There are so many pieces to the moving puzzle of an acquisition that many times the most important factor is left unaddressed. Where is the money? This can make all the difference between successfully selling your business and watching the deal fall apart at the last minute. A tool for buyers is financing, and it can be shaped from a variety of sources. Arguably the most common is the Small Business Administration -- SBA -- Loan.
The most attractive feature of an SBA loan is the instrument’s guarantees to financial institutions, who acts as the lender in these cases. If each institution acts as a lender, then it is able to mitigate the risk from buyers (like defaulting on the loan). The institution is also able to adjust lending requirements to meet risk comfort levels.
Founded in 1953, the Small Business Administration holds the duty of aiding small businesses across the United States. The four-pillar functions of the organization are as follows:
Small Businesses Advocacy. A major role, to testify and review legislation for small businesses. The SBA also helps institute research for US small businesses.
Development of Entrepreneurs. Coaching and mentoring are also features of the SBA to new entrepreneurs across the country.
Financing Businesses. Whether it is equity, debt, or any other financing option, the SBA is there to help.
Government Contract Work. The goal of 23% prime contract dollars for small businesses remain the goal of the SBA in conjunction with other government organizations.
REQUIREMENTS FOR STANDARD LOANS
Every lender technically can pick which businesses to fun, but these general guidelines are followed:
CREDIT FOR PERSONAL MATTER
The borrowers group (or individual) with above average credit, above the 650-690 range.
LOI - LETTER OF INTENT
An executed letter of intent between purchasing parties bodes good news between the buyer and seller. While these may be uneasy for both buyers and sellers, the SBA considers it nearly essential. A common remedy is to include language in the LOI that the offer is contingent on receiving SBA financing.
BORROWER INFORMATION FORM
Form 1919 is used to collect data on the crucial players in the company.
PERSONAL FINANCIAL STATEMENTS
Form 413 relays financial data on the borrower, partners, and anyone with more than 20% ownership equity.
PERSONAL/CORPORATE TAX RETURNS (THREE YEARS)
Tax returns from the business are generally preferred over personal returns.
BUSINESS FINANCIAL STATEMENTS (THREE YEARS)
Standard financial statements: Balance Sheet, Profit & Loss, and Cash Flow Statement.
Lists all of the debts and liabilities of the company.
EXPERIENCE OF MANAGEMENT TEAM
The borrowers need to instil confidence to the lender in its ability to operate the company. Industry experience is typically required.
DEBT SERVICE COVERAGE RATIO
The cash ratio available to service debt and interest payments, prefered to be 1.15 or higher, calculated by dividing Net Operating Income by the Debt Service.
Lenders hold firm with borrowers bringing stakes to the table at 20%, although 10% is not uncommon.
TYPES OF SBA LOANS
As discussed at the onset of the article, SBA loans offer many advantages, over of which is an extended 25-year repayment term and lower rates. The types of SBA loans are as follows:
CDC/SBA 504 LOANS
Reserved for companies searching for purchases or building already occupied commercial real estate. The two types of lenders who offer this SBA loan are traditional (lend up to 50%) and community development corporation, CDC (lend up to 40%) For CDC, the remaining 10% is required to be brought to the table from the borrower. Said borrower is required to occupy 51% of the commercial real estate and may rent out the remaining 49%. CDC rates are fixed. Borrowers can take out various 504 loans for multiple projects simultaneously. Additional borrow requirements include:
Able to repay the loan based on forecasted operating cash flows
Net worth < $15M
SBA EXPORT LOANS
Designed to aid small businesses expand their export activities. The SBA examines every working capital loan and ensures interest rate is reasonable. Repayments are monthly, with estimated time to funding from thirty to ninety days. Export loans come in three flavors:
Export Working Capital Loan: if the small businesses has a purchase order from a foreign customer.
Export Express Loan: up to $500,000 for working capital to help with export activities.
International Trade Loan Program: For businesses that need funding for working capital or fixed assets or if a business was negatively affected by imports.
SBA CAPLINES PROGRAM
Created for businesses that required a revolving line of credit for recurring payments. They cover up to $5 million and are typically issued to borrowers along with the traditional 7a loan or the SBA 504/CDC loan. This allows owners a degree of freedom to cope with ad hoc and capital needs. Also available is the Small Short-Term Line of Credit, with a cap at $200,000 and lower servicing requirements.
The five credit products available from the SBA CAPLines program include:
Builders Line of Credit: $5 million for contractors that build/renovate residential/commercial buildings.
Small Asset Based Line of Credit: $200,000 for transitioning short term assets into cash.
Seasonal Line of Credit: $5 million for seasonal increases in inventory, AR, or labor.
Contract Line of Credit: $5 million for labor and materials for contracts
Standard Asset Based Line of Credit: $5 million for transitioning short term assets into cash.
Designed for small businesses that need to finance working capital needs, 7A loans are one of the most common. Flexible for use on almost any business need, with long repayment terms and low interest rates (depending on the borrower’s credit score and the repayment term.)
Inside the 7A program, two subsidiaries reside. The SBA Express Loan Program, created to give borrowers needing $350,000 or less from certain lenders an expedited process as opposed to the standard 7A loan application can take months to process. Additionally, the Express Program guarantees feedback to every application within 36 hours, although processing and funding may take longer. Lastly, the Advantage Loan (SBA guarantees up to 85% of loans up to $250,000), designed for companies in underserved markets and who meet the requirements but have low revenues, low collateral or another factor blocking qualification from the normal 7A loan.
Designed to help businesses recuperate from a physical or economic disaster. Multiple loans can be applied for simultaneously.
The Military Reservist Economic Loan provides aid when a company loses an essential employee due to being called to active duty.
SBA MICROLOAN PROGRAM
Created to provide funds to non-profit lenders targeting non-profit child care centers and for-profit small businesses. However, these loans are not guaranteed by the SBA. The non-profit lenders can start by borrowing $750,000 from the SBA in their first year of business. Subsequent years increase to $1.25 million.
Interest rates can be set by the non-profit lender based on the credit of the borrower and business circumstances.
While the name might sound less than grand, small businesses provide the backbone of an economy. It is difficult when they have to face the harsh realities of obtaining the financing necessary to grow and succeed. Venture capital is likely out of the question and neighborhood banks aren’t as flexible to invest in small businesses these days, which why it's common for business brokers to routinely work with buyers that acquire businesses through SBA financing. In steps the SBA to reduce risk for institutional lenders, guaranteeing partial loan repayment and giving small businesses the opportunity to obtain funds. Everything else equal, the means to scale one’s business should not be limiting factor in competing in the marketplace.
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