FE International has helped many buyers successfully use SBA to acquire businesses over the past few years. We also have several SBA opportunities currently available, so please feel free to reach out to us directly if you would like to learn more.
Jordan Richmond is an SBA lender at Fidelity Bank. Fidelity is a full-service bank based out of Atlanta, Georgia. FE partnered up with Jordan on a webinar to cover helpful information, as well as tips on how to use the Small Business Administration, commonly known as SBA, Lending Program in the acquisition of an online business.
Fidelity’s two SBA departments do about $100 to $150 million a year in SBA lending. Between the two, there will be somewhere between $200 and $300 million in 2020. Jordan is based out of Boston (although he does lend nationally) and specializes in advising buyers in M&A transactions. Fidelity excels from about the $500,000 transaction range to about the $2.5 million to $3 million transaction range.
Fidelity typically specializes with e-commerce and SaaS in that $500,000, $2.5 to $3 million range. However, as a bank Fidelity lowered their minimum loan, raised it and then lowered it, to about $250,000. Typically, what is seen is 90% financing of goodwill transactions up to around $1.5 million in complete unsecured goodwill. You can watch the full webinar here:
SBA Loans to Buy a Business: Essential Guide
What is an SBA loan?
An SBA loan is a small business loan that is partially secured by the government (The Small Business Administration). The SBA works closely with a network of financial institutions, such as Fidelity. SBA loans are made possible due to partial guarantees from the SBA to these financial institutions. The SBA will back up some percentage of the loan a small business or buyer receives, so if the loan can’t get paid back, the SBA will step in and reimburse the bank to the predisposed percentage of coverage.
At a very high-level, there are many different industries and different types of SBA loans you can take. Jordan specifically handles business acquisitions, largely goodwill, so that is what we will cover today. Half his business is e-commerce or SaaS, and then he has another silo that deals a lot with franchise resales and just other manufacturing businesses. Along those lines, the requests that he gets are typically for the purchase of goodwill or intangible assets.
How does an SBA7(a) operate?
They do need to operate for profit in the United States. They can export, operate within territories such as Puerto Rico, and they can take intangible assets from other countries like the United Kingdom, or Canada. There are size requirements, though. An important benchmark is Fidelity is not to exceed $15 million in tangible net worth or $5 million in net income. It’s important to note that’s net income, not gross income. Many times someone will have a portfolio of businesses that get up $10 million or $15 million revenue. However, net income is crucial to decide if it is SBA eligible, and SBA’s definition of small business needs to be met. Those are the two items to bear in mind.
As far as the terms go, and just general broad strokes on what a business acquisition loan would look like, is the max exposure for any bank on an SBA loan, or a 7(a) loan would be $5 million. They’re all fully amortized with no balloons or call dates. Typically, the next bullet point you’ll see there, they say the terms are 5-10 years.
Real estate has a longer maturity, typically not any longer than 10 years max. For cash flow and forecasting purposes, a buyer wants to assume a 10-year loan, fully amortized, at prime plus 2.5. The rate is give or take, but that’s essentially where it’s at.
The rates are based on the prime lending rate, which is currently 5.5%. The rates will vary, but typically you’ll see 90% of the loans at prime plus 2.5%, and prime right now is 5.5%.
Something else to be aware of when you’re doing SBA lending is that the SBA is not a bank. Fidelity is the bank; they are the ones giving out the money. Fidelity is a preferred lender in that they approve loans on behalf of the SBA. Which is a rather coveted status to get for lenders, and especially on a national basis.
On deals more often than not there’s a significant lack of collateral sometimes. The SBA will guarantee in the case of default, up to 75% of the loan amount. On $1 million loans, in case of default, the bank would go to the SBA for recourse of $750,000.
It’s a significant credit enhancement. It’s not a bank fee, it’s an SBA fee and it can be up to 3.75% of the loan amount based off of the guarantee principle.
It is a tiered SBA fee. Typically, what you will be paying is 3% up to, $1 million of the guaranteed amount. Which is 75%. It’s really a $500,000 loan you’re paying the net fee is 2.25%.
People look at almost 4% in fees, that’s a tiered scale, up to $5 million and it’s net of what the guarantee is. In reality, on those transactions, about $500,000-$1 million, the net fee amount is roughly 2.25%.
Those business acquisitions, again, will come with working capital. Especially when there is a need for receivables and inventory. That said, there are certain eccentricities to doing goodwill transactions, especially online business transactions.
What is an SBA express loan?
SBA express loans, like normal SBA lending, are partially guaranteed by the SBA. Express Loans deliver credit decisions within 1-2 days, which is much of their draw. The SBA Express Loan program and the SBA Export Express Loan program are two programs under the umbrella SBA 7(a) Loan program. They both offer loans between $350,000-$500,000. It’s important to note that in exchange for a faster process, you will pay higher interest rates compared to a tradition SBA loan
Collateral
The SBA and Fidelity bank will not decline a loan based solely on lack of collateral. The collateral requirements are banks must take any and all available collateral that’s listed on a personal financial statement, and any personal assets, as well. That can include personal real estate or commercial real estate. The threshold for that is the value of a home. Fidelity will margin it at 85%. If there is additional collateral past that, after you subtract the liens, then they will take that. That’s not a bank requirement, that’s an SBA thing that you cannot get around, it’s uniform within the industry.
