Circumventing the “Perfect Storm”

People frequently use the term “The Perfect Storm” to describe a simultaneous series of events whose chance combination produces a far more powerful impact than that of any single contributing event. By their nature, perfect storms are rare – conditions must be just right and the slightest change to any one component of a perfect storm can lessen the overall impact.

One could argue that conditions are right for our nation’s economy to experience a perfect storm in 2008. Some of the catalysts causing this turbulence include:

• Liquidity concerns resulting from substantial losses in the sub-prime mortgage market
• Declining real estate values, once used as collateral or equity for many commercial loans
• Waning consumer confidence
• Concerns over inflation
• Tax rate uncertainties due to the upcoming presidential election

Individually, these events are manageable, but collectively they could have significant implications for your business sale or acquisition plans and your ability to obtain the necessary financing. Despite these factors, the United States Small Business Administration (SBA) and its network of Certified and Preferred lenders can help business buyers and sellers navigate these waters by structuring business acquisition loans in a way that requires less up-front cash from the buyer than might otherwise be necessary.

The SBA must adhere to certain lending parameters in order to manage risk. One such parameter governs the amount of equity that a business buyer must contribute to a business purchase. While the minimum required level is ten percent of the purchase price, in reality most lenders require between fifteen and twenty percent.

Proactive SBA lenders can find ways to mix and match seller notes not only to meet their equity requirements but also to allow deals to get closed. In doing so, lenders may supplement a buyer’s up-front cash with “equity” from a seller note. In order to be considered “equity”, lenders will require that the seller note standby (i.e. no principal repayment) for a period of time ranging from two to ten years, depending on how much up-front cash the buyer is contributing.

An example of how this would work is when the manager of a company is seeking to buyout the current owner. Assume the bank requires that fifteen percent of the purchase price be in the form of equity. In this case, however, the manager can only contribute five percent in up-front cash. In order to get the deal closed, the SBA lender can work with the seller to make up the difference by having the seller hold two separate notes. The first note would be for five percent of the purchase price and would be on full standby for the life of the SBA loan (ten years). The second seller note would also be for five percent but would have a shorter standby period, given that a full 10% of the purchase price would be invested for the life of the SBA loan.

There are two major reasons why this type of loan structure can be effective in today’s “Perfect Storm” environment. First, the owner will stay involved with the business and can help to transition customers and employees to the new owner. Second, with the turbulent home equity market, bifurcating the up-front equity requirement between seller note(s) and buyer cash will allow more buyers to qualify for financing.

Regardless of the “weather” or “whether” conditions, knowledgeable financial partners can find ways to satisfy their financial requirements and, at the same time, help buyers and sellers meet their goals and objectives. To learn more about the SBA and its loan requirements, visit www.upscapital.com or www.sba.gov.