In ten years of selling private businesses, financial leverage has consistently been one of the key success factors in expanding the pool of buyers and closing deals. Fortunately for business owners, the SBA loan guaranty program is an excellent funding source for deals up to $5MM. And, lenders are lending now. A lender analyzes both the buyer (borrower) and the business being purchased. Here are 10 things lenders look for when evaluating a loan request for a small business sale/acquisition:
1. Down Payment. Lenders want a buyer to inject 15%-25% of the total project in cash, depending on several factors including whether real estate is included in the sale. Common down payment sources are retained earnings, savings, retirement plan funds and gifts from family members. Your cash injection cannot be borrowed.
2. Creditworthiness. Lenders investigate a buyer’s credit at the outset of the approval process. A bankruptcy, foreclosure or judgment usually nullifies their chances, no matter how good other criteria look. Remove blemishes from your credit history before you apply.
3. Track Record. Individual buyers must have experience in the type of business and/or industry they are buying into. Lenders look for management experience, and they prefer to see prior business ownership. Tailor your resume to highlight your management and applicable industry experience.
4. Cash Flow is King. Business cash flows must service the loan and provide adequate income for the owners. Lenders analyze the historical tax returns of the business—allowing reasonable adjustments for owner perquisites and non-recurring costs. The quality of financial records comes into play here. Your business plan also comes into play. Synergistic benefits, increases in working capital and capital expenditure needs are considered in the cash flow calculation.
5. Collateral. Buyers with real property to pledge as collateral may compensate for weaknesses in debt service coverage, business assets, experience, credit, or liquidity. Generally, if you have equity in real property, the SBA requires that it be used to secure your business acquisition loan.
6. Positive Trend. Nothing scares lenders more than negative sales and earnings trends in a business or its industry. Conversely, a pronounced positive trend is a thing of beauty to a lender. They often look back several years to see how the business performed through past economic cycles.
7. Business Plan. Buyers have to submit a basic business plan for the business they are acquiring. Lenders want to see an intimate understanding of the business and industry. In most cases a plan calling for modest growth and incremental change is your safest bet.
8. Continuity. Commitments by existing managers, key personnel, suppliers and customers to continue with the new owner represents reduced risk to a lender.
9. Seller Training. Lenders want to see a well thought-out management transition plan. The training/transition period can be anywhere from 1-12 months, depending on circumstances. Be sure you negotiate this point up front and clearly spell it out in the purchase agreement.
10. Seller Financing. When a seller finances even 10-15% of a deal, subordinated to the bank note, it shows the lender that the seller is confident in the business under the buyer’s leadership. This deal point is commonly imposed by lenders.
Finally, for loans over $350,000, or whenever a buyer and seller have a close (non-arm’s length) relationship, SBA lenders require a fair market value appraisal from an accredited business appraiser to validate the borrower’s purchase price. The deal can’t exceed the appraised value. Sellers are advised to prepare months or years in advance, to increase their odds of cashing out when they are ready to exit. Ask yourself, does my business qualify?
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Al Statz, CBA, CBI, is President of Exit Strategies Group, Inc., a business brokerage, merger, acquisition and valuation firm serving owners of closely-held businesses in Northern California. He can be reached at 707-778-2040 or email@example.com.
The North Bay Business Journal, a publication of the New York Times, is a weekly business newspaper which covers the North Bay area of San Francisco – from the Golden Gate bridge north, including Marin and the wine country of Sonoma and Napa counties.