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Copyright Diamond America, 1 of a 4 part series 2013 Session 2.

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Presentation on theme: "Copyright Diamond America, 1 of a 4 part series 2013 Session 2."— Presentation transcript:

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2 Copyright Diamond America, 1 of a 4 part series 2013 Session 2

3 In this session we will explore the following 1. 10 actual SBA rules and how they can effect your listing 2. How to determine if SBA financing is a viable option 3. Understanding lender criteria to determine if they are a fit for your listing 4. Does providing financing really benefit your office and how? 5. Direct lender vs loan broker services, helping you decide 6. Pre-qualifying your buyer 7. Why seller notes may or may not help you secure financing Copyright Diamond America,1 of a 3 part series 2013 Narration by Stephen Mariani

4 Actual SBA 7a loan rules The 10 rules that matter to you (only applies to business acquisition loans) 1. The seller cannot remain with the business for longer than 12 months 2. The required equity injection on SBA loans (down payment rules) 3. If a seller note counts toward down payment (or not) 4. Why the license is required PRIOR to closing (not the sellers) 5. Proof of cash injection, why it’s never easy! 6. Buyer’s personal liquidity matters and why it does. 7. Loan term rule when including CRE 8. Why your loan might have to be sent GP 9. Required third party reports and outcomes 10. Why your commission has to come from the seller’s side of the HUD Copyright Diamond America,1 of a 3 part series 2013

5 The seller has to go Actual rule: The seller may not remain as an officer, director, stockholder or key employee of the business. (13 CFR 120.130) (If a short transitional period is needed, the small business may contract with the seller as a consultant for a period not to exceed 12 months including any extensions.) Copyright Diamond America, 1 of a 3 part series 2013 The seller may execute an employment contract but as it states above, cannot be a key employee and cannot remain for longer than 12 months. This rule was designed to be sure loan proceeds are used for arms length transactions and not as a way to secure funds for the existing management. The amount of this contact MAY be considered in cash flow calculations. NOTE: This rule applies to anyone within the selling entity corporation owning ANY amount of stock at all.

6 Actual rule: If the purchase price of the business includes intangible assets (including, but not limited to, goodwill, client/customer lists, patents, copyrights, trademarks and agreements not to compete) in excess of $500,000, the borrower and/or seller must provide an equity injection of at least 25% of the purchase price of the business for the application to be processed under delegated authority. (Seller equity is defined as seller take-back financing that is on full standby (principal and interest) for a minimum of 2 years.) The borrower and seller will agree how much equity each will provide. For example, the borrower and seller may each provide half of the equity or the borrower may provide 15% and the seller may provide 10%. Every lender interprets this rule differently and determines their own credit underwriting criteria and requirements. Determining down payments Copyright Diamond America, 1 of a 3 part series 2013

7 Seller notes and there effect The seller note can help, sometimes The good: There are 3 basic reasons a seller note may help in your transaction when considering an SBA financing option. A. To assist the buyer with a down payment shortage (as described in previous slide) A. When cash flow coverage does not meet a lenders minimums B. If the seller terms meet or exceed the lenders terms this amount can increase the cash flow coverage ratios The Bad: There are many reasons that the seller may not want to hold a note and some are justifiable as retirement, relocation, etc. Here are the top 3 reasons that a seller note may hurt your loan request. A) The term is typically much shorter than the 7a loan and reduces cash flow to the buyer and the debt coverage ratios to the lender B) The buyer loses some ability to negotiate during the purchase process C) The broker commission is sometimes considered by the seller to assist Copyright Diamond America, 1 of a 3 part series 2013

8 The buyer must hold all licenses and permits required to operate this new business prior to closing. The seller’s license is “typically” not acceptable to the lender after closing and should not be acceptable to the buyer either. Allowing the seller to remain as the license holder after closing will violate the previous rule stating the seller cannot be a key employee. If the seller decides to change their mind or the license is revoked, expires or is removed in any way, the buyer has to cease business operations and cannot be permitted to operate without a required license. This being said, if 2 or more employees hold the required license and the buyer can also qualify for one either today or in the near future, it is possible to continue the transaction without the required operating license in the buyer’s name. Licenses and Permits Copyright Diamond America, 1 of a 3 part series 2013

9 Proof of Cash Injection A. Equity injection (down payment) CANNOT be borrowed! B.Must show 3 months of bank statements with the required balance C.If using a HELOC, must show source of outside income for payments D.Can be a gift. Typically from a direct family member E.Can be injection from minority partner (under 20% ownership) F.IRA rollover or some such acceptable source G.Can be from the sale of a house or other personal asset H.A portion may come from the seller as a note on stand by for 2 years or more Copyright Diamond America, 1 of a 3 part series 2013 There are limited ways for a buyers down payment to be legally acceptable as cash injection. Be prepared to explain where it came from. Below we describe the most common forms of cash injection

10 Actual rule: Depending on the total financing package, this rule varies and we will discuss 2 sizes here. Loans from 250M to 500M and loans over 500M. Personal Liquidity rules Copyright Diamond America, 1 of a 3 part series 2013 1) Loans from $250,001 up to and including $500,000, the exemption is one and one-half times the total financing package or $500,000, whichever is greater 2) Exceeds $500,000, the exemption is one times the total financing package or $750,000, whichever is greater What this rule means to the average buyer is that aside from fully collateralizing the loan with available assets, we must also be sure they are not too liquid. Many high net worth buyers need to know and address this upfront.

