LESSONS LEARNED FROM FAILED SBA FINANCING

I’m early in my search so some of these lessons below might be obvious to grizzled veterans, however I wanted to share my story so that other new searchers (and prospective searchers) can learn from my experience. Plus I think we need to share more failure stories as a search community; we’re already really good about sharing and celebrating successes (which is amazing!)

Context: Less than a month into my search I stumbled across a fully remote company in the accounting & bookkeeping space. While it was smaller than my target SDEs, it was growing really fast...like a 40%+ CAGR over the past 3 years. The owner also had a good team in place so they weren’t working full time in the business. I was highly interested in the fully remote model and the growth was super exciting to me. I was in a fortunate situation where I could take a risk on a smaller deal with significant growth potential so I acted quickly. After hitting it off with the seller, we were under LOI in about a week.

Small note on price…. While the business was growing fast, we priced the deal based upon 2021 performance and exit run-rate. It was on the high end of the range even for 2021 performance, but I felt like it was justified given the growth. If I could continue even half the growth rate for the next 3-4 years, then I would be getting a bargain.

Once I knew this had legs I reached out to two different banks. First was a recommendation from the Broker and the second was a referral from a mentor of mine. This mentor told me (twice) at the very beginning “Make sure the banker says the deal will cash flow. Get him to confirm it in an email”. From my (inexperienced) perspective this deal was a slam dunk…. With a SDE ratio of ~40%, how could it not cash flow? However I followed his advice and shared the revenue and SDE numbers with the banker and he tentatively confirmed that it looked OK, however he said they would underwrite using EBITDA + add backs, and he asked me for those numbers. I told him that in my mind SDEs = EBITDA + add backs so we should be good...and I left it at that. (Note: I had not received any tax returns at this point; I was using the P&Ls in the CIM).

Fast forward 3 weeks and my deal is on life support because both banks are declining to underwrite the deal saying that the valuation is not supported by the historic cash flows of the business. I mean DUH… of course the historic cash flows aren’t sufficient. This is a fast growing business! However, it seems that banks are hesitant to lend capital (even partially guaranteed capital) to fast growing companies.

Here are my lessons learned:

Banks love tax returns and they don’t care about your QoE I definitely underestimated how much banks care about tax returns. Despite the fact that most small business owners try to reduce their taxable income so they pay less, the tax return is the gold standard for bankers. So much so that despite the fact that we had almost 10 months of operating history in 2021, Banker #1 would only use the 2020 tax return in underwriting. I mentioned that I was going to bring in a 3rd party firm to do a proof of cash to validate 2021 performance and his response was “I need to see a 2021 tax return”.

Banks don’t care about addbacks like you do Who doesn’t love a good addback? Brokers, sellers and buyers understand the value of add backs. They may disagree on the specific type and value of add backs allowed, but all are in agreement that they are a legitimate part of all deals. Banker #1 didn’t even discuss add backs. Banker #2 asked for the add backs, but I got pushback on ones that were specific to me as a buyer (e.g. health insurance...I’m covered by my wife). His feedback was that they always try to value a business without taking the specific buyer into account. That 40%+ SDE ratio I talked about previously? Wrong assumption.
High growth is a hindrance to SBA financing Never did I imagine that one of the biggest strengths of this deal would be its biggest weakness. I assumed that everyone would think that growth is good and get excited about it. As it turns out, high growth is a negative in underwriting. Banks want to see a consistent trend over 2-3 full years before they get comfortable as they are taking a weighted average of the cash flow. While they will weigh the current year heavier, they won’t underwrite a deal using only 1 year cash flow or a run rate.

Heres what I would do differently:

Take seriously all advice from advisors My mentor gave me the best advice right at the beginning: “validate the deal cash flows with the bank first”. I didn’t take that advice seriously enough and I was sloppy assuming my calculated SDEs = EBIDTA + add backs. I should have spent more time here.

Share the tax return with your banker early I actually got the tax returns fairly early, but instead of sharing them with the banks immediately as a sniff test, I sat on them and I spent hours completing loan applications, putting together projections, Personal Financial Statements, and writing a business plan. I wasted probably 10 days by not sharing the tax returns first.

Push the broker on valuation To be honest, I’ve hardly interacted with the broker on this deal. The deal was posted on their website and they set up the initial seller meeting, and thats the extent of our interactions. I negotiated the price, deal construct and got the signed LOI without them. In hindsight I should have asked the broker how they arrived at the list price and then just listened to see if they actually had a solid point of view. With anything fast growing I think you have more opportunities to push back, but I didn’t push back enough. I wish I would have discussed valuation more with the broker.
While I’m really disappointed, most of it is my fault. However, I did learn a ton so it wasn't all a waste. I feel much more prepared for the next deal.

Hopefully this will be helpful to someone.



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