The process of buying a business is anything but simple, and one of the toughest parts is determining how you are going to fund the purchase.
Unless you are sitting on a pile of money and can simply write a check, you will need help from outside sources. That capital can come from many sources: outside investors, mezzanine debt, private equity or bank financing.
Bank financing is an often-overlooked option. Sometimes that’s because the buyers do not have the necessary collateral. But many buyers overlook banks because they are not aware of the lending options that are available to them.
SBA to the Rescue
The purchase of a business frequently involves buying the business enterprise value—a good deal of which may be made up of “goodwill.” Bankers will refer to this component of the business as “blue sky,” because in a liquidation scenario—i.e., the buyer defaults on the loan and the bank has to sell the company or its assets to recoup its loss—there is no “real” value. However, the business enterprise value is often how these companies are valued and sold.
When I meet with borrowers who are interested in purchasing a business, they may look to their personal financial statement for collateral to pledge. If they lack sufficient assets, they will assume there are no other options.
This is when we turn to the U.S. Small Business Administration for help. The SBA has multiple loan products that allow a bank to provide capital to a borrower who may not be fully secured.
In fact, using an SBA loan to facilitate an acquisition makes perfect sense. The SBA provides a guaranty typically equal to 75 percent of the loan request. This guaranty helps to shore up any collateral risk that may be present in a business acquisition.
Down Payments and Terms
The SBA also allows for flexibility on the down payment requirements.
For acquisitions in which there are intangible assets of less than $500,000, the SBA does not have specific down payment requirements. It is really up to the bank’s comfort level and internal policy.
For acquisitions that involve more than $500,000, the SBA does require 25 percent down payment from the borrower. However, the SBA will allow seller carryback debt to count as equity if the payments are structured correctly.
To explain, a seller carryback loan is when the seller of a business does not require 100 percent of the sale proceeds up front, but rather takes a portion back in the form of a loan owed to the seller from the borrower.
Well, if this carryback is structured so that no payments of principal or interest are due in the first 24 months of the loan, then that can be considered equity down from the buyer. This is a wonderful tool that allows borrowers who may only have 10 to 15 percent in cash down to ask the seller to carry back the difference and satisfy the SBA loan requirements.
Additionally, the SBA allows for more flexible terms that can help keep the buyer’s monthly payments low. For transactions that do not involve the purchase of real estate, the SBA permits terms that are as long as 10 years. And if real estate is being purchased, the terms can extend as far as 25 years.
Find the Right Partner
The key to all this is finding a bank that really knows SBA and has funded these types of loans in the past. To do this, you can simply call the bank and ask about their level of experience. Or better yet, talk with the SBA’s local office, and the staff there can provide you with lists of the top-performing SBA banks in your district.
Although buying a business can be an intimidating process, finding a solid bank partner—one that can fully utilize SBA programs—will give you peace of mind and properly structure your financing to ensure your new business is a success.