Our Country’s recent economic downturn has placed business buyers and sellers under increased scrutiny when attempting to secure financing for small business transactions.
The loans that typically finance small business transactions are issued by either conventional lenders or SBA lenders. Both groups have lost their appetite for mediocre borrowers and, are less likely than ever before to make policy exceptions for these borderline borrowers. Lenders are requiring an increased level of due diligence from both buyers and sellers making small business transactions more difficult to fund.
A common misconception among borrowers is that the SBA lends money for small business transactions. The SBA does not lend money. It merely guarantees specific lenders that a certain portion of a qualifying loan will be paid back by the Federal government in the event of buyer default. This “government guarantee” is contingent on the lender adhering to a strict set of guidelines which may have been considered lax in prior years. That will no longer be the case. The SBA is tightening lender guidelines through the revision of its Standard Operating Procedure (SOP) 50-10 entitled “Lender and Development Company Loan Programs” effective June 15, 2008. Some of the changes that are taking effect include:
- A lender ordered, independent business valuation for an acquisition loan greater than $350,000;
- a life insurance requirement for buyers applying for an SBA 7a loan; and
- stricter environmental requirements (i.e. Phase I reports for most loans).
Lenders are looking deeper into buyer qualifications. Things such as industry experience, business and management acumen as well as a buyer’s personal financial situation have taken on increased importance when applying for a conventional business loan. Lenders will continue to examine a buyer’s equity position, business collateral and in most cases require a well thought out business plan. However, the projections in the plan will be scrutinized more closely. Sellers will often need to be involved in a transition period, and may be forced to provide bank subordinate debt in order to complete the transaction. As you may suspect, none of these criterion are new. However, a deeper level of lender due diligence is occurring and deals previously “on the fence” are no longer making the grade.
Even though the decline in the US economy has caused lenders to adjust their regulations, solid deals with good people will continue to secure financing amidst the currently unstable economic environment.