I get quite a few questions in reference to SBA lending for U.S. Entrepreneurs.  Here are a few tips on SBA oans.

Several new business buyers in the United States use SBA (Small Business Administration) loans to fund their first business purchase or a line of credit. There are some definite pros and cons for using these funds that business buyers should be aware of. I’ve listed 5 of the pros and cons so you can begin to evaluate the process for yourself. Remember all lenders expect to be repaid and businesses are not 100% fool proof.

1. All owners of 20% of the business are required to give a personal guarantee- When you go to your business banker they are going to request you to sign an application and a loan that commits you to a personal guarantee for the money you are borrowing. The bank is guaranteed by the federal government that they will get their money back if your business fails. On your loan documents it will state the percentage of the guarantee by the SBA. In the event of your default they can legally pursue all borrowers with personal guarantees.

2. SBA 7(a) loan lends up to 90% of the loan to value of your business purchase with real estate- Lenders have now increased their loan to value lending limits to encourage more business buyers and entrepreneurs to stimulate the economy. Not all lenders will lend up to 90% of the purchase.

3. Legal aliens are entitled to SBA lending – Legal aliens in the U.S. are entitled to the SBA program – you do not have to be a U.S. Citizen to get an SBA loan. In the underwriting process SBA lenders do look for time that aliens have been residing in the United States and other characteristics of the borrower that will make sure they can fulfill the terms of the loan.

4. A SBA loan can provide money to business buyers that may not be able to them in other ways – Financing a business acquisition is tough and the SBA loan can help. The requirements for SBA lending maybe less than a conventional business loan because the federal government is securing a portion of the financing.

5. Only about 10 % of business buyers use the SBA loan for a purchase – According to a recent survey, only about 10 % of all buyers of businesses will use SBA financing to purchase a business. There are several other forms of financing that business buyers can use that reduce personal risk for business buyers.

6. In the event of a personal bankruptcy including an SBA loan, borrowers can not receive another SBA loan until they have paid back the guaranteed portion – I’ve seen a lot of questions on the internet about Chapter 7s and SBA financing.

One of my readers ran into this pitfall.  He purchased a business assuming that he was going to be able to work with the previous owners’ relationships with the vendors and creditors.  Within a week after closing EVERY vendor showed up at his door asking for personal guarantees!  They all said that his business was brand new, it had no history or track record, and they would only do business with him if he gave a personal guarantee.  His FICO score dropped like a rock and finally some of the vendors started to refuse to give credit – because his credit was too low!!  Worst of all he had to use precious cash flow to pay the vendors.  Luckily the damage wasn’t permanent. I’m happy to say he’s still in business, however he’s learned an absolutely invaluable lesson about buying a business.

A good friend of mine and private equity coach, Lee Abbott, had the best response I’ve ever heard.  “A good business – a truly good business (meaning well composed processes, accurate and honest financial records, good industry, and great management) has great value.  You can never pay too much for a good business.”

Wow!  You can never pay too much for a good business – then what happens to the vast majority of people who buy businesses (thinking they are good,) and who get great bargains?    Here’s some more sage advice “Cheap Deals are usually cheap for a reason.”  This doesn’t mean just because the seller sells to you at less of a cost that the deal is bad.  Cheap and “good price” are two different things.  Ask my friend Richard Parker – author of “How to Buy a Good Business at a Great Price©,” www.diomo.com . 

Beware of business sellers that are willing to hand over the keys for next to nothing.  An associate of mine made me aware of a tanning salon business here in Denver.  A few years back the sellers began to sell their individual salons to unsuspecting business buyers on great deals for seller financing.  Why?  If the buyer couldn’t keep up with the payments they would merely reposes the equipment and keep the buyer’s down payment.  My friend told me that his brokerage refused to represent the seller after seeing the process happen twice.  He saw business buyers walk in with their life savings only to see it lost in a matter of months.  The buyers were devastated, the sellers had buyers steal equipment, and the business broker’s name was permanently tarnished.  No one wins when the objective is to pull the wool over someone else’s eyes.  Eventually after several lawsuits, theft of equipment issues, and tax issues the seller went out of business.   

