Owning and operating your own business is very much a part of the American Dream.  Not everyone is qualified to live this dream but to help qualified buyers, the US Congress through the Small Business Administration (SBA) has put together a third party lending program.  The SBA itself does not lend money direct to would be entrepreneurs, rather they allow qualified banks to manage and execute loan programs that meet criteria set by the SBA who will in return, underwrite a portion of the loan to lessen the risk of the banks.  The rules are complex and change in reaction to the economy.  However, a prospective borrower needs to put their best foot forward or their loan will not be successful.  Here are 10 reasons your request for an SBA loan more than likely will be declined.

1. The SBA requires a Personal Financial Statement from each loan applicant and this document needs to show how much and where the down payment will come from to buy the business.  The SBA program requires the buyer to make a capital injection to buy the business; they will not approve a zero down loan.
2. The SBA wants loans made to citizens with a clean criminal record.  If you’ve had a drink driving offense and it goes back a few years, they will require a full explanation of what happened so they can determine whether or not they will underwrite their portion of the loan.
3. SBA loans are for a business with a positive cash flow.  With the loan application there needs to be a business model that shows the cash flow projection of the business, the price and terms of the deals.
4. If the business the buyer wants to buy includes a lease from a landlord, the SBA loan application needs to show that the landlord has approved a lease for the buyer and the lease will need to correspond to at least the length of the SBA loan.  That is, if the SBA loan is for 10 years, the lease will need to be a minimum of 10 years.
5. One of the major reasons for an SBA loan not being approved at the moment is due to the buyer having insufficient industry management experience in the industry the business being acquired is in.  If the buyer has extensive management experience but it’s not the same industry then it’s almost certain the loan will be denied.
6. The business plan and financial cash flow models need to include working capital for the buyer.  If the business purchase price is $1,000,000 but the business needs $150,000 in working capital, make sure the loan application shows where the working capital will come from.
7. When a business is listed for sale it can often be 6 months or more before a buyer comes along and makes an offer.  The SBA requires financial statements of a business to be no older than 90 days so the decision to approve a loan is based on current information.  The seller therefore needs to keep financial statements up to date if an SBA loan is part of the purchase.
8. If the buyer’s offer requires the seller to remain as a consultant to the business, the maximum period of time they will accept for the seller to be a consultant is 12 months.
9. The SBA requires that the buyer have a minimum credit score for a loan to be approved.  At the moment the score is 700 but it’s much better if the score is 720 or higher.
10. There are many banks that offer loans.  In addition to banks, there are service providers that process and underwrite loans.  Many lenders manage a book of loans often based on a mix of industries they know and have researched to help reduce and manage their risk.  As a result, your loan may be declined with one lender as they already have too many loans exposed to a particular industry or in fact, they may not want to lend in that industry.

The Boys Scouts motto is “Be prepared.”  If you plan to apply for an SBA loan, this motto will serve you well as it is not a quick process and can be drawn out if you are not organized.

One of the companies I use for SBA 504 loans in Sacramento called GSCDC dba Capital Funding, just sent through a messaging saying:

“SBA has released their guidelines for the “Refinancing Program.” We expect to have an influx of applications. Remember, this is only a two-year program. We have highlighted the guidelines for your review below:

• Federally guaranteed debt is not eligible for refinancing (7A, SBA-504, USDA).
• Existing loan(s) to mature on or before December 31, 2012.
• Project costs up to $18,000,000 are eligible.
• Loan to be refinanced must have been used for SBA-504 eligible fixed assets (real estate and/or equipment).
• Property must be owner occupied (51% or greater).
• Payments must be current for at least 1-year prior to SBA submission. If refinancing for an existing lender, payment transcripts for the life of the loan is required. The existing loan must be at least 2-years old.
• Financing up to 90% of current appraised value or existing loan balance, whichever is less. Debt in excess of 90% would have to be paid down, written down, subordinated, or additional collateral provided. Subordinated debt will require at least a 3-year standby agreement of P&I.
• Standard SBA-504 loan structure:
  • Bank…Minimum 50%
  • SBA…Maximum 40%
  • Borrower…Minimum 10% cash or equity”

If you think it may make sense to refinance your 504 SBA loan, give me a call and I will introduce you to a company that can help.

