November 03, 2015
By Walter McLaughlin
Contributor, SBA Hot Topic Tuesday
SBA Hot Topic Tuesday — 10 Underwriting Tips for SBA Change of Ownership Loans (Part 2)
Second of a two part series.
On October 20, Part I of this short series was published.
Today, tips 5 through 10 for SBA Change of Ownership Loans.
- Cash flow: As stated above, the SBA’s debt service coverage ratio minimum is 1.15, although most lenders require a higher multiple. If the financing includes a seller note on fully standby for two years, it’s best to project out to when those payments start being made to ensure the business can handle the debt service at that time.
- Balance sheet: For loans over $350,000, a pro-forma balance sheet should be in the file that shows the net effects of the SBA loan, equity injection, seller financing and other debits and credits on the business, post-closing. A discussion of key pro-forma ratios (along with the adequacy of working capital) should be a part of your analysis. Since these transactions often strain leverage ratios, special emphasis should be placed on that subject. If goodwill exceeds $500,000, the down payment plus standby seller debt must be at least 25% of the purchase price to utilize PLP processing.
- Collateral: Include a collateral chart with standard liquidation factors. If the loan is over $350,000 and short on collateral, discuss the availability of outside real estate from the 20%+ owners. If the business will be a single-member entity or dependent on one person’s involvement, require life insurance if the loan is insufficiently collateralized. For loans $350,000 and below, the lender can follow its own policies and practices on both subjects, but at a minimum must include fixed assets as collateral – including a ‘best available’ lien on business real estate.
- Character: Follow standard processes and procedures on the new 20%+ owners.
- Business valuation: If the amount financed (minus appraised values of real estate and/or fixed assets) is over $250,000, an independent business appraisal from a qualified source must be obtained. Although the SOP allows the loan to be up to the amount of valuation, be sure to discuss any significant difference between the purchase price and the appraisal.
- 4506-T: The SOP says there should be “no material discrepancy” between the tax transcripts and the seller’s tax returns. Significant differences should be resolved satisfactorily.
In summary, when underwriting and processing an SBA change of ownership request, a little care goes a long way toward preserving the integrity of the SBA’s guaranty. As the late great Yogi Berra once said, “You can observe a lot by watching.”