SBA Loan Basics Part II

Recap from the last issue:

• Meet Shannon Hay of UMSB.

• SBA 7(a) program basics.

• Prepayment, working capital, project costs.

• Special option for internal (employee) buyout.

• Sellers as business partners.

• Buyers with home equity.

• Find ​Part 1 here​.

I love the strategy of growing your current company by buying another similar business and that's where we return to this SBA chat...

Della: Well, let me run this by you… So I've been doing a lot of in person business buying talks recently and one of the things I love to do is to send people to bizbuysell.com, which I tell everybody is kind like the Tinder of business buying, swipe left, swipe right, But it's a great learning ground. It's a great place to see what's out there.

So, I pulled up three random listings and one of them is a super small jewelry business. The cash flow on that business is only $60,000. And their price was too high. But, you know, I do a little bit of napkin math and I say, “if you got a loan for this, the loan payments would probably take about $30K per year. And you should have about $30K left for yourself.”

You know nobody can live on $30,000, but the carrot that I present is this: What if you already have a complementary business? You could add $30,000 of profit to your existing business in one little transaction. I mean, is that a strategy that you would vote for?

SBA Supports Growth through Acquisition

Shannon: I'm a multi acquisition strategist, Della. So I'm a big believer in expansion through acquisition. And honestly, that's one of the key elements of the SBA 7(a) program that most people aren't aware of.

NAICS Codes

The NAICS code is that identifier on the tax return that indicates your industry of operation. So the SBA says if your NAICS codes align on those tax returns, between your current business and your target co, you actually can borrow money to buy that business, as an expansion, for no money down. That 10% down payment just goes out the window because that 10% exists in your business already. You're just leveraging that into the next transaction.

The unfortunate part with the SBA is that all six digits of the NAICS codes must align. Take architecture for example. You have landscaping architecture, and you have traditional architecture. Those are two different NAICS codes. The $0 down payment is not going to be an option in that case.

Della: When I had my tax practice, people came to me long after they had established their business. They have no idea what code “somebody” put on their first tax return. Of course, we just carry it forward. So how far back is the SBA going to look? If I have a business and I think this is my plan and I know that there's this code, can I, you know, change it this year? Can I go back and amend my tax return for a couple of years? (Consult your own preparer, but after doing some research, I would say yes to amending a year or two back.)

Shannon: The SBA is always going to look at three years of tax transcripts. That's one of the key elements. In all situations, they are pretty much going look at the three years prior to funding the deal. The transcripts and the tax returns provided by the seller must line up exactly. If there's any deviation, that's a due diligence trigger flag, right? And they'll dig into why that is, right? We can't white out that code on the piece of paper we have here.

Della: Exactly! And that's a great tidbit because I don't see anybody talking about expansion through acquisition and I definitely don't see a lot of talk about this particular strategy with the SBA not requiring the down payment. So I love that. That's a very valuable share, Shannon!

Shannon: Well, think about the data. It also has a runway of $5 million for an individual guarantor, right? So, if you buy your first $500,000 business and then leverage that, you know, build some equity, re -leverage that equity into another million-dollar business, right? And then leverage it into a $1.5 million and so on.

Having Multiple SBA Loans

Della: That's a great point you added in there. Can one have multiple SBA acquisition loans? And is that as long as they don't total more than the $5 million limit?

Shannon: That's correct. Another fun fact is the SBA using the same NAICS code variable says that you can actually have $5 million tranches as an individual guarantor in different NAICS codes, as long as you've proven your ability to manage them. So you can only have up to $5 million in accounting. But say you wanted to go and own an insurance business, which is not in the same code, but correlates in a sense. You can cross refer those businesses to each other. You could actually have up to $5 million in that particular NAICS code category. It could get really interesting.

Della: So, how would that play into either a husband and wife buying team or an unrelated buying team?

Family Ownership

Shannon: There are some unique strategies available here with family ownership. For example, Dad could have 10% equity in daughter's business. Mom could have 10% equity in it as well. As long as Mom and Dad are not over 20% owners, they don't have to PG {personal guarantee} the loan. Lots of details go into this. It should be its own conversation!

Della: And they could do a similar ownership arrangement with another business, switching the ratios around? Definitely worth a deeper dive!

SBA Terms

Della: You mentioned a 10-year term earlier, but oftentimes, these businesses come with, or can come with real estate. How does that play into the term and the interest rate and such?

Shannon: Yeah, yeah. The real estate is treated separately. And it would have to be owner occupied. So the business that is borrowing the money has to be a 51% occupant of that building. That's one of the first rules. Say it's a strip center and there's multiple businesses within that strip center. You would just have to occupy 51% or more. That real estate loan has a 25-year term.

The limited money down situation is something that can be discussed and reviewed because of what you are allowed to do with the SBA as a 51% occupant. You can actually leverage the equity in your business. You're buying the business and hopefully we can prove there's equity that exists within that. Now you can do a limited money down purchase of that real estate that you occupy.

Prepays

Shannon: So those longer-term loans, greater than 15 years, are going to have minor prepays. It may be a 3-2-1, or a 5-3-1; that is a prepayment penalty of 5% in year 1, 3% percent in year 2, and 1% in year 3. You can also add working capital or build outs or improvements into that.

Real Estate Heavy Transactions

Shannon: Now, if you're doing an acquisition of commercial real estate simultaneously with a business acquisition, and let's say the commercial estate happens to be greater than 51% of the total project, or said another way, the business acquisition is 49% or less, you can lengthen the term of the loan beyond 10 years.

If the business acquisition is greater than the real estate, then you would want to keep the real estate separate.

Della: I love real estate and this seems to open up a lot of possibilities!

Part 3 coming your way in the next episode of my chat with Shannon. In the meantime, reach out to either one us or check out SBA.gov