Remember, you can never pay too much for a good business and cheap deals are cheap for a reason.

Here are a few points on why it’s better to buy a business instead of starting one:

1. An existing business can be financially predictable- A business that has been around for at least 2 years has a track record. The future expenses, cost of goods sold, employment expenses should have some correlation to the past years.

2. Financing is more readily available- Banks are strategic betters. They like to “bet” on ventures that are proven instead of new concepts. Statistically businesses that have been profitable for more than two years are going to continue to be profitable – or at least have income.

3. You can replace your income- When you buy a business you can potentially predict replacing your current income. Most business buyers are what I like to call “job buyers.” These are people who are looking to replace their current job with a new income and a new position.

4. An existing business should have sustainability-The businesses should already have existing policies, procedures, and employees. All of these elements will help you to sustain the business without the massive effort of starting a new business.

5. Starting a business takes a lot of energy to start- Starting a business is difficult and people frequently fail due to undercapitalization, poor planning, or misconceptions about owning a business. However, undercapitalization, poor planning and unprepared entrepreneurs are major reason on why business acquisitions fail. The big difference is that for the first year of starting a business you are just starting a business. You have so many things to worry about that you aren’t able to focus on making money. When you buy a business you can use your time effectively.

6. Current economic conditions favor business acquisitions right now but deter business startups- While I write this article we are having major financial issues as a country. Starting a new business today is like starting a new business in the great depression. Buying a business is an excellent time because businesses are selling for the lowest prices they’ve seen in over two decades! That means there is great opportunity for people who are prepared.

Best wishes

Ted E. Sanders

Founder

A friend of mine works in mergers and acquisitions. He called to tell me an interesting story.  Obviously in conveying this story he left out names, and specific information to protect his client. He was putting together a PPM (Private Placement Memorandum) for a gentleman who was buying a group of used car dealerships throughout the southeastern United States.  This entrepreneur was in his mid 50’s and reportedly had finished the 10^th grade before walking out of high school.  The entrepreneur had also declared bankruptcy TWICE in his relatively young life – having his second Chapter 7 discharged recently after a messy divorce.  To make a long story short the entrepreneur has purchased over $10 million dollars of business and assets – not using one penny out of his own pocket!      He leveraged the real estate of the business, and the assets (mostly used cars) to fund the acquisition.  He also engaged the help of a few private investors to make up the difference. 

 So – can anyone do this?  The answer is a resounding “NO.” 

 This entrepreneur was obviously familiar with private equity fund raising and structuring acquisitions. He also knew what he was looking for in a deal. He did have the help of a great attorney and good advisors.

 He did not however have a degree from a big name university, a big pile of cash, great credit, or a home! (Apparently the gentleman has been living in a family member’s spare room.)  

 My friend, the Mergers and Acquisition attorney, – is red with envy!  His exact words were “If this guy can do it why can’t I?”  Obviously I said – you can!

An 11 year old boy in Oklahoma grows his paper route by knocking doors and obtaining more customers.  One day he figures out that he increase his business by buying other kids routes.  Within less than one year he has developed a massive paper route – and extensively assisting the financial support of his parents, grandparents and extended family.

 A young medical student leaves school before graduation, sacrificing a promising career.  He gets an entry level job at a mergers and acquisition firm and begins to see companies that are poorly ran and have no accountability to its’ shareholders.  The young man teams up with investors to champion the cause of responsible business leadership in America, consequently become one of the wealthiest men of the 20^th century.  

 A young Russian buys one of the most prominent steel plants in the United States, borrowing against the existing assets of  the business and uses little if any money out of his own pocket.  This Russian dropped out of school at the age of 13.

 All 3 of these men have been termed “corporate raiders.”  During the 1980’s the term “corporate raider” was considered a dirty word that had people imagining pirate type business tycoons that were only focused on fulfilling their pocket books.  I firmly believe that these individuals were creative, resourceful individuals from whom we can learn several lessons on entrepreneurship, creative finance, and determination to succeed.  I strongly encourage you to study these historical figures and learn how they accomplished great things, and made major mistakes.  “The Corporate Raiders Guide” is aimed at teaching creative finance techniques and unique strategies for buying your first business.