I had just wrapped up an online meeting with a JRB client yesterday and was heading out for a late lunch when I got this email from Mathias, a loan officer at a CDC client. I ordered lunch in.

MATHIAS. Richard … Jimmy and Joanna own the Mom & Pop Restaurant & Bakery. They have an opportunity to purchase the building they’ve leased for over 20 years and have approached our CDC for a 504 loan.

Here’s the situation: Cash flow at the Mom & Pop is tight. In fact, it’s below 1:1. and the business provides minimal discretionary personal income to Jimmy and Joanna. But they own a separate building which they lease to Pots & Pans, their wholesale restaurant supply business. Jimmy and Joanna also own 100% of Pots & Pans, which is profitable and within the same market.

When Jimmy and Joanna bought the Pots & Pans building, they financed it with a conventional loan with the required debt service of about $160,000 a year. Last year they paid themselves $170,000 in rent from Pots & Pans, using it to reduce the debt. In previous years they paid themselves more than $200,000 rent. I’m guessing they charged themselves less rent last year in anticipation of purchasing the restaurant/bakery location. Anyhow, the rent on the wholesale operation is highly discretionary..

My question: How will SBA react to using affiliate income and its excess cash flow to support the DSCR Loan for the OC?

ME. First off, since Jimmy and Joanna own more than 50% of Pots & Pans, it is an affiliate of Mom & Pop. (SOP 50 10 7.1 p. 16). But let’s set aside the wholesale operations for the moment. Mom & Pop Restaurant & Bakery is your primary operating company. SBA won’t like it that the primary OC does not have cash flow. Your only recourse is to get projections for the restaurant/ bakery only for the next two year-ends (e.g., … for the  years ending 12/31/2025 and 12/31/2026) at a minimum, and projected monthly cash flow for the next 12 months.

If the projections show repayment in Year 2 but not in Year 1, sufficient liquidity must be shown to cover the shortfall in Year 1. Hopefully, the projections will show repayment at least in Year 2. So by the end of the second year, the restaurant must stand on its own cash flow, without relying on the wholesale operations.

However, you say “… the business provides minimal discretionary personal income …” to the principals. In preparing the projections, you can minimize owner salary/draws from Mom & Pop if the cash flow from Pots & Pans can provide Jimmy and Joanna with enough to cover their personal obligations. SBA does not have a required personal debt service coverage ratio. But you will want to show that the principals can cover their personal debt service .

You also must describe how the restaurant will make payments on the interim financing until the debenture sells. You can’t rely on the projected income, as it will not kick in until Day 1 after the purchase. So the interim lender may have to accept interest-only payments for a while.

I know you can handle it from here. Good luck!

Richard Jeffrey, Senior Associate
CDC/504 Program