Business acquisition financing is among the more difficult financing requests for banks to underwrite and support. Most business acquisitions feature at least three key aspects that banks find difficult to align with their risk profiles:
1. Higher leverage
Higher than normal leverage (i.e., the loan amount requested by the borrower relative to the EBITDA/SDE of the target company) makes it difficult for lenders to build cash flow models that reflect sufficient cash flow, the primary source of loan repayment, within the lenders’ preferred repayment time frame, which is usually less than seven years.
2. Collateral shortfalls
Unless real estate is involved in the transaction, frequently there is a collateral shortfall with business acquisition financing, increasing the likelihood of an impaired secondary source (liquidation of collateral) of loan repayment in the event the cash flow of the target company is ultimately insufficient or does not meet covenanted coverage levels.
3. New and unproven leadership
With most business acquisitions, there is new and, often, younger and less experienced ownership involved post-closing. Even for well-run companies with thoughtful transition strategies, this can present challenges. Will new ownership be able to maintain and grow relationships with customers, suppliers and employees? Do they have experience in the relevant industry? How will they respond to economic events? Do they have the requisite personal liquidity and resources to inject cash into the target company, if needed? These questions all point to the possibility of an impaired tertiary source (personal guarantor) of loan repayment.
The SBA 7(a) program and accompanying loan guaranty (typically 75% for loans greater than $350,000) can be very helpful in mitigating all three of these risks. It allows banks to get comfortable with longer repayment periods than what they are usually willing to underwrite; up to ten years for business acquisitions, which serves to make the cash flow modeling easier and the sufficiency of the primary source of repayment more apparent.
Additionally, for both the collateral shortfall and new ownership dynamic of these transactions, the guaranty provides additional assurance around the secondary (liquidation of collateral) and tertiary (personal guarantor) sources of loan repayment. As we mentioned in our May update, the SBA has recently approved new maximum loan amounts of $10 million (vs. $5 million) for business acquisitions in certain industry categories, primarily related to manufacturing and on-shoring of supply chains. While this change is new, we expect it will raise interest in borrowers who might otherwise be eligible for conventional financing (for example, family offices) to consider using the SBA for access to additional capital and a more flexible repayment schedule.
Why Use Diamond Financial Services to Obtain SBA Financing?
We believe the answer to this is two-fold and compelling. First, DFS works with a network of banks nationwide. We know their lending preferences when it comes to preferred industries, geographies and deal structures. These preferences can change quickly as banks seek to balance their own portfolios to make sure they are not overexposed to certain industry or geographical risks and/or that certain “capital buckets” that they designate and limit internally are not overly committed. We are in constant dialogue with our lending partners to understand these changes and maximize the potential for aligning your borrowers with lenders that are most suitable for their financing requests.
Finally, at DFS, business acquisition financing is essentially 100% of what we do. Business acquisition financing is not only challenging for the banks; it can be challenging for all the parties involved. It can be time-consuming, deal structures can change, there can be surprises in due diligence, it is document-intensive, and it involves multiple parties. It is a different request than an existing bank borrower requesting an increased working capital line or equipment financing package. Our business development officers are experts in business acquisition financing and are prepared to address these challenges. They have years of experience working between business buyers, business sellers, their representatives and legal counsel, and our lending partners to keep deals on track, facilitate smooth information flow between all parties, and make sure the SBA’s requirements are satisfied. BDOs at most banks do not typically see the volume of business acquisition requests in a year that we see in a month. Let our expertise and network of lenders work for the benefit of you, your sellers and your buyers.