Sorry for advance for the lengthy post. There have been several topics specific to SBA loans posted recently that addressed concerns that likely should have been addressed by the lender prior to closing. Additionally I have been fielding emails and calls from former contacts that closed SBA loans with other institutions but that are looking for help post- closing (re: working capital, personal mortgages, etc.).
Given the topics discussed in these posts I thought it was worth posting some commentary from a session I did a few months ago. The session covered many topics but the main focus of this post will center on working capital, business acquisitions with real estate included, and generally your overall relationship with a bank when borrowing with an SBA loan. Feel free to email me or DM if you have any questions or concerns on these topics. Topics for discussion: 1. Working capital • Inventory a) How much do you need v. how much the business normally carry? Is it included in the purchase price or are you buying it on top of the EBITDA multiple? Most businesses today are cash heavy an inventory management isn’t a priority. You might be buying excess inventory which can hit your cash flow. b) Is there aged inventory you are paying for that will end up being written off? If so you are paying for the seller’s mistake.
c) If you are paying for inventory, what timeframe will you have it in your possession? If you pay for inventory and it takes 6 months to cycle, you just hit your return. **main point is to figure out how much you need v. how much they have today or what is “normal.” If there is excess or if some inventory sits on average for a long period of time then have the seller carry it until it is sold.
• Accounts Receivable a) Are you buying aged A/R? Similar to the inventory are you going to have a write-off. b) Buying A/R v, using a line is can be cost prohibitive. Paying a premium for A/R feels secure but it is a cost prohibitive way to borrower v. using a line of credit
• General working capital a) How much do you need v. how much they normally carry? Do your homework on a cash flow forecast so you don’t overbuy working capital. This is often the biggest mistake I see buyer’s make when they are making acquisitions. b) Financing WC in an SBA 7A loan is incredibly expensive!!! Ex. $350,000 in WC at close will cost you $456,000 over 10 years with a 7A loan and that assumes no interest rate changes. You pay on this even if you didn’t need the full amount. This is the most bank friendly way to finance working capital and costs you the most money.
c) Get a line of credit at close. This is the cheapest way to borrow working capital and ensures you have access to funds post close. A line can be increased if needed to support growth at a later date. Getting a line after close is very difficult/nearly impossible. If you bank says they cannot do a line then that should be a red flag about how you will function with them post- acquisition.
2. Real estate as part of the acquisition • Combining the real estate and the business into one 7A loan is very bank friendly. This pays the highest premium on the secondary market and gives the bank the most protection re: 7A coverage. This isn’t to say it doesn’t make sense in some instances for all parties but ask for options.
• The payment might be cheaper but you are paying significantly more interest over time. A $2M building loan over 25 years will cost you $3.865 million in payments (assuming no interest rate changes). A $1.2 million 504 loan on the building and an $800,000 7A loan on the business would cost you $2.965M (again assume no interest rate changes). This $900,000 difference is why the banks (and investors who buy the guarantees) love combining real estate and business loans. This doesn’t mean it isn’t the right choice for you, but make sure your bank is presenting you options and explaining the pros and cons of each option.
• Ask your bank for three options, 7A combo, 504 for the real estate and 7A for the business, or conventional loans for the building and 7A for the business. If your bank cannot accommodate all three options and only offers the 7A, then how will they fund the business 2…3…6 years down the road? This is a 10 year (possibly 25 year) relationship so make sure you know your bank partner’s capabilities in the long run.
3. Relationship with the lender The hardest part about acquisition financing is the hyper focus on the closing. While this is obviously important, ask your bank what the process is post- closing.
• Who is your relationship manager AFTER you close? Is it a senior person who knows your business or a junior person who will cycle through every 6 months? Who will handle subordinations (i.e. if house is pledged), who is handling title releases on vehicles, or who is helping you get capex loans after close. If you buy a building will they be able to finance that as well, or will you only be able to get another SBA loan?
• Deposit relationship. This is the biggest tell on if a lender is just a transaction or a long term partner. If they are not asking for the deposit relationship then how will they be able to help you when (not if) there is an issue post- close. Deposits are the early indicator if there is a problem and if a bank doesn’t ask for this then they likely aren’t interested in what happens after you close. Simply getting quarterly or annual financials tells you about a problem long after it occurred. Deposit accounts are where you see possible issues in real time and can help the business owner before it is too late.
• Lines of Credit at close are pivotal to the long term success of your business. SBA lenders will often try and put working capital on the 7A loan. As stated above, this is the most bank friendly way to provide WC and is also the most expensive way to borrower short term money. Ask your lender what happens if you need a line 2 years into closing to support growth. You will likely not get a line at that time since the 7A loan has a lien on all the working capital assets. If you close with a line in place the A/R and Inventory are supporting the line in a first position. This means you can grow a line of credit as well to support growth. ALWAYS get a line of credit at close, even if you don’t need one at that point. If not you will most likely not get one when you need it.
4. The biggest point I can say in working with your lender is that the 7A loan is the easy part. The 7A program somewhat boxes you in so the term, guarantees, collateral pledge, etc. will likely look pretty similar bank to bank. The day/month/year after are where most borrowers make the mistake in choosing their lender. Right now premiums are high and the guarantee is taking almost all the risk off of the bank. The risk for you as the borrower starts the day you take on the loan. The SBA acts as an insurance policy for the bank and the math is in our favor. Ask your bank for references not from someone who just closed a loan, but rather from someone who they closed a loan with 2+ years ago. a) Your lender should be collaborative and I would even say it is our responsibility to question the deal. If your bank is the only one who could get your deal done in this market then that should be a huge red flag.
b) Make inquiries to several banks. The seller’s representative will likely have a preferred bank they work with and that is fine. However, make sure you cover your bases and speak with multiple banks.
c) Ask your bank how they are compensated. Are they selling the guarantee and collecting a big fee? How much are they expecting? Are they keeping the loan and making interest? How much do they make by combining the real estate and the business into one deal v. splitting them into separate transactions? While they likely won’t know the exact amount they can give you a ballpark. Ask them how much bigger their premium is on adding working capital or combining the real estate into to a 7A loan v. doing a line or a 504/conventional loan. All of these are pretty simple to estimate so you should get an answer. Banks have to make money too so there is nothing wrong with any of these situations. However, they should be honest so you can assess everyone’s motives.
d) Lastly, remember you are buying a business during a depressed interest rate environment. Loans done in 2019 were likely having rates in the 7’s. If you are floating in your rate then make sure you are forecasting what your debt service will look like when interest rates start to rise. If you deal barely works right now, you could be in trouble in another year or two.