It’s the ’24 Olympics. As an SBA lender, sometimes you might feel like a track runner, clearing obstacles to close the deal. A scenario: Your prospective borrower is eager to buy a business, but doesn’t have enough cash to swing the deal. Look for a way. And go for the gold. Amos, a new loan officer, called last week with this situation:
AMOS. Quinn, my prospective buyer, is excited about this opportunity. He earned his Doctor of Chiropractic degree three years ago and has been working at Dr. Zeke’s Chiropractic Practice. Zeke has told him he’s retiring and selling the practice. Naturally, Quinn wants to buy it. He’s been saving, but the opportunity came earlier than he’d planned. He’s worried about having enough cash.
Zeke wants $1 million for the practice. Quinn has $60,000 in cash. He’s asking if there’s any way he can buy the practice now, because if somebody else buys it, Quinn will have to move his practice. I know SBA requires a minimum down payment of 10%. How can I work this out?
ME. Even though Zeke has been in business for many years, SBA considers a change in ownership to result in a new business. (SOP 50 10 7.1 p. 111). So yeah, Amos, you are right that SBA would require a minimum equity injection of 10% of the total project costs. And those costs probably will be more than the purchase price, as they constitute all costs required to complete the change of ownership.
AMOS. Quinn tells me the business has about $40,000 in furniture, equipment, and miscellaneous goods. He’s asking if adding that to his $60,000 in cash will be enough for the injection.
ME. Even without my doing the math, you can tell Quinn that idea won’t work. SBA requires that the equity injection be new cash or other acceptable assets added into the project that aren’t on the business’ balance sheet now. (Ibid). How about asking Dr. Zeke to carry back part of the purchase price? Your bank might be able to do something like that, especially with an SBA guaranty. However, there are a few conditions:
- At least a quarter of the equity injection must be from a source other than the seller. So if the equity injection is $100,000, Quinn has to inject $25,000. He has $60,000, which is more than the $25,000 SBA would require. First hurdle cleared.
- Quinn and Zeke must negotiate the repayment term. And the seller’s note cannot have a balloon. Make a note of it and communicate with buyer and seller. Second hurtle.
- Payments must be on full standby, with no principal or interest payments allowed, or depending on cash flow, your bank might allow Zeke’s loan to be on partial standby, with interest-only payments allowed. Third hurdle.
AMOS. Wow, I feel like I’m running the steeple chase!
ME. Okay, Kenneth Rooks! He’s the steeple chase runner who has qualified for the 2024 Olympics, and who won the 2023 National Championships after falling down during his race. So my advice to you: Keep going. Put all the conditions in a standby agreement, along with your standard subordination agreement. SBA has a form for that, Form 155. Or you can use your own form. as long as it tracks the 155. The agreement should contain the approved repayment terms and subordination of the seller’s note to your note.
Importantly, have Quinn run the agreement past his attorney. And you should put the standby/ subordination in your LOI so everyone can understand it or negotiate it ahead of time. That way, both Quinn’s attorney and Zeke’s attorney can take a look at it. I have found that it’s important for the seller and its attorney not only to agree to the terms, but to actually read and acknowledge them early in the process. The terms are largely non-negotiable and boilerplate. So the best approach is reasoned and calm communication.
And by all means, “Keep Calm and hug your SBA consultant!” That should get you over the finish line. Keep me posted.
Richard Jeffrey, Senior Associate
Chief Underwriter
richard@jrbrunoassoc.com
www.jrbrunoassoc.com