The SBA has successfully funded many small business acquisitions over the years. Since August 2008, it had become increasingly difficult to successfully apply for an SBA loan as approval criteria was tightened in response to more loans performing poorly. In recent weeks, however, the SBA has become more “user friendly” in a bid to try and help kick start small businesses which in turn will lower unemployment.

If you are a potential business buyer and applying for an SBA loan to help fund part of your business purchase is one of your strategies, to make your loan application more likely to succeed, consider the following:

1. Management experience is one of the more important criteria for an SBA lender to approve a loan. During 2008, the SBA did some research on the reason loans were failing and one of the consistent reasons was a lack of management experience. The bottom line is that you will need a resume to submit with your loan application. Make sure your resume is up to date and make sure it highlights real managerial experience including industry experience in the same industry you plan to buy your business.

2. Something an SBA lender likes to see on a loan application in addition to management experience is also experience managing a Profit and Loss Statement. A P&L reports the monthly flow of income and expenses of a business. If a borrower shows they have this skill and therefore understands cash flow, this is a great asset.

3. Part of the review and approval process for your loan will include looking at your 1040 tax returns, credit report and resume. Therefore, make sure they are consistent with each other.

4. If the business is the sole source of family income this will need to be presented clearly. If the business has a current cash flow, you will need to explain what cash flow you need to support and pay for the family’s personal needs such as mortgage, weekly groceries, car payments, transportation costs and other household expenses. You will also need to show how the loan and any interest will be serviced.

5. To make sure you are a reasonable credit risk, the SBA lender will require a copy of your credit report and credit score. Before you make your SBA loan application, review your credit report to make sure it is accurate and has no errors on it. Mistakes on credit reports are not unusual but make sure you remove these mistakes or it could mean the difference between loan approval and rejection.

6. The SBA lender will want to see you have cash to use as part of the down payment to buy the business. The SBA lender will not allow the down payment to be borrowed. If the down payment or some of the down payment is being borrowed from a family member, they will require the family member signing a letter saying they will make no claim for the money at some point in the immediate future.

7. Obtaining an SBA loan has never been easy. If an SBA loan is approved then it means a lot of things have been researched and studied and put in place to enable the borrower to be successful. Equally, if an SBA lender rejects the loan it should be for good reasons and help the borrower know what they need to do next time to be successful.

Obtaining finance to buy a business is particularly challenging. One of the advantages of buying a business in the United States that very few other countries have to assist with this process is the Small Business Administration or the SBA as it is commonly called. If you have retirement money in a 401(k) plan, this money can be used to move into a corporation and fund the purchase or down payment to buy a business. This option can be combined with an SBA loan. Both of these processes are very formal and deliberate and therefore take time, but if applying for an SBA loan is part of your business acquisition plan, consider the following 5 tips.

1. SBA lenders make their decision to approve a loan from a risk model not an opportunity model. That is, you can have the next best new business idea in the world but SBA lenders approve loans against cash flow. That is, if the business exists and it has positive cash flow, that’s the first thing a lender wants to see.

2. If you want to use the loan to buy an existing business with a positive cash flow, the banks will understand that the current owner of the business will most likely have non-business expenses sitting on the business profit and loss statement so it reduces the amount of tax the business owner pays. These non-core non-business expenses are called add-backs and to get at the net operating cash flow of the business, they will accept a reasonable number and amount of add backs through a recasting of the financial statements. These add backs must be legal and easy to identify.

3. A recent requirement to the SBA loan application process is that the banks need to obtain an independent third party valuation of the business to support their loan decision process. The valuation must be realistic and defensible, that is, the appraiser needs to explain in their valuation report how they arrived at the final value of the business.

4. If a lender approves an SBA loan and the borrower defaults, the SBA has auditors who look at the loan application and approval process used by the bank. The auditor’s ultimate responsibility is to understand the loan application process and why it was approved and then understands why the borrower defaulted.

5. If the SBA loan auditors are not satisfied the loan application was handled correctly, they can withdraw the ability of the bank to approve SBA loans and be covered by the risk mitigation the SBA provides. If the bank does not have preferred lender status, the bank can be prohibited from applying for presenting loans for approval.

The bottom line is, banks have a lot at stake including not getting it wrong; so be patient with their process as ultimately the person at the bank who approves the loan is responsible. The SBA loan process provides great help to business buyers (and indirectly, business sellers) as it provides a source of funds for entrepreneurs. Over recent years those rules became much more difficult and therefore saw a large drop in the number of loans approved. This is now starting to change but a business must present itself in the best light possible to have any chance of obtaining an SBA loan.

