Your Business Broker Can Be a Key Player in Obtaining Bank Loan Prequalification to Attract Qualified Buyers
Aftermarket business sales are rarely completed without some type of financing. Generally, the money used by the buyer for the purchase will come from either third-party bank financing or seller-financing, or a combination. As a shop owner contemplating the sale of your business, understanding the elements of bank financing is key to ensuring you will maximize the sales price and minimize the process time.
The Small Business Administration (SBA) gives participating banks some comfort room and elbow space in approving business purchase loans by guaranteeing as much as 85 percent of bank loans up to $150,000 and 75 percent of loans more than $150,000. SBA loan terms and interest rates are competitive and attractive. Typical terms are 10 years at 6% fixed interest or floating at 2.75% above the bank’s base rate. In addition, working capital for the buyer can be included with the purchase loan under favorable terms.
I’ve been involved in the sale of about 50 automotive service businesses in the past few years. I’ve arranged for bank/SBA financing for approximately 2/3 of them. I’ve had the pleasure of teaming with a business colleague, Mark Cyrus, who is the Business Development Officer for San Francisco-based Wells Fargo Bank, a SBA Preferred Lender in all 50 states which has consistently been America’s top SBA lender in dollar volume. Wells Fargo approved a record $1.6 billion in SBA loans for fiscal year 2014. Mark agreed to collaborate with me in this article to provide his expertise and knowledge of the process.
Consider How Your Business Sale Will be Financed and Prequalified by the Bank
The biggest difference between a conventional business loan and an SBA loan is that you don’t have to have a lot of collateral for an SBA loan.
It helps greatly to get a business pre-qualified by the bank. That prequalification demonstrates credibility with a buyer that the business is solid enough that a bank will lend the money if the buyer is qualified.
Mark Cyrus said, “At Wells Fargo, we do prequalification for businesses all the time. When I get the business documents, I carefully review the business financials first and then I look at the client who is trying to buy the business. So I make sure that first the business can hold the debt and if it can, then I make sure that the client has got the cash injection they need. To be considered as a viable buyer, previous automotive service experience is not necessarily a requirement. I just want them to have prior management experience.”
Preparing & Properly Packaging Your Business Financials
As a business broker specializing in the automotive aftermarket, I often work closely with my clients who are preparing their business for sale during the business succession planning process to make sure that business income and expenses are properly categorized and consistent from year-to-year and to determine whether or not the aftermarket business is going to ultimately qualify for financing.
Buyers determine their offer price based primarily on your cash flow, using your historical information to predict how much cash the business will generate for them to pay themselves a reasonable salary, make debt payments, and provide a return on the buyer’s cash investment.
Both the buyer and the bank will have expectations that you supply at least three years of tax returns and profit and loss statements.
Before your business can be properly marketed to a buyer or a bank, I prepare a comprehensive Confidential Business Review (“CBR”). It is, indeed, a comprehensive document, providing all the data needed for a buyer to evaluate your business and for the bank to make a financing decision.
Mark Cyrus noted, “Art’s Confidential Business Reviews are the best write-ups from any business broker in any industry that I’ve seen. Art knows exactly how to zero-in on documenting what is needed to assist the seller, the buyer and the bank to make a successful deal happen. By providing those, he saves 3 to 4 days of the underwriting process because they don’t have to ask all the questions already answered in that document. So he is really able to streamline the process. I don’t get stuff like that from other business brokers, not in that kind of detail. It’s awesome data.”
As a business broker, I often perform the service called “recasting” your financials before they are presented to a bank or to a buyer. Adding back payroll that is not applicable to a buyer is one of the most common adjustments.
A recasting spreadsheet is really the guts of how you maximize the cash flow documentation and hence maximize the selling price of your business. Generally, the cleaner it looks, the less the buyer and the bank will question it and it makes your business easier to sell.
Mark Cyrus commented, “A business has to have a cash flow and spreads that make sense. At Wells Fargo, we hone in on that more than anything. Many shop owners may not know that we are looking at the business more closely than we are looking at the buyer when it comes to approving a loan.”
Mark continued, “We want to see the new business owner thrive. To that end, we can offer interest-only payment schedules for the first few months, along with a substantial line of credit extended to the buyer in addition to the business purchase loan, which can be used to give the business a shot in the arm by kicking up the marketing and advertising, updating equipment, or purchasing new inventory. Many times, when a buyer buys a business, the buyer exhausts all his available capital to purchase the business and then when he really wants to improve the numbers he doesn’t have the working capital to dedicate to marketing and advertising and equipment and inventory. At Wells Fargo, we know that having additional capital on top of the business loan makes a huge difference. We arrange the loan so that, if for some reason it isn’t needed after all, the buyer pays no interest on it and after one year it will be taken off the loan principal.”
