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Financing Small Business Acquisitions/Startups
Once again, the emphasis is more on acquisitions than startups; but the general themes are the same.
To start, getting a lender to provide funds for less than $100,000 is not likely to occur. Sometimes, the higher the amount you can legitimately justify, the more interest you will have from traditional lenders. Whether it is true or not, part of the issue is that the business that requires less than $100,000 is less likely to survive, and risk is the most key element in all lending decisions: Can you/your business survive long enough, and with sufficient cash flow to pay off the note; and if not, do you or does your business have sufficiently valuable assets for the lender to liquidate those assets and recover the majority of the money it loaned?
There are all kinds of gyrations of deals. What will be discussed here are the major considerations. Yes, you have a brother, who knows a sister of the mother of the guy that borrowed in a different way… Then stop reading and go talk to him! This is Real World stuff here and not based on Lotto-type odds.
How much money will you need down? That is usually the first question we get.
The answer is all over the place. With the SBA, you can potentially get in with 10% down, particularly if you can get the Seller to provide a note for another 20%. What that means is that you normally need 10% of your own money. Any lender wants to know that you have “some skin in the game”. Getting in for no money down is a pipe dream, and we have written a post on that very issue, elsewhere in this blog. Even if you are not looking for a “no money down” deal, you should read that post, as well. There is additional insight that is important, but that we will not repeat here.
Stated another way, the SBA will readily lend 80% of the acquisition for a qualified business and business operator. With your own 10%, that leaves 20% due to the Seller. The idea is to ask him/her to finance that amount so that you then have 30% to bring to the SBA.
There are at least two areas of caution, in doing things this way. First, you then have two loans: One to the SBA/Bank and the other to the Seller. You need to make certain that you have the Cash Flow that will permit you to make uninterrupted payments to both, every month.
Second, the Seller may balk when he understands that the term of your loan with him MUST match those of the loan with the SBA/Bank. That means that if your institutional loan is for ten (10) years, you cannot sign a financing agreement with the Seller for a loan of anything less than those same ten (10) years. And you cannot have a prepayment arrangement with the Seller that will shorten the term of that note, such that it is paid off before the SBA loan is paid. The loan documents with the SBA will demand your signature and agreement, under some serious penalties, if abridged!
For small businesses, the SBA is unquestionably, undeniably your best bet! Commercial Banks do not want to deal with small business loans, without SBA cooperation. Keep in mind that the SBA does not LEND money; it GUARANTEES loans, which are then actually funded by a Bank. (This is why we stipulate the term “SBA/Bank”, in some of our post.) This goes back to the issue of risk, expressed earlier in this post. Banks generally DO NOT take risk. This is why you cannot get a direct Commercial Bank Loan, without SBA participation.
Angel investors? Sure, they exist. Bridge Loans? Yep. Mezzanine Funding? Oh, yes. Private Lenders? Unquestionably. They all exist. But they are also incredibly hard to find, they are often exceedingly picky in what they will fund and their terms are normally extremely high. They will also, frequently demand some semblance of control that most Business Owners find to be unreasonable.
Other ways of getting loan money, either for down payments or direct loans are those from friends and family. They are your best bet for smaller amounts…unless you have a filthy rich Uncle Ted, who will lend you the big bucks!
Historically, some Credit Card companies would lend to some small business Buyers, if the Buyer would sign long term contracts with that Credit Card Company to process its charges. We have no idea how that worked out, or whether it is even still going on. The charges would probably be higher than you would normally receive from Card companies without a loan, and it could even be more financially problematic and costly than a conventional loan scenario. But it may be worthwhile to pursue; HOWEVER, WE WOULD ONLY CONSIDER THAT WITH THE APPROVAL OF BOTH YOUR ACCOUNTANT AND ATTORNEY. Anything unconventional is frequently unconventional because it is fraught with risk!
So, the SBA is still your best bet. And there is a LOTof erroneous information about SBA loans out there. Some of these are:
- SBA Loans take forever to obtain. Not true. SBA loans can be obtained in as little as 45 to 60 days by competent Banks or Loan Brokers – and Loan Brokers are sometimes much better than the Banks, themselves. (But do not agree to application fees in advance, unless it is going directly to the Bank that the Loan Broker has selected.) Most of the delays are caused by people that do not know how the loan application process works, and who provide information that is incomplete. Some of those people are the Bankers, themselves!
- SBA is not processing loans. There was some time when the process was slowed to almost a grinding halt, after the 2008 economic meltdown. Most of the refusals by the SBA at this time have to do with the perceived viability of the business. The SBA will not come to terms on a loan for a business with a poor financial history. It will not lend to a borrower with a poor credit history record, and it frequently will not lend to someone who has no experience that demonstrates that he/she can operate a successful business. In January of 2010, we were involved in a teleconference with the regional SBA Representative herself; she expressed delight about the acquisition application we were attempting to present to her. She said it was the first business application forwarded to her in eight weeks that did not show a loss, or an history of eroding Revenues! We got the loan approved for our Client!
