The U.S. Small Business Administration (www.sba.gov), or SBA, was founded in the 1950’s to “aid, counsel, assist and protect, insofar as is possible, the interests of small business concerns.” Today, one of the major functions of the SBA is its role in acquisition financing for small businesses, yet many potential buyers who could benefit from SBA-backed financing are either unaware of its existence or are under misconceptions about restrictions on SBA-backed financing that no longer exist. As two simple examples, it is no longer true that SBA-backed financing cannot be used in connection with the transfer of a family business from one generation to the next, and SBA-backed financing can now be used in connection with the purchase of substantial amounts of goodwill.
Nonetheless, there are strict guidelines that must be met in order to qualify for SBA-backed financing, particularly when large amounts of goodwill are involved. This is because the SBA essentially acts as an insurer for the bank actually making the loan. In most cases, the SBA insures 75% of the loan, making SBA loans an attractive proposition for local banks. We will not attempt to address all of the guidelines here, but to give you a flavor of what SBA-backed financing offers, a short overview of some of the basics follows. The SBA’s 7A program is the SBA-backed financing program used for small business acquisitions. Under this program:
- There is a maximum loan value of $5,000,000, but no maximum on overall deal value.
- Interest rates are typically tied to the prime rate and can be fixed or variable.
- If there is more than $500,000 in goodwill being purchased, a 25% down payment and an independent valuation of the business are required. There are several restrictions on the source of the down payment.
- The borrower must have at least a 50% equity interest in the go-forward business (i.e., the borrower’s investors, if any, cannot be majority owners).
- The seller cannot retain any equity but can be involved in a “key role” for a maximum of 12 months and in a non-key role indefinitely.
- Contingent payments, such as earnouts, are not allowed, but note or seller financing is permitted, subject to certain conditions.
- 20% equity owners and certain “key employees” must provide personal guarantees of the loan (even if the key employee holds no equity!).
- Cash flow is a key metric, so proper financial records are important.
Although certain of these requirements, particularly the personal guarantees, seem somewhat onerous, once the SBA-backed financing is obtained, the continuing covenants are minimal compared to traditional bank financing.
If you are interested in using an SBA-backed loan to finance an upcoming acquisition, please contact us here at CMPR. We can refer you to a local bank that is a preferred SBA lender and can of course also assist with the legal documentation necessary to accomplish the acquisition.
If you have any questions about these or any other issues, please feel free to contact Adam Rosenblum, 707-526-4200.