Decades ago, obtaining funding to buy a business was nearly impossible. Back in the “old days,” mainly seller financing enabled business buyers to purchase a business. SBA loans were almost impossible to obtain. You had to be turned down at other banks, have enough money to be solvent, and put a nice down payment on the business, but not have too much money. Otherwise, the SBA would feel you did not need the loan. But things have changed, and over the past 20 years, SBA-guaranteed loans have become the primary way business buyers acquire both main street and lower middle market businesses valued between a couple hundred thousand and five million dollars.
Recently, the SBA changed its guidance and regulations, which have impacted both business buyers and sellers. Below are a few recent changes and the impact that professional business brokers feel they might have on the industry and the business selling process.
Number of SBA lenders
Previously the SBA had limited the number of lenders authorized to make SBA-guaranteed loans. But ever since the PPP loans were initiated, the SBA has approved more lenders and opened the program to FINTECH, or financial technology companies. Now we have local community banks, larger regional banks, nationwide banks, and online financial service companies that can fund SBA loans. In theory, a greater number of lenders should make loans more available, create more competition between lenders, and make the application and approval process easier. But one word of caution to both business buyers and sellers. You need to ensure that the lender doing the loan for your transaction has done hundreds of previous deals and that you have a point of contact or representative to deal with personally when issues arise. Because with business acquisition loans, issues come up.
A change in criteria
The SBA is trying to streamline the evaluation of borrowers by eliminating certain criteria. Before the new rules, nine factors were considered when evaluating potential borrowers, but now, they focus on three. These include the business buyer’s credit report, the business’s cash flow, and the equity (down payment) and/or collateral. Gone are previous considerations like the character and reputation of the buyer, which the SBA felt could be used to discriminate against certain groups of buyers or create a bias in the lending decision.
Other changes of note
The definition of a “small loan” has been changed from $350,000 to $500,000. SBA has programs that streamline these smaller loans, and the increase will help more business buyers qualify for these loans. One notable advantage to these smaller loans is that additional real estate collateral is not required.
Sellers who sell their company, and retain a small percentage of ownership, can now stay on with the company longer than a year. However, the seller can only own up to 19% of the company; otherwise, they must sign and be responsible for the buyer’s business acquisition loan.
Sellers who take back a note where the buyer’s equity was less than the lender required previously were put on a full stand-by basis for ten years. Meaning if the buyer put down 5%, and the lender needed 10% down, the seller could carry a note for 5%, which the lender would count towards the down payment. But the seller was prohibited from collecting any principal or interest for ten years to ensure the business had enough free cash flow to service the SBA loan. Now, that full stand-by is only two years.
Perhaps one of the most significant changes is to expansion loans. If a buyer who owns an HVAC company wishes to buy another HVAC business in the same geographic region, this can now be done without any down payment by the buyer. The buyer and the acquired business must share the same NAICS classification category and be in the same geographic region.
Check with your SBA preferred lender on these changes and any other requirements. Some lenders might only adopt some changes and stick with their previous credit policies. And some of the changes are either proposed or suggested, and some might not come to fruition.
So, what does this all mean to business buyers or business sellers? Of course, over the past year, the interest rates on business acquisition loans have doubled, along with the prime rate. But these proposed changes should be good news for both buyers and sellers and hopefully open the program up to allow more buyers to achieve the American Dream of business ownership.