11 When CRE is included in the loan When CRE is included in the loan (Commercial Real Estate) 7(a) Loan Maturity: May use blended maturity or a maturity up to the maximum for the asset class comprising the largest percentage of the use of proceeds. The maximum maturity for these loans is 25 years plus any additional period reasonably necessary to complete the construction or improvements. What this can mean to you What this rule means is that the lender can determine the maturity or loan term if the acquisition includes commercial real estate that equals 50% or more of the loan amount. This rule is not always utilized by every lender and if yours is not using it, ask why. The rule changed about 3 years ago and greatly increases the SDE (or cash flow) of the business to the buyer. Making it a much more attractive listing. FYI- (Loan term maximum without CRE is 10 Years) Copyright Diamond America, 1 of a 3 part series 2013

12 What causes a loan to go GP (sent to SBA processing) There are many factors (as many as rules exist) that can cause a loan to be sent to central SBA processing, and not all are bad. Here are some of the more common reasons. If the current seller has not owned the business for the last 3 years (or since inception) More than 2 criminal charges ever on the part of your buyer may cause it to go GP. The removal of collateral required under SBA rules The borrower is refinancing SBA debt with another SBA loan A change (removal) in borrowers assets in the last 6 months prior to application Arms Length transaction Copyright Diamond America, 1 of a 3 part series 2013

13 Third party reports To close any SBA loan there are many mandated third party reports required and the outcomes do matter. Here is a small list of them. Business Valuation. Since 2010 the SBA has allowed for a 10% variance when reviewing the valuation. This means a BV can come in at 90% of the selling price and the lender can continue to close the loan. Environmental report. Or phase 1 or 2 depending on the property use. This assures the lender and borrower that the property being purchased is clear of EPA issues or concerns. Must be ordered by the lender. Appraisal. A full complete commercial appraisal must be ordered by the lender and done by an approved appraisal firm. Lien and judgment searches. On each borrower, guarntor and seller. UCC state lien search. Must show business is or will be transferred free and clear of liens. Copyright Diamond America, 1 of a 3 part series 2013

14 SBA rules regarding fees If you never heard of a form SBA159 then you have done it correctly and not tried to collect any commissions or fees from the borrower’s side of a closing statement. And you probably never want to. The SBA feels no person, agent or consultant should be charging the borrower for any NON direct expense fees and requires every dollar paid to anyone assisting with the loan application to be disclosed to them for review. They monitor these fees closely and disallow any they feel are not justified. They also require a detailed invoice for any services charging over $2,500 to the borrower and do not allow any of these fees to come from loan proceeds. All lender paid fees are also included and the 159 form is required on each and every “Lender paid” fee. The SBA has NO CONTROL of the sellers side of the HUD and cannot prevent any seller proceeds from being distributed to anyone they choose. Lender fees are sometimes offered to brokers but consider their offer as just a way to view your deal first, it may not be to your benefit. Copyright Diamond America, 1 of a 3 part series 2013

15 Lender policies vs. SBA rules This topic has been covered in module 1 but is worth mentioning again because of it’s importance in working and understanding SBA lenders. There is always confusion as the lenders inject many of their own policies into the application and lead many to believe it is an SBA rule. A lender that has no interest in your deal or needs to adjust it to conform to their policies does not have your buyers or sellers best interest in mind. One of the most important questions you can ask a lender is: if what they require is SBA rule or lender policy- many times they differ a great deal. ◦ Example 1: “Goodwill is capped at a maximum of 1.2MM.” NOT TRUE, although many lenders would like the public to believe this to be SBA rule. Actually the SBA rule on goodwill maximum is 5MM. The motive behind this is to lead you, and/or the buyer, to believe that no lender can offer a better program with more goodwill funds. ◦ Example 2: “We MUST have 60% collateral coverage.” Again, this is a lender rule and specific to only that lender. Don’t fall into believing that once a lender says something like this that it is the only option, many times it is not. The list goes on with the differences between the 2. You should always ask the question, “who’s rule is this?” The current SBA SOP has 373 pages of policies and guidelines and if you are unsure, find out. Do not rely solely on the information being provided by the lender reviewing your deal. Copyright Diamond America, 1 of a 3 part series 2013

