What does the SBA expect in return for a 75% loan guaranty? a series designed to help lenders finance a change of ownership

RMA Journal, The, Sept, 2002 by Garry Barnes

Is there value added? Factors to take into account when considering the value added to the sale include:

* Will the sale enhance the future development of the business?

* Will the sale ensure continued existence of the business?

* Has the sale been attested to and justified in the lender's loan file?

Is the sale an arm's-length transaction?

* The price should be fair market value.

* The seller/buyer must receive no other undisclosed benefits.

* All rights, benefits, and conditions of the sale must be disclosed.

How do you determine value? The SBA recognizes five valuation methods:

1. Gross revenue multiplier.

2. Adjusted book value.

3. Discounted future earnings.

4. Capitalized adjusted earnings.

5. Cash flow valuation.

The SBA may also recognize other valuation methods. A qualified bank loan officer or an independent third party may conduct the valuation.

The agreed-to selling price must be compared with the value determined by an independent third party. The SBA states that the buyer/seller agreement to a selling price is not adequate representation as to the true worth of the business. A lender must support the price or third party using recognized methods of value determination.

What is the reason for the sale? The lender is required to understand and explain the reasons for the sale. Full disclosure of the real reason is required!

Is the business a going concern? If the change of ownership involves the purchase of a going concern, the borrower's repayment ability will normally be based on the historical financial performance of the company, without regard to whether the sale is a stock purchase or asset purchase.

As can be expected in any leading arrangement, the selling entity's repayment ability will, in part, be based on the historical financial performance of the company; therefore, historical financial statements from the seller will be required.

Financial Documentation

Accounting is the language of business, and a general communication dialog is carried out using financial statements. Three years of financial statements and tax returns on the business are required. In addition, current balance sheet and three years of tax returns are required from the borrower. A pro forma income statement (forecast) by month for the next 12 months might also be required.

In many cases, term loan agreements may be used to support SBA loans. A few conditions that may be found in a loan agreement are:

* Financial reporting requirements--financial statements must be submitted to the lender on a periodic basis.

* Salary and dividend limitations--owners/managers are limited as to the amount of salaries and dividends they can pay themselves during the life of the loan.

* Increased debt limitations--the company faces restrictions on the amount of additional debt can incur.

* Minimum financial ratio requirements--the company must consistently perform to certain minimum financial standards.

The factors listed above, like most terms and conditions found in a typical loan transaction, are generally negotiable.