SBA Loan Updates and Changes From October, 2013
SBA loans have become a critical source of finance when a seller wants to sell their business and a buyer wants to buy a business. The SBA or Small Business Administration is a federal government initiative and since the Great Financial Recession has been the primary source of third party finance allowing businesses to be bought and sold.
Just like all things, the program is constantly evolving and changing. Here’s an update on a lot of those changes so you can include them in your thinking if you want to sell your business or are looking to buy an existing business. The SBA program also allows those that wish to buy a brand new franchise qualify for a loan if the franchise meets certain criteria. If a franchise is on your buying list, give me a call on (916) 570-2674 so I can help you find the right franchise with the right finance option.
So what are the ‘new’ changes that you would want to know if SBA finance is part of your deal or answers to some common questions that borrowers like to ask.
- A common question asked is – Can I get an SBA loan to buy less than 100% of the business? The answer is no – the buyer must acquire 100% of the business. Buying say 50% equity in the business is not an option.
- A buyer must have ‘skin in the game’ with some cash as their downpayment. The cash can be in a 401k or IRA plan and follow the rules for using this money.
- The borrower should show they have a downpayment early in the process or the SBA lender will not invest time processing their loan.
- The borrower also needs to have cash available to show they have enough working capital for both the business and to live on personally for a period of time while the cash flow from the business kicks in.
- Some seller finance is becoming the new norm with SBA Loans. Seller finance often means the seller’s note is on full standby for 2 years. Full standby means the buyer doesn’t need to start making any payments on the sellers note including principal and interest for two years as the SBA lender wants the buyer to learn and operate the business as strongly as possible. I just closed a deal where the buyer brought a downpayment of 15% and the seller had to carry finance of 25% with the SBA lender contributing 60%. This transaction took about 7 months to close because the SBA loan process was so difficult; but that’s another story.
- Sellers should be willing to provide strong training to pass the business on to the buyer. The arithmetic is simple – Good seller training = increased buyers chances of success. If the business is a franchise then less seller training is OK because the franchisor should be providing ongoing training. Also, the SBA will not allow the seller to remain as an officer, director, stockholder or key employee of the business.
- SBA lenders don’t like a lot of an intangible asset in the transaction called goodwill. Sellers expect to see a lot of goodwill in a transaction because they think their business does exceptionally well and they want to be rewarded when they sell. If the purchase price includes goodwill that’s in excess of $500,000 the SBA lender will want to see a minimum cash injection of at least 25% of the purchase price.
- A third party certified business valuation from an accredited appraiser to confirm the valuation of a business being acquired by the borrower has been an SBA requirement. The rules have now been relaxed a little if the amount being financed is $250,000 or less as the lender can now perform their own internal valuation of the business saving both time and the borrower some money as they paid for the third party appraisal. The requirements come with a few rules and these are as follows. The lender can perform its own internal valuation if the amount to be financed to buy the business is less than $250,000 and this is calculated by SBA loan plus seller not) minus the appraised value of any real estate and/or equipment.
- If a buyer wants to apply for an SBA loan, at a minimum they will require:
- Credit History
- Liquidity/Down Payment
- A buyer’s credit history remains a key factor when approving an SBA loan. If an SBA lender has no previous lending history with the buyer and they have numerous charge-offs and past dues it will be difficult for the lender to provide finance.
- The borrowers work experience is often subjective but common criteria to make that evaluation include:
- Does the buyer currently own a business?
- Has the buyer owned a business in the past?
- Does the buyer have experience in the industry they are buying the business as an employee in a similar business?
- Will the borrower get sufficient seller training to allow them to be successful.
- Liquidity and downpayment are critical from two perspectives. First, for a lender to approve an SBA loan they need to see the borrower has sufficient cash not only for the down payment but secondly, they also have sufficient cash reserves for the business operations plus their personal obligations. This is part of the reason you’ve heard the expression – cash flow is king.
- An SBA loan provides the lender with a security in the loan to about 75% of its value with the guarantee of the full faith and credit of the US taxpayer. To make sure the SBA helps manage that risk properly, the SBA requires that all available collateral from the buyer be pledged to collateralize the loan. If the buyer pledges all available collateral but it is still not sufficient to “fully secure” the SBA loan, it is then up to each lender to decide if they have sufficient collateral for the request.
If you would like more information about selling a business, buying a business, buying a franchise or a related service such as valuing a business, please visit my webpage Services and choose from the drop down menu the information you would like. If you would like more immediate help, you are welcome to send an email to Andrew Rogerson or give me a call on 916 570-2674.