December 9, 2015
By Walter McLaughlin
Senior Vice President, Banner Bank
C-Suite — Is the Change of Ownership Boom Peaking?
In life, the relationship between supply and demand is so straightforward that even infants understand the principle. When supply is high (i.e., Gerber’s Mixed Vegetables), its relative value diminishes; when supply is low (i.e., a cookie), its value increases. Let’s not talk about them dipping the cookie in the baby food.
The same laws apply to enterprise value. Due to the ravages of the Great Recession, over 200,000 small businesses disappeared between 2008-10. During this time net new businesses (the difference between startups and closures) plunged deeply into the negative. The math has improved since then, but is still challenged in part because lenders — no doubt recalling the large number of small business failures during that era— remain cautious.
Change of Ownership Dynamics
Given that so many businesses closed and the pathway toward starting new ones became much more difficult, it only makes sense that the spate of healthy businesses hitting the market have been in high demand. Change of ownership scenarios remain complex to underwrite due to the transaction’s effects upon the pro-forma balance sheet, management’s projections, the qualifications of new ownership and other factors. Yet, these types of loans have grown sharply in recent years, pushing 7(a) loan volume to record heights.
Alas, every good thing eventually comes to an end. Business owners who had planned to sell back in 2008 but were stymied by the economy have had success, and in doing so have pushed the average price upward. This triggers the first rule of supply and demand: as price goes up, demand goes down. Interest rates slowly edging upward will further impact the equation.
According to BizBuySell.com, year-over-year small business transactions fell nearly 9% in the third quarter of 2015. Although one quarter is not enough to establish a trend, it is reasonable to believe that the boom in change of ownership deals will peak soon. It may even have already happened.
The Importance of Underwriting
All of this leads to a premise that SBA and the lending community can agree is more critical than ever: thorough, careful underwriting. The 50 10 5 (H) speaks volumes about the SBA’s perception of the risk: SBA considers a change of ownership to be a “new” business because it will result in new, unproven ownership/management and increased debt unrelated to business operations.
Consider taking Coleman’s Certified SBA 7(a) Loan Underwriting Training in 2016. With the balance between supply and demand constantly shifting and the unpredictability of the economy a persistent concern, staying abreast of the intricacies of SBA underwriting is more critical than ever. As Laurence J. Peter once wrote, “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.”