There are two critical things a buyer of a business is looking for and these are cash flow and potential. They may be willing to compromise on almost any other thing but if the cash flow’s not there to provide an income to sustain their family and livelihood, service the debt of the business and include a buffer in case they need time to re-establish upward momentum in the business and the industry the business is in is declining, then it will be a challenge to close the sale.

If the cash flow and potential are good, consider the following 6 questions to help present the business to the market. And a Golden Rule I use when helping buyers and sellers is to put your feet in the shoes of the other party, that is, don’t see things from your perspective, see them from the perspective of the other party.

1. Does the business present itself positively and therefore have buyer appeal? We’ve all heard the expression – does it sizzle? A buyer wants to be excited about the business and what it does. Making sure it has plenty of sizzle and presents itself well to the market is very important. In residential real estate it’s called “curb appeal.” Make sure the business presents well and has good “curb appeal.”

2. Who is the best buyer of the business? Not every business can be bought by every buyer. Criteria that may exclude a buyer, depending on the business, include technical skill sets or mandatory qualifications.

3. How is the neighborhood around the business? If the business is located in an attractive mall or in an upscale area it follows that it will attract a similar clientele. This would obviously be more attractive to a potential buyer. Incidentally, this doesn’t mean the business is worth more, as some sellers expect, it just means if the business is valued and priced correctly it may have a better chance of selling.

4. Most sellers can quickly explain what they would do if they had more time. This can be useful talking points between the seller and buyer. Most qualified buyers will be looking for things they can do better if they owned the business. As we said above, potential is critical to a business buyer.

5. What is the buyers risk level and how easily can it be quantified? Buying a privately held company comes with a lot of risk; unaudited financial statements, changes to the law that affect the industry the buyer is looking at joining or changes to the tax laws that affect how much money the buyer as the business owner gets to keep, and more. As the seller, you have a lot of business and industry knowledge. Don’t be afraid to share your observations without couching it in terms of guarantees or future expectations of the performance of the business.

6. Does the price and terms of the deal pass the “smell test?” One of the services I provide is business valuations as well as machinery and equipment appraisals. After doing all the research to arrive at the final value I always do a “smell test” to make sure the figure arrived at makes sense. If it doesn’t, it means doing more research. The “smell test” or “gut check” is a great way to keep things real.

Buying or selling a business is complicated. It’s generally a series of questions with follow up questions looking for one final yes. It requires patience and stamina as there are so many moving parts.

On Monday, September 27, 2010 the President will sign into law HR 5297, the small business bill.  This bill has huge ramifications on commercial lending AND the economy.  Most people don’t realize how big this bill is and the ramifications of it on small business lending.

The key SBA provisions of HR 5297 are noted below:

7A SBA loans

• Increase to maximum SBA 7a loan amount to $5,000,000 (permanently)
• 90% guarantee through December 31, 2010
• Fee waiver for the rest of 2010 (subject to available funding)
  

504 SBA loans

• 504 Debenture increase to $5,000,000 for most applications and $5 ,500,000 for manufacturers (permanently)
• Two year window for refinancing debt (details provided below)
• Two year extension of the First Mortgage Pool (FMP) program from the date of the first pool issuance – first pool issuance expected to be September, 2010
• Fee waiver for the rest of 2010 (subject to available funding)

504 Refinance Provision

Here is a summary of the provision:

• Property must be owner occupied (51% or greater)
• Debt must be at least two years old
• Borrower in operation for the entire two year period
• Proceeds of which must have been used for 504 eligible fixed assets for the benefit of a small business concern
• Payments must be current for at least one year prior to application
• Maximum Loan To Value on the existing property is 90%
• With additional collateral, the maximum LTV on the existing property is 125%
• Federally guaranteed debt is not eligible for refinancing (7A, 504, USDA)
• Two year window

It is important to note:

• Not every bank will participate in these changes.
• In addition, it could be MONTHS BEFORE THE CHANGES IN LOAN AMOUNT AND THE REFINANCING PROVISIONS ACTUALLY KICK IN. The bill is vague in its timelines.  Basically, Congress has passed it, now the lenders and the SBA need to execute it and that can take a month or two or three.

