📈 The Two Questions SBA Lenders Can Ask

INTRO

It’s Michael.

In today’s issue:

• THE WEEKLY: 📈 Business Buyers: Two Questions You Gotta Know the Answers to

• BEST RESOURCES: 

  • Valuation Multiples

  • ‘Back-of-the-napkin’ LBO Model

THE WEEKLY

This one will be a bit shorter because I got feedback that my last email was a bit too long. If you have any feedback or questions, just reply to this email!

Ok, let's dive in to Part 2 of The CPA’s Role in Business Acquisitions 👇

Ben Mallah, self-made real estate centimillionaire famously said that he wouldn’t be where he is today without the bank.

His strategy:

1. Managed properties in Oakland, CA for an owner

2. Stacked cash and skills

3. Borrowed money from the bank to do his own deals

The same strategy applies to buying businesses.

When you decide to buy a business, you can either:

1. Patiently stack cash until you have enough to buy the business outright

2. Stack up enough cash to cover the down payment on a SBA 7A loan

Life is short. I prefer option #2.

But just because I prefer option #2 doesn’t mean I can make option #2 work.

Will the bank even give me the loan?

The two biggest questions a bank will ask to determine if they will give you a loan 👇

First Question: What’s the Cash Flow and Debt Service Coverage Ratio (DSCR)?

There are four steps.

First, calculate the SDE

The broker / seller usually provides this. If not, the formula is 👇

Second, calculate Free Cash Flow (Before Debt Service)

Third, calculate Annual Debt Service

Fourth, calculate Debt Service Coverage Ratio

Example

Thought Experiment

If you:

• Have $130,000 to invest

• Take out a loan for 90% of the purchase price (so PP is $1.3M and loan is $1,170,000)

• Want an annual salary of $50,000

What does the target company’s SDE need to be for it to make sense for you and your bank?

Answer = $337,130

Second Question: Who’s The Buyer?

When meeting with SBA lenders, they’ll get info on:

• Whether you have management experience in the target industry

• Your credit score (shoot for 650+)

• Whether you’ve ever been through bankruptcies or loan defaults

• Whether you have any collateral (not a dealbreaker b/c some lenders are OK with just the cash flow of the target business, if it is strong)

On Valuation

The best resource I’ve found on valuation for SMB acquisitions is from BizBuySell. Here’s the link.

When you’re running your numbers, check what the SDE multiple is in your ‘back-of-the-napkin LBO model’.

In the thought experiment, it was 3.86x.

That is very high, unless you’re buying in one of the below industries:

• Junk/salvage yards

• Car washes

• Assisted living & nursing homes

• Funeral homes

On Other Finance Options

This edition focused on the SBA 7A loan because that’s what I have the most experience in, but there are other options. Here they are (this is just a few), ranked by the amount of friction to get it done.

1. Seller Financing

2. Private Money (ie raise debt/equity from private individuals)

3. Assumption of Seller's Debt

4. Crowdfunding (ie raise money from individuals online)

5. SBA 7a (added here to emphasize that this has the most friction)

THAT'S A WRAP

How I Can Help 💰️

I’m the owner of Divergent CPA, an advisory firm that helps business operators and business buyers with:

• Strategic tax & accounting

• Dealmaking

If you’re interested in a strategy call & demo, book a free consult with me 👇 Note: We’re keeping things small intentionally, like a boutique. So, don’t wait.