Most businesses have intangible assets that are difficult to value and nearly impossible to collateralize. You will hear terms like “blue sky” or “goodwill” to describe these assets.
Due to the more flexible collateralization standards associated with U.S. Small Business Administration (SBA) loans, these assets can be financed along with the more tangible assets that are a part of the business acquisition. This is just one reason why a business owner should consider an SBA loan for a change of ownership or business acquisition, over a conventional loan.
Smart Business spoke with Mitch Kendall, vice president of SBA/business lending at Ridgestone Bank, about the advantages of utilizing the SBA for business acquisition financing.
Beyond flexible collateralization standards, why else are SBA loans more attractive?
Conventional loans for business acquisitions are based on a three- or five-year term. This can make it tough for the business to meet the debt service requirements of most lenders. Utilizing an SBA loan, the acquisition can be stretched out over seven or even 10 years. This lowers the payments and makes it easier for the borrower to hit the debt service targets of the lender.
Stretching out the amortization of the loan also frees up additional cash flow for the new owner of the business. He or she may then use that cash flow to invest in marketing, implementation of new initiatives or adding a product line. Cash flow is king.
In addition, long-term amortization can help with the ebbs and flows of business that inevitably arise. If you are in a downslope when a three-year conventional loan becomes due, the bank might put you in forbearance or impose monthly renewal fees. With the SBA, you have something in place long term.
Is seller financing sometimes involved in a business acquisition?
Yes, quite often. With SBA financing of a business acquisition, a seller’s note can be used as a portion of the required equity injection.
Typically, lenders in a business acquisition scenario prefer a 25 percent equity injection from the borrower. This can be a tough requirement for many borrowers. If the seller agrees to hold back a note, and it is structured correctly, that note can be counted as part of the borrower’s equity injection, thus making it easier to come up with the needed equity.
Also, the sellers are often sole proprietors or family businesses and they want to see their legacy carried forward. Keeping the seller engaged assists the buyer in making the transition and assures the bank there is a team in place that can make it longer term.
What was the change the SBA made to its ownership rules and why?
The SBA removed the liquidity requirement a few years back. Without that requirement, the SBA made it possible for businesses with owners who have strong liquidity to obtain financing through an SBA loan. Removing the liquidity requirement allows borrowers who may not have good liquidity to bring an equity partner who has liquidity to the table to help them get an approval.
The reason the SBA made this change was to provide borrowers more flexibility in how they can structure their business when they seek SBA financing.
When business owners use an SBA loan for a business acquisition, what do they need to understand about the lending process?
Business acquisition loans are complex. Anyone who is considering utilizing bank financing for a business acquisition should engage his or her banker early in the process. Ideally, before you even start negotiating with the seller.
Your banker can advise you on areas where you can be flexible in negotiation and areas where you need to be less flexible. He or she also can alert the buyer to some of the pitfalls to avoid.
Since a lot of information will be needed from both parties, the sooner documents are provided, the easier the process becomes. Also, be sure there is open and honest communication from the start. Don’t leave any surprises to the end, or your financing can be delayed or compromised.
Always make sure you are dealing with a lender who has SBA experience and a bank that is a preferred lending partner with the SBA.
Insights Banking & Finance is brought to you by Ridgestone Bank