4 Reasons to Use the SBA to Finance Business Acquisitions

October 6, 2017

4 Reasons to Use the SBA to Finance Business Acquisitions

 

Have you ever had to turn down a borrower that wanted to buy a business, because the physical assets didn’t cover the requested loan amount? You’re not alone. But, if your traditional approach to acquisition financing leaves you turning away too many opportunities, take a look at what you can do with the help of the SBA.

 

In business acquisitions, a successful business will have a value greater than the sum of the physical assets. Most lenders have difficulty financing enterprise value, sometimes referred to as “goodwill” or “blue sky.” But, most borrowers need a financing package that covers more than just the physical assets of the business. I’ve found a good rule of thumb for deciding how much financing to offer a prospective borrower.

 

Start with the purchase price of the business, add an adequate amount of working capital (do not short change your borrower here!) plus the closing costs, then subtract buyer equity injection, seller financing, and other forms of debt from the total.

 

Does this sound different from the conventional loan formula you’re currently using? The problem is, conventional loans don’t offer enough flexibility because enterprise value, working capital and closing costs rarely have any collateral attached to them.

 

Let’s say a successful business has a value of $2,000,000, and also working capital needs and closing costs of an additional $250,000. But, the business only has $1,000,000 of physical assets. How does a community bank fund the large gap? Most individual borrowers, even experienced, successful borrowers, will not have $1,500,000 (or more) to inject into the business.

 

Do community banks really want to walk away from opportunities to help successful local businesses continue beyond the working career of the current owner?

 

The financing package you offer to a prospective buyer is a critical tool to support the health and growth of the business. This, in turn, imparts numerous benefits to the local community. Here are four important ways an SBA loan can help.

 

1. Intangible assets. Most businesses have non-physical assets like intellectual property, client lists, customer relationships, processes, and goodwill that are clearly beneficial to the success of the business, but have no collateral value. SBA 7(a) loans are structured around the cash flow of the business, not the collateral. The program has no specific loan-to-value requirements, and it is possible to loan $2,000,000 (or more) on $1,000,000 (or less) of collateral. In recent years, the SBA has removed limits on the amount of intangible assets that can be financed, although there are special rules for amounts greater than $500,000.

 

2. Working capital. Proceeds from an SBA 7(a) loan can be used for permanent working capital needs to cover things like the start-up of seasonal operations, rapid growth, inventory purchases, payroll and overhead expenses. These items have little or no collateral value, and they are also difficult to finance with short-term lines of credit as they cannot usually be repaid within 12 months. The loan can be structured with a 10-year term to give the borrower ample time to repay the debt, while allowing the business to accumulate cash.

 

3. Closing costs. Borrowers can roll closing costs into an SBA loan, helping them to retain more cash. As the old saying goes, “cash is king.” Allowing the borrower to keep their cash to ensure a smooth start-up for new operations, weather any unforeseen problems and fund receivables and inventory growth is essential to ensuring a good start in their new business, without the unnecessary stress of worrying how to make payroll twice a month.

 

4. Longer terms. SBA loan repayments can be stretched out up to 10 years, which provides significant advantages to the borrower. Longer terms lower the monthly payment and allow for better cash flow. This can be critically important for borrowers that may encounter a revenue slowdown during the transition period, or for those who are buying a seasonal business. The goal of any loan structure, in addition to the repayment of the debt, should be to assist the borrower in accumulating cash. This provides adequate capital to withstand business cycles, replace worn out or obsolete equipment with minimal borrowings, and have cash to grow the business without overextending a line of credit.

 

Every acquisition is unique, and has its own complexities. VITAL is an experienced Lender Service Provider, and we are experts in using SBA programs to finance business acquisitions – and structuring the debt to help preserve the health of business for many years after the initial acquisition. Contact us any time.

 

Tags: SBA Loan Business Acquisition