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Tip of the Week
Business Acquisition - Areas of Practical Confusion
One major benefit of being a lender consultant is to have the opportunity to get into the actual specifics of real life lender deals and to be able to experience (through the lender's lens) the confusion that can arise when trying to remain in compliance with SBA regulations. A common area of confusion is in the arena of financing business acquisitions. The SBA "rules" surrounding a change of ownership transaction have been evolving over time (a seemingly moving target) because this area of financing can be fraught with "missteps" by multiple parties (the lender, the purchaser/borrower, the seller, and the third party vendors). SBA has always held the position that there must be a reason for the transaction to occur - in other words the change of ownership must either "preserve the existence" or " promote the sound development" of the business (there must be a benefit to the business - not necessarily the individuals involved).
SBA also places special emphasis on determining the value of the business and states that this value is the "key component" to the analysis of the loan application in a change of ownership. An accurate business valuation is required because it assists the buyer (your borrower) in making a determination that the seller's asking price is supported by historic operations and permits the buyer to make a reasonable return on their investment. The business valuation puts the SBA loan amount into perspective. Is the amount you are financing reasonable in respect to the total value of the business?
As consultants to our clients, we seem to continually encounter some of the same issues over and over. These issues fall into 3 categories:
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Collateral and financing intangible assets
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Using "going concern" real estate appraisals for business valuations
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Term of SBA loans - stock purchase vs. asset purchase
Dealing with the "fully secured rule" when Intangible Assets are Involved
Remember, SBA requires the lender to take all available collateral to fully secure the SBA loan and the liquidation value of all collateral must be considered when determining whether enough collateral has been required to secure the loan. In all business acquisitions, SBA requires that the business valuation exclude the value of real estate. If real estate is part of the business purchase and the SBA loan exceeds $250,000, the lender must also require a USPAP type appraisal (in addition to the business valuation). The business valuation should reflect any intangible assets that will be included in the business acquisition. The lender may finance those intangible assets BUT if the amount of intangible assets exceeds $500,000 and the equity contribution (from the buyer and seller combined) is less than 25%, the loan application must be processed through non-PLP procedures.
Using a "Going Concern" Real Estate Appraisal as the required Business Valuation
The lender may use a going concern appraisal to meet the business valuation requirements IF the loan proceeds will be used to purchase a special use property. Also, the appraisal MUST be performed by an appraiser experienced in that particular industry. Make sure you document the compliance of both those requirements in the appraisal report (emphasize and highlight these two issues). The appraisal must allocate separate values to the individual components of the transaction including land, building, equipment and intangible assets. When using a "going concern" appraisal, it could be argued that values are often inflated under this approach, thus overstating the collateral value and putting the bank in the position of non compliance with the "fully secured rule". We have seen lenders apply their liquidation value for commercial real estate value across the board for a going concern value (even though the total value included non-real estate assets and intangible assets). We advise lenders to be careful when analyzing the credit to make sure to separate out each of the asset categories.
Term of Loan: Stock Purchase versus Asset Purchase
The maximum maturity for a loan used to refinance a business acquisition is 10 years, unless the largest percentage of the small business's assets is real estate which would permit a maturity up to 25 years. Remember, SBA categorizes business acquisitions as either a going concern purchase (stock purchase) or an asset purchase. BOTH are considered business acquisitions and must follow SBA "rules" under change of ownership (e.g., business valuation requirements). If the business acquisition is an asset purchase, make sure the buy/sale agreement depicts what assets are being purchased and their value. If the change of ownership is an asset purchase (not a stock purchase), the lender may base the term of the loan on the life of the actual assets being purchased. When a change of ownership is between existing owners, the "entire interest" of the selling owner(s) must be purchased (or 100% change of ownership). That can still occur with an asset purchase; as long as the buy/sale agreement spells out the terms of the purchase (the existing owner is selling their interest in the business assets).
These are a few of the "issues" that have crossed our path while assisting lenders with what is proper, accurate and complete documentation when financing a change of ownership transaction. This is a "tricky" area of compliance since SBA seems to be more sensitive to these types of transactions because of historical experience with fraud (by appraisers, packagers....and yes, even lenders). Let's be respectful of SBA's sensitivity and do our best to interpret SBA regulation and comply appropriately.
We provide guidance on these types of issues in several types of "venues", such as our Lifeline relationships with our clients, on-site consultation when developing policy and procedures and specific loan file review. We stand ready to assist you in your daily effort to deal with SBA regulations. Call us for a free telephone consultation to determine how we may best address your needs. And in the meantime, all best wishes for a happy, healthy and prosperous New Year!
Take the Right Approach.
Karen McHugh and Brian Burke
SBA Access ©2009 - All Rights Reserved
All content is copyrighted and unauthorized use is strictly prohibited. If you would like to quote any part of this text, email bburke@sbaaccess.com or kmchugh@sbaaccess.com for permission.
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