By: Heather Endresen and Lisa Forrest | Live Oak Bank
Middle market business buyers are faced with many considerations when preparing to buy a business.
The Small Business Administration (SBA) guarantees bank loans to small businesses that meet the SBA’s
criteria. These criteria vary by industry, but are notably more lenient than a bank’s typical loan
standards. Terms are generous, up to 10 years for a business loan with no prepayment penalty.
As a lender who specializes in SBA loan programs to finance mergers and acquisitions, we want to help
you prepare for your next business acquisition. The following six elements outline considerations and
criteria lenders review in any acquisition deal.
Stable or Positive Trend
Lenders like to see positive or stable trends when examining a business’s financials. Positive trends,
while generally a good sign, also require additional diligence to support that any recent growth, or
margin improvement is sustainable. It can also be challenging to value very recent improvement in
EBITDA. Underwriting is based, to a large extent, on historic cash flow analysis and historic debt service
coverage. So, stability in trends are generally the easiest for a lender to have confidence in.
Additionally, revenue concentrations must be analyzed to ensure sustainability risks are fully considered
and that the deal structure helps mitigate any large customer concentrations. Revenues concentrations
in certain industries, such as ties to cyclical industries like new construction, should also be fully
analyzed. A decrease in revenue is a red flag. If the business you are looking to purchase has negative
trends, be sure you can identify the problems and include ways to increase value in your business plan.
Most lenders will want to stabilize, if not reverse, a negative trend before lending.
Buyers are required to provide the bank a basic business and transition plan for the business they are
acquiring. Lenders want to see that the buyer/operator has a clear understanding of the business and
industry. Plan to include ways to improve the existing business where you see fit. Details about the key
transition risks, such as customer and employee retention, or any planned software system upgrades
should be discussed. It is also important to include an analysis of the downside risks to the business and
how these risks might impact EBITDA. Each business and industry has different key downside risks, and
addressing these thoughtfully will demonstrate a very important operator skill to the lender.
Consideration should be given to the planned velocity of change implementation. Lenders will be leery
of a plan that may appear to change too many things, too fast.
When purchasing a business, remember the reputation of the company can be considered an intangible
asset. The staff and community relationships play an important role in the success of the business.
Secure commitments from existing managers and other key staff members. Lenders like to see key
employees stay on with the new owner as it diminishes risk and makes the transition easier for
customers in some cases. It is also critical to understand which employees are critical to customer
retention and to consider appropriate incentives.
Seller Transition Period
Fully understanding the roles and responsibilities of the seller is critical to creating a successful
transition plan. As the new owner, how are your skills going to augment the loss of the seller and/or is
any replacement salary needed to back-fill critical seller duties. Lenders want to see that the seller will
make themselves available for a reasonable period of time to train and assist the new operator. The
transition and training period can be anywhere from one to twelve months, depending on
circumstances. Work with the seller to negotiate the training and transition up front and clearly define
them in the purchase agreement. The Small Business Administration (SBA) rules require sellers to get
out of any key role after 12 months and not roll over any of their equity.
When a seller finances even a small portion of the deal, it shows the lender that the seller is confident in
the new owner’s abilities and leadership. The terms of the seller carry note are negotiated between the
buyer and seller; however, you’ll want to involve your Lender in the discussion early-on to ensure
payment terms meet debt service and cashflow coverage ratios. The seller note can also be used to
protect the buyer from material misrepresentations, or even key risks such as customer retention
through carefully written claw-back clauses. Robust and carefully structured seller financing can often
make the difference in overcoming critical risk factors with the lender.
Experienced M&A Lenders will analyze the operational and transitional working capital needs of the
company. Reviewing monthly P&Ls and balance sheets over a two to three-year period, including Yearto-
Date is extremely important. The deal negotiations should consider how much net-working capital
may be included in the purchase and/or how much working capital needs to be provided in the loan
structure. If there is any seasonality in company operations, that will need to be factored into the
working capital analysis and potentially deal structure/price. If seasonality exists, the closing timing
should be considered to ensure the optimum working capital is available at funding. Lenders will want
the buyer to be able to articulate a clear understanding of the need for, type of (term or seasonal line,
or in some cases, both), and amount of working capital needed for a successful transition and for go
If you are looking to purchase a business using SBA financing, we are here to help. Talk to your lender
about your loan options and how to prepare for financing.
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