Bill Whitehurst, Texas Business Broker explains the potential problems for buyers and sellers in financing a business loan.
Prior to 2011,Small Business Administration (SBA) loans for starting a business did not include time restrictions on how long a seller could remain in the company after the sale. The seller could become a general manager, or an outside salesman, or stay on in a consulting capacity with the firm, thereby aiding in an orderly transition for the new owner.
SBA rule changes in 2011 now sets a limit of one year in which the previous owner can stay with the business. With this change, the new owners will not have the luxury of leaning on the expertise of the previous owner. Sellers frequently are not tired of working in their industry; they are just burned out from the daily grind of being a business owner. Staying on after the sale allowed them to continue working and drawing a paycheck without the burden of running the business. The continuity was a good option for both parties. Now new owners must now ask how to finance a business while maintaining access to in-house consultation.
With this change, new business owners who choose to accept loan financing in the form of bank loans or a business loan from the SBA will not have the comfort of having the previous owner as an in-house consultant, unless the prior owner agrees to provide his services for free. This creates need for alternate business finance options. An increasing number of business owners are now financing a loan to the buyer of their business, working under the assumption that if the seller has a vested interest in the success of the business, he will be more inclined to offer assistance if the new owner needs it.
Another recent change is that the SBA will no longer fund for stock purchases. The only option for sellers is to sell on an asset basis. This is a potential deal killer for some C corporation owners that previously avoided double taxation in selling on a stock basis. C corporation owners should talk to their certified public accountants (CPAs) to see what, if anything, can be done to sell on an all asset basis.
Although not new, a couple of conditions for SBA funding that frequently come up in transactions have come under more scrutiny from underwriters. One is in regard to customer concentration. This means having one customer who generates 20% or more of sales. In many cases, the business loan underwriter will subtract the profits derived from the potential loss of the large customer, lowering the value of the business and hence lowering the amount for lending.
Problems in the credit market have tightened the scrutiny SBA banks give their customers. Prior to 2008, banks were not overly concerned with the buyer having specific industry experience in the type of company being purchased. That is now an important consideration, and business brokers are vetting their buyers to make certain prior industry experience is in line before showing the offering.
For more information, please read our latest blog,5 common mistakes business owners make in selling their business. In all, lending, and specifically SBA lending, is tougher than in prior years and is sure to get tougher in the future. Success for both business sellers and buyers will depend in part on becoming aware of the lending changes and how they impact prospective business loan financing.