SBA Facilitates Business Sales
Business sales financed by the Small Business Administration (SBA) often allows buyers the opportunity to purchase the business of their dreams. Banks are encouraged to make small business loans by the government through the SBA program for the purpose of facilitating economic growth. Sellers of businesses may take advantage of SBA-backed lending to realize a premium purchase price for their business with more favorable terms. It is essential that both parties understand the general terms and potential pitfalls of SBA-backed business sales.
How Buyers Use SBA
- The SBA is the mechanism by which many buyers seek and obtain loans with which to purchase businesses.
- The SBA essentially acts as the guarantor of the loan.
- The loans are administered by banks with whom they (and the buyer) do business.
- The purpose of the SBA is to enable buyers to more easily purchase businesses and thereby facilitate economic growth.
- The standard 7(a) SBA business loan has a maximum loan amount of $5M and guarantees 75% of the loan amount after a minimum amount of $150K.
- It should be noted that a buyer will incur significant appraisal and administrative fees when using an SBA-backed loan.
Seller Must Agree to SBA Financing
The seller of a business must be aware of the advantages and disadvantages of agreeing to a purchase agreement or LOI that is contingent on a buyer receiving SBA-backed funding. The advantages of agreeing to SBA financing for the seller are being paid (mostly) in cash at closing, as well as allowing many more potential buyers a realistic way in which to fund the purchase. This makes for a much quicker sale. On the other hand, the SBA lending process is lengthy and intrusive, and some buyers may not qualify for the loan as measured by SBA standards. Business owners need to be aware that an SBA loan ultimately depends on an appraisal of the business, and the seller may be required to accept a small amount of seller financing depending on the structure of the deal.
Buyer Needs to Qualify with SBA
The initial SBA loan application process includes the buyer giving a resume or description of their prior work history and education. For many businesses – particularly in the construction or health-care related industries – the SBA will require that the loan applicant show proof of specific work history in relation to the business being purchased. For example, a buyer seeking to purchase a large kitchen and bath remodeling company through an SBA-backed loan typically is required to either have a trade license necessary to run the business (such as a General Contractor license) or to have specific work history in a construction-related industry within the last five or so years. The SBA realizes that the loan is far more likely to be repaid if the buyer has relevant work experience or industry knowledge.
The SBA Uses Appraisal
After the buyer is initially told by the bank that they are preliminarily qualified to proceed with the loan and after the buyer and seller agree on a letter of intent or purchase agreement, the buyer orders and pays for an appraisal. An appraisal is a very involved business evaluation conducted by an agent of the bank or SBA. The SBA uses the appraisal to determine how much funding they are willing to commit to the loan (this amount is ultimately expressed in the loan commitment letter) . The appraisal fee can amount to several thousands of dollars depending on the type of deal in question. It is a non-refundable expense for the buyer
Factors Used in Appraisal
- The main factor used in the appraisal is the financials of the business.
- The financials include the tax returns and profit and loss statements for the last 3 years or more.
- The appraisal does not typically take into account personal expenses that the owner may have used as business expenses nor does it take into account unrecorded sales.
- The physical equipment and leasehold improvements are also major considerations as that is collateral that the SBA can use against the value of the loan.
- Lastly, the SBA often may require that the business has a long term lease in place (sometimes as much as 10 years!), especially if the business in question is in the retail industry.
Seller May Be Required to Seller-Finance
Like any lender, the SBA will want the loan to be repaid. In accordance with this goal, the SBA will want the seller to have some ‘skin in the game’ after the closing. This is crucial for any business where the seller himself or herself is an instrumental part of the success of the business. The SBA (and most buyers) will want sellers to pave the way for a smooth transition so the business does not lose any customers, suppliers, or employees after the sale. In structuring an SBA-backed deal with seller financing, the SBA typically mandates that the Seller’s Note has certain terms that are (to put it mildly) unfavorable to the seller. In the case of a default, the Seller’s Note (typically 10 percent or so of the purchase price) is subordinate to the SBA’s loan.
Stand-By Provision
Moreover, the seller’s Note also may have a stand-by provision. A stand-by provision requires that the payments towards the seller’s Note (owed to the seller by the buyer) not begin for a set period of time after the closing. The ‘stand by’ period may be two years or more. The reason for the stand-by provision is simple: The SBA wants to get paid first!
A professional business broker should always educate both buyers and sellers about the general provisions and timeline of an SBA-backed business deal. This way, there will be no surprises and each party can best take advantage of SBA funding.
Give Martin at Five Star Business Brokers of Palm Beach County a call today with questions about the SBA process if you are a buyer or a seller of a business.