If you are thinking of becoming a business owner, you have three choices. Those choices are to start a business from scratch, buy an existing business or buy the rights to a local franchise. Each option appeals to a different type of entrepreneur. If you more information, you can go to www.businesstransactionbooks.com where you can buy and immediately download a copy of a book on each option and decide what makes the most sense to you.

Per the Coleman Report – Today the Senate voted 61 to 37 to pass a motion to invoke cloture on Boucus Substitute Amendment to H.R. 5297, the Small Business Lending Bill.

After the vote, Majority Leader Harry Reid (D, NV) said that passing this motion was the most significant thing the Senate has done since the Stimulus Bill was passed to create jobs.
The bill is expected to create between 500,000 and 700,000 new jobs.
“We have community banks now with the ability to compete with big banks, and the ability to loan money to small business,” Reid stated.

The support of Republican Senators George Voinovich (OH) and George LeMieux (FL) was critical in reaching the sixty votes needed to pass this bill, and Reid called Voinovich’s recent decision to “break up the log jam” and vote for the bill the major breakthrough.

Senator Mary Landrieu (D, LA) also spoke and thanked the numerous senators that she has worked with during this process.
“This was the vote for this bill,” Landrieu reminded the Senate, “If sixty one senators didn’t say yes to the country and no to politics, this bill would be in the trash can right now.”

A vote on final passage will hopefully be done by the end of the week, after which the bill would then move back to the House of Representatives for a vote before going to the President.

The House could delay the process with votes and amendments, but it is expected that they will pass what the Senate sends to them.

“This is not a victory for the Democratic party; this is not a loss for the Republican party,” Reid concluded, “This is a win for the American people. This is going to help small business which has always been the job generators of our country.”

For most owners of a privately held company, when the time is right they want to sell their business for the highest price possible in the quickest time possible and live happily ever after. There is nothing too complicated in that and at a basic level, that’s perfectly fine. However, a question to ask is whether the business owner wants to sell the business or is their preference to transition the business?

The difference between selling the business and transitioning the business is as different as night and day. Selling the business simply means looking for the buyer at that moment in time who will pay the highest price possible. Transitioning the business requires the owner to step back, systematically review all the options available to the business then creating a plan to arrive at that outcome.

For example, the business owner may have other options other than selling the business and taking the highest or best price. If the business owner has immediate family working in the business the preference may be to continue the legacy of the current owner by transitioning the business to the immediate family members. If this is the case, this brings into play a number of actions that need to be carefully and fully researched. Answering questions such as tax implications, legal questions such as what liabilities and responsibilities move from the current owner to the new owner, finance questions such as how any current loans need to be handled and indeed, how much and where is any money coming from to pay the current owner for the value they have created in the business that will fund their retirement or next journey in life.

Before spending time working through the above scenario, the question of transitioning the business goes back to a simpler level. And this is the point of this article. It requires the current business owner to look at their own needs and either make decisions or arrive at conclusions that make sense to them. A list of the items to consider can be long and obviously vary with the individual but could include asking questions about what to do with the business and how any decisions impact the owner’s family needs. Other less self evident areas include the owner themselves and what they want from their legacy. It also touches who they are as well as their attainment of goals, self esteem, need for recognition, appreciation and self respect.

Owning and operating a business often provides many emotional and life sustaining needs such as job security, retirement, business colleagues, group affiliations, status, recognition, self respect, success and creative energy to name a few. If owning and operating a business provides these, then selling the business requires the business letting these things go and moving to more or equally rewarding opportunities. If you are a business owner planning on selling your business, recognize these areas so you get answers before you start the process of trying to sell and perhaps end up changing your mind. If you are planning on becoming a business owner, recognize these areas will be part of your decision making process as you look for the right opportunity.

The Small Business Administration’s 7(A) Loan Guarantee Program has recently gone through some modifications and changes. These changes include an increase in credit availability for owners of companies with purchase prices between $400,000 and $4,000,000.

The SBA 7(A) program helps small entrepreneurs start or expand their businesses with loans through bank and non-bank lending institutions. Previously the loans only allowed a maximum of $250,000 in intangibles (including goodwill) to be financed. However, under the revised rules, it is now possible to finance any amount of goodwill (even up to this program’s lending limit of $2,000,000), as long as at least 25 percent equity exists in borrower down payment and/or seller stand-by financing.