16 Determining if an SBA loan is right for your listing The business must show cash flow to support the debt for the last 2 years as reported on tax returns. It is “possible” to find a lender that will consider only 1 year of cash flow but you must provide significant reasons why it did not in year 2. Cash flow will include many of the addbacks you reviewed to determine SDE (sellers discretionary earnings) but will not include any type that blatantly violates IRS rules. Lenders MUST review the last 3 years of financials and tax returns to determine the trends of the business and quality of operation. Upward trends and supporting cash flow will determine how many lenders may have an interest in financing your listing. Copyright Diamond America, 1 of a 3 part series 2013 Knowing which deals to consider financing for and how that can make you more money

17 Determining if an SBA loan is right for your listing What addbacks many lenders are willing to consider are those expenses related to the departing seller and NOT buyer specific expenses (moving forward). These should be explored and understood before compiling any SBA loan application. Lender coverage ratios and how they vary is also a big concern and something you should know and understand BEFORE presenting any loan request to a lender – This can SAVE your deal and you, your buyer and seller a lot of wasted time and frustration. Debt service coverage ratios will be anywhere from 1.25 and go up to 1.65 depending on the lender and there experience in a specific industry. Also something to explore and understand before loan submission. Copyright Diamond America, 1 of a 3 part series 2013 Knowing which deals to consider financing for and how that can make you more money

18 Determining if an SBA loan is right for your listing To determine which lender should be considering your listing you must first understanding each lender and their specific industry policies and guidelines. Do NOT try to put a square peg in a round hole as this will cost you time and money. Qualify your buyer upfront and know the concerns (if any) before presenting him to a lender. Here are the three basic things you MUST know about your buyer.  Buyers credit rating  Buyers resume’ and how it relates to this business  Buyers down payment and where it’s coming from Other considerations- - Additional collateral if and when available (why it may matter) There are many brokers and lenders that can pre-qualify your buyer upfront and save you time and money, you may want to explore these. Copyright Diamond America, 1 of a 3 part series 2013 Knowing which deals to consider financing for and how that can make you more money

19 Determining if an SBA loan is right for your listing Which lender to use and how to know the difference  Is your lender or BDO (business development officer) looking out for your sellers best interest (and yours). Are they explaining to you how underwriting will evaluate your loan application or are they just telling you what you want to hear to get a look at your deal?  Have they proposed on listings in the past and not performed?  Do they have experience in financing the industry you have listed? If your answer to the above is no then you may want to consider other options. In the current lending environment there are many inexperienced lenders out there that can waste your time and cost you a deal, understand the rules and don’t let that happen. AFTER ALL – Time kills deals, we all know that Copyright Diamond America, 1 of a 3 part series 2013 Knowing which deals to consider financing for and how that can make you more money

20 Things you should consider when deciding Things you should consider when deciding Direct lender May not be experienced in your listing industry Once information is provided it cannot be adjusted or corrected Only has one box to fit your request into Receives a salary and may not have the same interest as you May take 3 to 5 weeks for a decline Cannot suggest structuring changes that benefit both sides if they cannot provide them Their internal polices may limit the benefits to both buyer and seller Loan Broker Most experienced brokers have done loans in every industry Always presents corrected information(over 84% are typically presented incorrectly) Familiar with MANY lender boxes and can best fit the lender to your listing Only receives their fee if your deal closes -they live where you live A decline typically comes within a few days (and that’s important) Always structures the loan upfront for the best chance of approval Explores all financing options available for your transaction Closes more deals than any BDO We’re NOT just another lender! Copyright Diamond America, 1 of a 3 part series 2013 Direct Lenders or Loan Brokers We may be bias but the decision seems easy

21 We think it should always be explored if possible We think it should always be explored if possible Buyer injection is great reduced Seller leaves the closing with all (or most) of the selling price Working capital is always included MUCH larger pool of buyers Lower monthly buyer payment amounts AND THE NUMBER ONE REASON TO CONSIDER FINANCING OPTIONS The seller is very pleased with your office and DOES NOT RE-negotiate your commission! We’re NOT just another lender! Copyright Diamond America, 1 of a 3 part series 2013 Can including an SBA financing option benefit your office? We may be bias but the decision seems easy

22 ۩ Exactly what the underwriter’s views on add backs are and why ۩ How your memorandum looks to a lender and how to make it look better ۩ What items you’ll need to discuss with your seller to make the deal happen ۩ How to improve your chances of securing financing from the start Try our newest service designed just for your industry, AskDiamond@easysba.com AskDiamond@easysba.com Tech support for all your SBA and structuring questions. (Whether it’s our loan or not) Broker Financing Assistance ~ Complete Customer Service ~ Greater Financing Avenues Sharing our financing knowledge with you Put the power of our experience to work for you! Copyright Diamond America, 1 of a 3 part series 2013

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