October 20, 2015
By Walter McLaughlin
Contributor, SBA Hot Topic Tuesday
SBA Hot Topic Tuesday — 10 Underwriting Tips for SBA Change of Ownership Loans
First of a two part series
With the economy on the rebound and roughly 10,000 baby boomers retiring every day in the United States, it’s no surprise that change of ownership has become a wildly popular use of proceeds in 7(a) lending.
It makes a lot of sense. For the seller, it’s a chance to secure their retirement while passing the business they built on to younger, energetic successors. The buyer gets the keys to a business they have generally worked at for years without the challenges of starting their own business.
It’s a win/win, right? If done correctly, it sure can be. However, there are a number of very specific factors that need to be addressed when underwriting an SBA request to finance a business acquisition.
Since the SBA’s guaranty is always critical in change of ownership financing, let’s start with their general thoughts on the matter. SOP 50 10 5 (H) says the following:
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.
On the surface, that might seem counter-intuitive, but there is solid rationale involved. With management skills critical in business operations and often a very large amount of good will being absorbed, both the numerator and the denominator are potentially stressed. If management can’t operate the business successfully and/or the debt service requirements ultimately become too burdensome, the business may go under.
So what are some of the key points that should be included in change of ownership underwriting? Here are the first five:
- Loan structure: Check the SOP for structural requirements. Depending upon the scenario, the business must either be a borrower or co-borrower.
- Term: As with all SBA loans, use a term consistent with the use of proceeds and the borrower’s ability to repay. 10 years should be the general maximum.
- Benefits to the business: Discuss the benefits of the change of ownership to the business, promoting sound development and/or preserving its existence.
- Management skills: Carefully underwrite new management. The new owner and key management should clearly possess the ability to run the business. SOP 50 57 states that if an early default occurs related to underwriting that was not consistent with prudent lending practices, a full denial of liability may be in order.
To be concluded next week