There is more good news, in that the SBA has temporarily increased its guarantee from 75 percent to 90 percent of the total loan amount, and currently waives the guarantee fee (2.6 percent of the loan amount) charged to borrowers.
For buyers and sellers of a business that want to use an SBA 7(A) loan, it is important to keep in mind that each bank will likely have their own criteria and means it is necessary to contact your bank to determine its specific approach. Some good talking points to help you though include:

1. Cash flow. Remember, SBA loans are cash flow loans, that is, the business must be generating a positive cash flow. Each bank will assess the company’s loan repayment ability using the Debt Service Coverage Ratio (cash available for debt service divided by cash required for debt service). Banks will usually deny a loan if revenues have declined in recent years, although they may make an exception if the company can demonstrate a current stabilization or growth trend.
2. Buyer downpayment. In general terms, a lender will want to see the buyer provide about 20 percent down payment to buy the business. A buyer could then finance the remaining 80% with a combination of the seller carrying a note of say 15% and bank finance of 65%. The buyer downpayment could come from sources such as family gifts, a tax-free rollover of a 401(k) or IRA, or home equity line of credit (as long as the buyer has an additional, unrelated income stream large enough to feasibly pay off the debt). A bank may also accept a seller’s note on full standby, which means the seller agrees to forgo any payments until the senior bank debt gets paid in full.
3. Buyer management expertise. The lender will expect a potential buyer to have extensive and relevant ownership or management experience. In 2007 the SBA did some research to see why businesses were failing with an SBA loan and they found one of the main reasons was a lack of management experience in the industry the business was operating. The lender may waive this in the case of an established franchise, as long as the company is not in the hotel/motel, restaurant, or construction industry.
4. Collateral. The requirement for collateral varies with a bank as does any specific minimum coverage. However, where it is available helps the buyer’s loan application position. Most lenders also favor deals where real estate is available.
5. Buyer credit and legal history. A FICO score of at least 650 is typically required and often higher, that is, 680. A buyer also needs to have a relatively clear legal history.
6. Loan amounts. Although the SBA currently limits loan amounts to $2,000,000 for non-real estate transactions (and up to $5,000,000 for 100 percent real estate deals), it is possible to combine SBA financing with other payment options to accommodate proposals with larger financing requirements. For instance, you can use current asset-based lending or seller financing for this purpose.

 The temporary provisions may only extend through the end of 2010, but Congress is expected to raise the overall guarantee limit to $5,000,000 (with up to a 90 percent guarantee.) In addition, the SBA 504 program limits for 100 percent real estate transactions may increase to $14,000,000.

What are my options if I cannot sell my business?  This current recession is marked by how low the economy has gone, the increase in unemployment, but most frustrating of all, how long it has taken before the “green shoots” appear. If your business is struggling and you think your only option is to close the door and hand the keys back to the landlord, here are some things to consider.

First, it’s rarely as simple as closing the door and handing the key back to the landlord. If your business has a lease you obviously need to discuss the situation with the landlord. If you have a good relationship and feel you can handle it on your own to save hiring help, take care as you handle the issue. Bear in mind the landlord is no different to you. They lease the real estate to make money. If you close the doors, they need to find a replacement for you which may take time to achieve. This can be a talking point with the landlord as you may be able to bring a tenant to replace you. If this is the case, make sure this is correct as the landlord may become frustrated if the person changes their mind. Similarly, the landlord is not required to accept the person you bring so be aware the landlord has options.

Second, and this is the main reason for this article, some businesses are cash poor and so are struggling to keep their doors open. That is, they are unable to generate enough sales to produce the profit that allows them to keep their doors open. However, some of these businesses are rich in assets. If this is the case, a real option is to manage down the assets to either keep the business going or get the best price possible for the assets. Here are some suggested strategies.

If the business has a lot of excess inventory but limited cash, move the excess inventory. This means going through each piece of inventory to make sure it’s in good condition. If its condition is questionable, discount it but get it sold. Better to have a few dollars in the business and free up some space than have it sit around and collect dust. This is especially true if the business is paying to store any inventory as costs can be reduced by eliminating unnecessary storage space.

Most buyers are interested in two things when buying a business; cash flow to service debt and provide an income to sustain the buyer’s lifestyle and potential. Buyers are not excited about buying a business and managing it down to a smaller business. If you own a business that is challenged by cash flow and limited potential, your buyer may be someone in the industry who is looking to add the assets of your business to their business and therefore take you out as a competitor. These buyers can be harder to find and they are almost always only motivated by paying as low a price as possible.