To give a quick example of that, on a $1 million home, that would margin to $850,000, or 85%. If there was a $500,000 first mortgage on it, you would now have $350,000 in available collateral. This scenario would be okay to proceed.
How to apply for an SBA loan to buy a business
Since the SBA is a government entity and partial guarantees are implemented, the application process is very thorough. When applying for an SBA loan through a financial institution, you will be asked to submit all financial documents and statements, business plans, and personal tax returns. The process of receiving an SBA loan can be lengthy, up to 3 months. In order to expedite the process, you can give all the needed documents to the lender upfront. The lender will then determine if you and the business which you wish to purchase are trustworthy.?
A purchase agreement is required for an SBA loan that detailedly expresses purchase price, date of ownership transfer, liability responsibility, the terms for seller help with the transition, description of the asset being purchased, and requirements of both seller and buyer at closing. Fidelity and other lenders require this as it allows them to learn more about the business as well as to begin the conversation of collateral.
Business financial documents are also required when applying for an SBA loan. These documents are needed for the lender to verify the businesses good financial standing. Some of the required documents include business plans, last three years of business and personal tax returns, information on business debt, profit and loss documentation, cash flow statements, and balance sheets. Other documents can be asked to be provided.
Historical Cash Flow
Some form of cash flow must be shown, whether that be from the business you were buying, or from the existing business. In general, in the online business, the ability to service debt is typically stronger than other businesses, manufacturing, or just mainstream retail.
In theory, Fidelity will go down to the SBA minimum, which is a 1.15 debt service requirement. However, with online businesses, especially FE’s, more of the ability to service debt 1.5 times.
For example, if the annual debt payment is $100,000, annual loan payments are $100,000, we want to see free cash flow of $150,000. That would be a 1.5 debt service requirement.
If you have a higher multiple company, larger companies will certainly have a higher multiple, you can offset that lack of debt service with an existing company or external income. Fidelity also looks at global consideration.
If you are buying a business that has a much lower debt service it is a synergistic acquisition. Say you were taking another component of an e-commerce business, and now you’re expanding from specialty apparel into another type of specialty apparel, you take that into consideration from a global standpoint, and you will have a lower debt service requirements, as well.
Seller Notes
Fidelity wants to see that it does not hamper the cash flow of the business, and shows that the target business still has the ability to service the debt. It’s very typical where Fidelity will ask for a seller note to be on standby for 2-3 years. Many sellers are not okay with that, it’s not palatable for the seller, and that’s completely understandable.
Not only is the bank may mandate how the loan should be structured, or how the selling mode should be structured, but it could actually cost the buyer something at the end of the day because now the seller has a holdback. The time value of money, or the opportunity cost of the buyer not getting paid, 100% of the transactions is a rather large factor, as well.
Portfolio Crafting
Often people are using their existing engineering, their existing staff, their existing accounting, and creating synergistic acquisitions. They are case by case. The largest caveat is setting up a direct timeline. Fidelity wants to see that the first business has been stabilized before they move on to the next one.
In terms of questions, it’s important to engage the lender, and the banker, sooner rather than later. Fidelity wants to know what they’re dealing with. They want to look at each individual credit if there are significant cases they may speed up that time horizon to the next fiscal year. Or, they may want to see an actual 12 months of history.
Do I need to own a business, or do I need to actually have been operating a business to get an SBA loan or purchase another business?
The answer is no. However, a very strong component of lending to goodwill is business acumen and experience, so although ownership is not required, transferable skills are certainly necessary. In some, there is business ownership experience, but in all, there is some kind of transferable skill set where lines can be drawn to show that there’s either significant business development on maybe the SaaS side or significant marketing on the e-comm side, coupled with management and just technology skill sets, as well.
Can I purchase an online business that is outside of America?
Yes. If the assets, meaning goodwill, is coming into the States and being transferred into a US corporation, then the answer is yes. Last year Fidelity funded the acquisition of a Canadian SaaS company that was 100% goodwill. Those assets were initially in Canada. It was a Canadian company where another New Jersey company came in and bought it. It was a $1.7 million loan- it was all SaaS and goodwill and intangible assets coming into the States. The caveat with international deals is sometimes tax terms. So, United Kingdom, Canada, other countries that have their tax returns in English and also can verify those returns with some kind of revenue. The tax department of the other country, we’re able to get around that and be able to fund those deals. As long as the buyer is a US entity, the seller does not have to be.
Partner Buyouts
Another thing happening a lot recently is partner buyouts. In that regard, business acumen is of utmost importance. Business ownership is always a plus. In a scenario where you have a partner buyout- a significantly stronger deal- you have a partner who not only has the industry experience and the skill set to run the business, but they’ve already been running the business.
Can I buy a business and then another business?
