When does buying the business & real estate make sense?
June 05, 2024
by a searcher from Harvard University - Harvard Business School in Westchester County, NY, USA
Typical self-funded searcher here. Lenders, help me out, please!
RE for sale with biz, and due to the nature of the business kind of hard to separate from the opco.
When does it make sense to buy the RE also?
How would it work? SBA 7(a) for the biz and SBA 504 for the RE? What are the pros and cons?
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
First, buying the real estate will typically require an additional capital outlay, so you need to judge if the real estate is really going to be of value to the business. If it is going to be a long-term value for the business or you are getting it at a good price, then it probably makes sense to try and buy the real estate. Please keep in mind, the business must occupy 51% or more of the subject property for it to qualify for SBA financing.
If you are doing an asset purchase on the business and buying the real estate, you can buy both combined into one loan using the SBA 7A loan product and get an extended amortization on all of the debt. If the real estate is 51% or more of the total acquisition cost then you can amortize all of the debt over 25 years. This will provide you with a substantial cash flow savings. If the business acquisition cost (including any working capital or other business costs built into the loan) is 50% or more of the total acquisition cost, then you can get a blended amortization on the debt. The lender assigns 25-years to the portion of the debt associated with the real estate, ten-years to the portion of the debt assigned to the business assets, and you end up with a blended amortization between 10 and 17.5-years. By pushing out the business acquisition debt with the blended amortization this will typically save you between 5% and 20% in annual debt service versus doing both loans separately.
There are three key things to keep in mind related to the above.
The first is if you are buying the business via a stock purchase, the new SBA SOP sets the maximum amortization at 10 years for stock purchases. So you cannot do a combined SBA 7A loan for the business and real estate unless you want to amortize it all out over 10 years. So you would need to do a separate loan for the real estate if you want to secure the 25-year amortization on the real estate. If the real estate is owned by the operating company you will want to do a separate asset purchase for the real estate and not include it in the stock purchase. If included in the stock purchase it could only be amortized over 10 years like the business debt on a stock purchase. Everyone hopes the SBA will eventually update this rule, but right now it is the rule for stock purchases.
Secondly, even though you can technically do an SBA 504 loan for the real estate and an SBA 7A loan for the business, with better interest rates typically available on the SBA 504 loan, few SBA 7A lenders will offer this as a solution. Most will either want both assets in the same loan as additional collateral or will want to do both as SBA 7A loans so they have the full deal under their control (no SBA CDC involved on the 504) and have the 75% government guarantee on all of the debt. One benefit here is that most SBA 7A lenders will offer better pricing on all of the debt when real estate is involved, so you do benefit from better pricing on all of the debt from an SBA 7A perspective.
Third, if you are doing an SBA 504 loan at the same time there is a change in ownership of the business, the SBA 504 will only lend you 85% of the property cost. So you would need to put 15% down on the real estate portion of the acquisition versus the 10% required with an SBA 7A acquisition. One way to get around this is to purchase just the business and sign a lease with an option to buy the real estate and then come back six months later or more and buy the real estate at that time. In doing this you will then qualify for 90% financing on the SBA 504 loan as you will already own the business at time of acquisition of the real estate. Also if you are buying the real estate later, the SBA 7A lender cannot require it all done as an SBA 7A loan. You can then use a different lender for the SBA 504 at a later date if need be. The only risk here is the business cash flow will need to continue after acquisition to qualify. If the business cash flow falls off, you might not be in a position where you can finance the real estate at a later date or may be delayed in doing so.
Some lenders will do the real estate as a 504 loan. If you are pushing up against the SBA limits of $5 million, then doing the SBA 504 loan can help keep the total deal under $5 million. Every dollar you borrow on an SBA 7A loan counts against your $5 million SBA limit. However, only the SBA guaranteed portion of the SBA 504 loan counts against your SBA limit. As an example, if you are purchasing a 51% or more commercial owner-occupied property for $1 million, then under the SBA 504 program on a change of ownership transaction you would put down 15% or $150,000, the Bank would fund 50% or $500,000, and the SBA 504 would fund 35% or $350,000. Only the 35% piece or $350,000 of the $1 million purchase price would count against your SBA limit of $5 million. So using the SBA 504 loan in theory allows you to borrow more on SBA debt and leaves you more dollars for the SBA 7A guarantee on the business acquisition. Under normal circumstances (no change in ownership) using SBA 504 dollars, and assuming 10% borrower capital down, you can get a total of $12.5 million between SBA 504 and Bank debt under the SBA 504 program, but those funds can only be used for owner-occupied commercial real estate and equipment (excluding most vehicles), and not for business acquisition, working capital, etc.
One last thing to keep in mind. If you are buying a company with an NACIS code in the world of manufacturing, you can qualify for an additional $5.5 million in SBA 504 borrowing in the future. However, you cannot access that additional capacity at the same time you access your base $5 million in borrowings. If you are buying a company in manufacturing and will be exceeding your $5 million SBA limit, then this would be a good situation to lease the real estate and look to buy it at a later date. Not only will this allow you to finance 90% of the real estate purchase six months or later from closing, but if the business is in manufacturing, you could borrow up to another $5.5 million in SBA guaranteed debt. With only 10% required down using SBA 504 financing that would open you up to $13.75 million in additional capacity for the real estate or future equipment needs. Of course the cash flow has to be there to support this request. You do get to add back historical rent expense to adjusted EBITDA when financing the real estate.
Hopefully this information is helpful. If you have additional questions or would like to walk through any scenarios, you can reach me here or directly at redacted
from University of Missouri in St. Louis, MO, USA
While it makes sense from a financing standpoint if the building is 51% or more, you should also consider the long term impact v. just the financing. For instance, if you think you will outgrow your space and need to move, you would have to break your SBA loan which isn't the easiest thing to do when a building and business are intertwined into one loan. There is also the equity consideration in that the amount down would jump since you need 10% on the business AND the building.
Depending on the situation on the property and your equity, you could also consider a rent-to-own option. In that case you would put down 10% on the business (or less if the seller would consider deferred payments) and then you could buy the real estate at a later date with 100% "expansion" financing. This would allow you to own the business with less capital deployed and less overall leverage. The down side is that you would not have the 25 year repayment if you bought them at the same time.
Piggybacking off of Brad's comments above, if you went the 504 route at the time of closing, you would likely have to put down 15% on the building, although the seller can be a bigger part of this equity under more flexible terms than seller financing on a 7A. So if you want to pursue the 504 then that would get you a cheaper long term rate but could cost you more capital upfront.