Taxes and Income
Some businesses don’t report all of their income in order to save on taxes. This “Phantom Income” will not be considered by a bank or buyer, so be prepared for the fact that your business will be valued based upon reported income only. Remember, I’m not an accountant or the tax man, but if you expect to maximize your sale price you should have at least a year or two where all income is reported.
If you don’t own your building, your lease terms are absolutely critical to transitioning your business. Banks will want to see at least a 10-year lease, including options. The lease should clearly detail landlord and tenant responsibilities for who pays taxes, insurance and maintenance. It should include no rights for the landlord to terminate the lease.
I have a client now who claims to have a great relationship with his landlord, but is on a month-to-month lease. No one is going to buy that business unless they can first get a good written lease.
When should you go to your landlord for any needed extension? Before you have a buyer is certainly better than after you have one and no longer have any negotiating strength. Tell the landlord you are in the process of refinancing the business and at some point in the next three years, you might consider retirement and having your kids take over. Then ask for additional options totaling 13 years.
As far as the bank is concerned, they are going to want to see 10 years as of the date of closing, so you need to cover yourself and not have to go back to the landlord at the last minute for an extension.
If you are selling a franchise, be aware of transfer fees, minimum financial requirements for the buyer, and how much time you have left on your franchise agreement. Also, the bank will want to see that there are at least 10 years left on the franchise agreement and the process for renewal.
In managing your inventory, if possible return any older inventory and replace with faster moving items. Don’t expect to get paid for inventory of obsolete, slow moving, or used parts when selling your business.
Properly Pricing Your Business
It’s never too early to get an idea about what your business might sell for. The exercise of going through a valuation of your business with a broker, business appraiser, accountant or financial consultant will help you understand:
• How the value is determined
• How buyers will perceive your business value
• Whether or not it will likely get bank financing
• What a 3rd party bank appraiser will value it at
I have had sellers significantly undervalue their business and many who have a well inflated opinion on what it might sell for.
Mark Cyrus added, “Trends are a huge factor…we look at trends. We like them to either be stable or on the upswing. A business that has been having more than 15% declines year over year will have a hard time getting a financing deal approved.”
It is important to look at your business objectively and not get caught up in the emotions of all the sweat equity that you have expended over the years or what you need to get for it in order to consider retirement.
Businesses are generally valued as a multiple of cash flow. It is not linear, so the higher the cash flow, the higher the multiple. Generally the range is 1.5–3 times the Seller’s Discretionary Cash Flow, a term that you may see on Internet sites like BizBuySell.com and will become very acquainted with during the business valuation and sales process.
Seller’s Discretionary Cash Flow is defined as the bottom line income of the business, PLUS:
• Seller’s compensation, benefits and perks;
• Depreciation and amortization, which are non-cash expenses;
• Possibly the shop manager’s income if owner is a semi-absentee;
• Usually any income a spouse may be taking if the position is not required by the buyer, such as 5-15 hours a week of paying bills and other administrative tasks;
• Major non-recurring capital expenditures, such as lifts or new alignment equipment;
• Interest payments on the seller’s debt service, since it would be paid off at closing, including equipment leases that would be paid off; and
• Personal expenses that can be documented, if not excessive
From a business succession planning perspective, every dollar that you can add to cash flow will likely yield you $2.00 to $3.00 in the most likely selling price of your business. So you can see how critical maximizing Seller’s Discretionary Cash Flow is to the selling price.
I am very satisfied with the mutually beneficial relationship I have been able to establish between Mark Cyrus at Wells Fargo Bank and my clients, both independents and franchisees. Mark noted that, “Wells Fargo has broken records in the dollar value of SBA loans and there are reasons that buyers should consider us. For example, the underwriters who I work with have ten years or more experience and have a complete understanding of business acquisition. Where I work, I sit close enough to the underwriters that I can go over there and talk to them face-to-face, thus eliminating time delays. We can process SBA loans up to $1.5 million without collateral and fixed rate loans for 10 years, a big advantage over variable rate loans with a looming balloon payment. We do so many SBA loans, for both independent shops and franchises, that we have the processes down pat. All of our closers are very familiar with the process of purchase. We have a timeline and try to get them closed within 45 days. It doesn’t always work out that way but that’s our goal. As I stated before, we have the best interests of the borrower in mind and want him to succeed.”