- The paperwork is horrendous. So, you want them to offer you $500,000 on the basis of your smile? ANY lender is going to require a lot of paperwork! YES the paperwork is tedious! But if you do not want to actually work to get the business, why should lenders give you money that would actually require you to work, in order to pay them?
- SBA Interest and Points are high. They are lower than those offered by Benny, the local loan shark! They are usually lower than Angel Investors require; or those of Bridge and Mezzanine Loans. And you cannot get a Commercial Loan. Even without those comparisons, SBA loan terms are actually, very affordable.
- The SBA will not guarantee loans for the purchase of some businesses. Correct. The SBA will not consider loans for illegal businesses. But your bigger concern is the Bank that actually processes the loan. Some Banks, for example will not lend for Gas Stations that include the Real Estate; the concern is over EPA issues and liabilities. (Remember, the Bank takes no risk!) Others will not lend on the basis of a Restaurant purchase, because of the high failure rate of Restaurants. Many Banks have specific percentages of loans to be undertaken within their “portfolios”. In that case, a given Bank may decide that it will not devote more than 10% of its loans to Convenience Stores; once it lends to that limit, it turns down applications for more Convenience Stores without even looking at them.
Some Banks are less efficient with or knowledgeable SBA loans. So, if you get vague answers from one Bank, talk to another. The first question you would want to ask is whether that Bank is part of the “Preferred Lender Program”. Those Banks are specifically skilled and certified to streamline SBA loans and are, by far the more qualified to answer your questions.
Loan Brokers can be your best friend, in “packaging” your loan application and getting to the Bank with the best chance of getting you funded. We would shy away from those requiring up-front application fees; all are going to require that you sign an agreement that demands payment, if and when you actually get your financing. The fees vary and are usually negotiable.
Your application will require at least the following:
- A formal Loan Application, and SOME banks will require an application fee.
- A Personal Financial Statement, listing your current Assets and Liabilities; this will usually also require a list of your personal, monthly expenses, so the SBA knows that the business will provide you with sufficient Cash Flow to minimally pay your Personal Expenses, as well as the Business Loan Payments.
- Three (3) years of SIGNED CORPORATE Tax Returns from the Company you are purchasing. If the business has been in operation for less than three (3) years, it could be a problem for you to get funding.
- Financial Statements of the business on a Year-to-Date (YTD) basis that must represent information that is no older than 45 days. If your loan gets hung up by a Bank Loan Committee or for some other reason, the SBA/Bank will frequently ask for updated documentation. This does not mean your loan is in trouble and you should not get frustrated, anxious or angry. It simply needs current information so the lender knows, among other things, that the Seller has not dropped the ball and allowed the business to sink, now that he/she thinks a sale is imminent. You will want that assurance, as well.
- The Seller’s W-4 forms for those same three (3) years may be required, if the Seller has put him/herself on a formal payroll.
- Two (2) years of your own SIGNED Personal Tax Returns. Frequently, the Bank wants to know that you have actually filed, so it is not lending money to an individual who will have his/her business taken over by the IRS, for tax reasons.
- Copies of Bank Statements, Stock Statements and other documents that verify the Assets you have listed on the Personal Financial Statement. These should be no older than 45 days. If your loan gets hung up by a Bank Loan Committee or for some other reason, the SBA/Bank will frequently ask for updated documentation. This does not mean your loan is in trouble and you should not get frustrated, anxious or angry. At the time the decision is made, the Lender simply needs information that attests to the validity of those Assets, and they must be in your possession within a 45-day time limit.
Business Plans are FREQUENTLY required, and ALWAYS required if your loan is for a startup. (See our previous posts on Business Plans.) At the very least, the SBA/Bank will normally require a three (3) year Pro Forma P&L, which projects your objectives for the upcoming years in terms of Revenue, Expenses and Profit/Loss. The lender wants to know your level of confidence, competence, knowledge of the business you are attempting to purchase and your full understanding of your financial commitment.
The actual funding of the loan is always fun, with the number of papers that need to be signed. Most of these are Government-required and many are there to again make certain you fully understand your responsibility and the terms under which you are taking the loan. Our favorite is the one that you sign to swear that you are you, that you are giving yourself permission to initial areas where a signature could be required and that the signature and initials are yours and yours alone… Okay, that is an exaggeration – but only by a very little bit!
One last note is that there are a number of private Loan Companies and Loan Brokers that are saying they can get you a loan by using the Assets of your 401k. UNDER NO CIRCUMSTANCES DO WE RECOMMEND THIS!!! It may well be a perfectly legal strategic move; we simply do not believe it is smart business.
(Receive in-depth, personal consulting online, with The BAF Group’s principal at https://clarity.fm/donaldbarrick .
The BAF Group LLC is a full service Business Brokerage, with a history of more than a decade of service. Its Principal Broker possesses 25+ years of Business Sales and Divestiture. Although most of our work is involved in the Mid-Atlantic States, we have represented Sellers and Buyers throughout the Continental USA, and a number of overseas Buyers, as well. Some of our listings and additional information about us can be viewed at www.bafgroup.com. Thank you for your interest.)