifying the purchase price allocations is one of the first things to consider as this will unlock the overall structure.
A third party independent business valuation will be required in most cases when the goodwill of the transaction is greater than $250,000. This will not only be a key form of due diligence for the lender’s analysis but will be required by the SBA to validate the purchase price allocations agreed upon by both the buyer and seller. A business valuation is used in a similar manner as a real estate appraisal when purchasing real estate.
The experience of the potential buyer will also be evaluated. Having industry experience or experience in a similar business will be an important factor when applying for an SBA loan. Owning a business doesn’t necessarily translate into success if the current business is not the same as the business being purchased.
Lastly, developing a detailed business plan including projections will be required. Being able to demonstrate cash flow sustainability during the ownership transition will be a key factor when applying for financing. In many cases, the increased financing obligation will necessitate increases in sales and/or expense reductions to generate the required cash flow needed to support the loan. Most lenders will understand this point; however, the key will be to determine how reasonable these assumptions are and can they be met. Do drastic changes, like increasing sales or cutting major expenses, need to be made for the business to be successful? How do projected expenses compare to historical expenses? Do these assumptions seem reasonable based on historical levels? These are all key questions to consider when compiling projections for a business acquisition.
Given the state of the current economy, business acquisitions will likely be a hot topic of discussion in the near term. If you are considering an acquisition yourself, the SBA 7a Program may be worth considering.
Jeff Billig is Senior Vice President & Director of the Structured Finance Group at Old National Bank. This group is responsible for underwriting and servicing SBA 7(a) and SBA Express loans for the Bank. He is a graduate of Hillsdale College where he earned a degree in Finance and has over 23 years of commercial lending experience.
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