Financing through the SBANavigating the Underwriting Process through a Seller’s Lens

Financing through SBA – Navigating the Underwriting Process through a Seller’s Lens.

For many brokers and sellers, the underwriting process is often one of the most mystifying and frustrating stages in selling their business. They’ve prepared the business for sale, vetted potential buyers, provided intimate financial details, and now suddenly find themselves lost in the proverbial black hole of SBA underwriting with what might feel like poor communication, little control and unclear timelines. While the financial institution is typically not chosen by the seller, it is possible for the seller and their broker representation to give their chosen buyer a “leg up” when working with a lender by taking some steps in the early stages of the deal. In some instances, the broker and/or seller may even assist in introducing their buyer to a lender who is either familiar with the business, or who they know has been successful with acquisition financing in the past.

How long does underwriting take?

While the timeline is often greater in M&A circles, if a complete financial package is provided at the time of submission, the SBA underwriting process typically only takes 7-10 business days. As the underwriting process progresses, questions often will be asked of the buyer and/or seller about aspects of the financial results, the proposed structure of the deal, or other material considerations. It’s important to note that this 7–10-day clock can be paused while waiting on answers.

Providing incomplete

answers

Or Simply Not

responding in a timely

Manner

can cause the underwriting process to drag on. At times, buyers may be fearful to go back to the seller to ask these questions, thinking that it might scare the seller or weaken their negotiating position, and thus attempt to provide answers on their own that may not suffice for underwriting. The seller and broker can often head off these types of issue by letting the buyer know that they welcome any questions from the lender and by just being generally approachable throughout the process.

Delays can also be caused if the financial package is incomplete. While most sellers understand that year end financials, tax returns and other reports will be necessary, they don’t always fully understand what will be required of them for their buyer to gain SBA approval of the loan. Three important pieces of information that will typically be required are Interim Financials, an Addback Schedule, and an explanation of any one-time expenses:

Interim Financials

The seller should be preparing an income statement and balance sheet on a monthly or quarterly basis. The lender will expect interim financials that are within 90-120 days of the date of underwriting. These should include a prior year comparison showing the matching time frame. If the seller is unable to produce everything that is mentioned here, it’s important to discuss that up front with the buyer and their lender to determine what accommodations (if any) can be made.

Addback Schedule

Any expenses that will be eliminated as a result of the acquisition should be detailed in an addback schedule. Accurate and specific amounts should be provided for each financial period and tie back to the tax return or interim financials submitted to the lender. Additional supporting documentation might be requested such as W2s, Invoices for benefits costs, etc to verify the amounts. Addbacks such as seller’s wages and benefits, salaries of key personnel exiting the business, and eliminated rent are typically easy to justify. Expenses that are more personal in nature may not be allowable under SBA underwriting guidelines.

One-Time Expenses

It’s very important to make sure that the buyer is prepared to address any one-time expenses in the financials. The seller should not attempt to hide or gloss over these items, but rather explain and mitigate them. Perhaps there was a large one-time inventory write-down due to a lost customer, or repairs & maintenance costs were abnormally high in one year due to an act of nature – these items are explainable and it’s always better to call them out as early in the process as possible.

The best advice to navigate the underwriting process with speed and efficiency is to remember that “The most complete package wins.” If the seller provides all necessary information up front, delays will be avoided during the underwriting process.

What can I do to help qualify my buyer?

As a broker or seller, qualifying the buyer can often pose a challenge. The buyer is hesitant to share too much about their financial position for fear that it may weaken their negotiating position. Selecting the wrong buyer can set the process back significantly, so finding ways to prequalify potential buyers is an excellent strategy to avoid this pitfall. The primary areas that a seller may wish to examine would be source of equity injection and relevant business experience:

Source of Equity Injection

While the buyer may not wish to provide a full personal financial statement or copies of their bank statements, it is critical that they have sufficient liquid assets to meet their equity injection. Most SBA loan structures require a minimum of 10% equity. A well-qualified buyer will typically have liquid assets (personal cash, business cash, stocks) of 15-25% of the purchase price. The method for assessing a buyer’s financial strength may vary depending on the size of the transaction and the seller’s relationship with the buyer, but without a source of equity, the loan request will ultimately be declined.

Relevant Business Experience

SBA Borrower’s do not need to be a prior business owner, in fact many are first-time business owners. However, any potential business owner must possess the relevant experience necessary to qualify to purchase the business. This may include currently possessing a management role in a similar company or past experience in a related field. The industry and complexity of the business will greatly affect the level of experience desired. Some businesses may require specialized knowledge and experience, examples include a law firm, manufacturer, or contractor. Having potential buyers provide a resume that highlights their experience relevant to the target business and industry might be helpful in selecting the most qualified prospective individual or ownership group.

Should the seller discover that a potential buyer perhaps doesn’t quite meet the qualifications described above, providing a level of seller financing into the transaction may help mitigate that weakness. When a lender sees that the seller is willing to defer a portion of their sale proceeds over the life of the loan, that demonstrates a belief the seller has in their buyer to successfully navigate the transition and pay them back over time. Seller notes can be structured in a variety of ways, and it is recommended to discuss any potential structure with both the buyer and their lender before making any firm arrangements.

The Bottom Line…

For many brokers and sellers, the underwriting process feels like a stage that is out of their control. With proper preparation on the front end and a strong relationship with the potential buyer, the seller can have greater involvement during this critical portion of the acquisition process. Introducing a potential buyer to a lender with experience in business acquisition financing can also be a great way to help expedite the underwriting process.

KeyBank believes small business loans are at the heart of a growing economy. KeyBank is a Top SBA 7(a) Lender in the Nation* and also has been designated as a Preferred Lender for more than 20 years**. The Small Business Administration (SBA) loan programs available through KeyBank offer terms not always available with other loan types including longer terms and lower monthly payments.

TIM KELLANDER

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