A buyer came in and had bought a business six months previous. Fidelity did the second transaction for the borrower to fit into his portfolio of online businesses. That was his second transaction in two years. Many ask “can I rinse and repeat, and build a portfolio of possibly Shopify, possibly SaaS businesses that have some kind of synergistic purpose?” And the answer is yes. Fidelity has done a few of those this year. Then, the rest Fidelity does go outside of online businesses and tech companies, such as engineering, medical, amongst others.
For example, the $400,000 e-commerce business for hunting tools that Fidelity closed with FE was with a serial entrepreneur. He had three businesses, or three acquisitions, over the course of three years that were completely intangible- there was no collateral to secure to. The SBA had secured to his real estate in previous transactions. That’s something Fidelity is comfortable with and used to being able to fund.
As long as there is a shown cash flow, and that showcase is consistent and historical, Fidelity is okay lending without any collateral.
What is goodwill and how is it calculated?
Fidelity will fund just a goodwill transaction. When Fidelity looks at that, they look at what the goodwill max will be. All banks have a goodwill tolerance, Fidelity caps it as low as $350,000. Many other banks will go up to about $1 million. Fidelity does go up to $1.5 million, which is rather aggressive in the marketplace.
So, to keep this in mind, the goodwill will be considered after you factor in buyer injection, collateral, and seller financing.
For example a $2.2 million transaction. That is coming with seller paper for $350,000. It is coming with buyer injection of $350,000 and mezzanine financing of $350,000. In that regard, you would look at it and you would say, “Okay. We have, between buyer and seller injection, we have $700,000 in equity going to the deal”. That reduces a $2.2 million transaction to a $1.5 million transaction. Then, the inventory need was about $350,000, as well. Now, we’re clearly over what that goodwill threshold is- closer to $1.9 million. We were able to bridge that with mezzanine financing.
Equity Requirements
Up until the beginning of 2018, it was highly typical to see a combination of buyer injection, seller paper, up to 25% of the transaction. Since 2018, the SBA changed their requirements. They deleted the 25% requirement for goodwill transaction. As a result of this many transactions will either have 10% or 15% equity injection for the buyer. It’s been highly competitive since then. A lot of buyers are now using the SBA to leverage the 7(a) program and buy businesses that they hadn’t been able to previously.
It’s important to mention what the injection will be. Although the minimum is 10%, many banks and many debt service requirements, you’ll see you have to get into that 15% realm to make the transaction more palatable for the bank.
Seller Notes
Fidelity wants to see that it does not hamper the cash flow of the business, and shows that the target business still has the ability to service the debt. It’s very typical where Fidelity will ask for a seller note to be on standby for 2-3 years. Many sellers are not okay with that, it’s not palatable for the seller, and that’s completely understandable.
Not only is the bank may mandate how the loan should be structured, or how the selling mode should be structured, but it could actually cost the buyer something at the end of the day because now the seller has a holdback. The time value of money, or the opportunity cost of the buyer not getting paid, 100% of the transactions is a rather large factor, as well.
Portfolio Crafting
Often people are using their existing engineering, their existing staff, their existing accounting, and creating synergistic acquisitions. They are case by case. The largest caveat is setting up a direct timeline. Fidelity wants to see that the first business has been stabilized before they move on to the next one.
In terms of questions, it’s important to engage the lender, and the banker, sooner rather than later. Fidelity wants to know what they’re dealing with. They want to look at each individual credit if there are significant cases they may speed up that time horizon to the next fiscal year. Or, they may want to see an actual 12 months of history.
Source and Mezzanine Funding, Equity Structure
Source funding and mezzanine debt deal structures are also on the table. Source funding is directly correlated to the who must guarantee bullet point, as well. In many cases, someone might to Fidelity and might only have 15% equity of the company. They have five buyers who all have 10% of the company, or, five investors. That is fine, just bear in mind that as you’re structuring your transaction, anyone who has 20% or more will be asked to sign and guarantee. If you need something, if someone does not want a guarantee or does not want their personal financials to help be a credit enhancement or guarantee, they must be under 20%.
It should also be noted that the SBA is for active businesses. Fidelity does not fund people who are just investing. They want people who are actually running the business.
That’s not to say you won’t have managers or a hierarchal corporate structure where there could be an entire management team in place, but Fidelity does want directors and equity partners over 20% to sign.
Mezzanine debt is something seen a lot more in the past three years or so. Mezzanine is essentially someone coming in who is not taking equity, restructuring the deal, in probably a shorter time frame, possible a higher rate than the SBA world. It’s a great way to reduce the exposure for the bank.
It’s been used in scenarios where transactions are over that $5 million mark. The SBA max is $% million, but Fidelity gets the mezzanine debt to come in $500,000- $1 million lower than that of SBA standards. If the goodwill is just significantly higher than a bank would lend to, Fidelity can have mezzanine come in and do that as well.
Capital and Inventory
Banks typically want the working capital documented. The inventory is very easy to document. Fidelity funds working capital, they do want to see some kind of cash cycle need for the business.
If it’s a 30-day receivable, that’s when there will more likely be working capital. If you’re hiring an individual engineer, paying salary, or you want to beef up marketing, that is also on the table. Significant working capital needs, Banks could ask for a business plan.