The Small Business Administration (SBA) plays a crucial role in helping entrepreneurs acquire small businesses. Recently, we have observed some SBA program changes in the new guidance release that affects several key programs, including the 7A program, which will change some important aspects of these loans starting August 1, 2023.
To provide information about these changes to the community, we invited Heather Endresen, owner of Viso Business Capital and experienced SBA lender, to discuss the new guidance with our CEO Josh Levine on an episode of Private Market Insights. With Heather’s expertise in loan brokerage and her new role at Viso Business Capital, the conversation focused on providing insights on the effects of the new SBA guidance and its impact on the ETA community.
Check out the full conversation here:
Understanding the New SBA Guidance
In our wide-ranging conversation with Heather, she focused on several key elements of the new SBA guidance that she felt would make the biggest difference for the future of search funds and the SMB acquisitions space overall. These include:
- The potential for “partial buyouts”, to change the seller’s role both during the acquisition process and their contributions to the company post-acquisition.
- The potential use of seller rollover equity as a contribution to the down payment on an SBA loan.
- The integration of seller notes into the acquisition process.
- Changes to the personal maximum liquidity rule, allowing more people access to SBA loans.
- Changes to the way the SBA considers loans for religious activities
The impact of partial buyouts
One key element of the SBA program changes is the modification to allow Partial Buyouts. In the past, a buyer using an SBA loan would need to acquire the full business. This new regulation permits sellers and key employees to stay on with the business. There are a few key benefits to this new regulation.
First, it allows key employees who own minority stakes in the company to stay on with the company and retain their equity. In situations where key employees were rewarded with equity, under the prior rules, those employees would have had to exit the business, hurting the employees, the new owner, and the business overall. Now they can continue to lend their expertise to the business and benefit from its growth.
Second, partial buyouts loosen restrictions on businesses in industries with strict licensing requirements. In cases where the seller was the key license-holder within the business (for professions like HVAC or electrical contractors, for example), buyers without licenses would have trouble making a purchase because the license would leave the business along with the seller. Now, sellers can stay with the business in a partial capacity, broadening the pool of buyers for businesses requiring licenses.
Heather notes that the SBA has rules around key employees, who may need to put up their own personal guarantees if they stay with the business as assurance to the lender. This piece is still up for interpretation, but could have a cooling effect on the benefits of this part of the new rules.
Using seller rollover equity and seller notes when pricing a business
One change that’s been discussed at length on forums such as Searchfunder and SMB Twitter is the potential for using seller rollover equity to increase the purchase prices of the business by using seller equity as part of the down payment. Theoretically, these changes could mean that buyers could purchase a business for 0% down, with seller equity making up the full required 10% down payment.
Heather agrees that it might be possible to buy a bigger business if the seller keeps a large amount of ownership. But she’s unsure if the part of the business that the seller keeps could count as the 10% down payment usually required. This facet of the rules is still being interpreted.
Heather also wonders if it would be possible to get an SBA loan without a down payment, structuring the down payment as a seller note. Given the strict text of the document, this might be possible as long as the seller doesn’t get paid for two years. However, Heather questioned whether this is in line with what the SBA intended, as it’s very different from the old rules.
Heather talks about a new rule where a seller only pays interest on their loan and the buyer only has to contribute 2.5% of the down payment. This changes the old ‘five and five’ rule to ‘two and a half and seven and a half’. However, not many lenders might be comfortable with a deal where the buyer doesn’t put in any cash.
Changes to the personal maximum liquidity rule
Prior to the SBA program changes, individuals with substantial personal liquidity were unable to access the SBA 7a program, a regulation that many found counterintuitive. This particular restriction has now been lifted, paving the way for those who were previously obstructed due to their high personal liquidity to take advantage of the program.
SBA Financing for Nonprofits and Risks in Rollover Equity
“For a long time, the SBA prohibited loan proceeds from being used for anything of a religious nature. This even extended to religious schools and daycares. That prohibition has now been completely eliminated. Loan proceeds can now be used for religious activities.”
Heather Endresen, Viso Business Capital
However, she clarified that nonprofits and churches are still not allowed to use SBA loans. The difference is that a for-profit business can now use the loan money for religious for-profit purposes such as producing and selling religious materials.
Navigating the current uncertain period for SBA lending
With the new standard operating procedures coming into effect August 1, Heather notes that there is still plenty of time for the SBA and lenders to clarify how the rules will be implemented and interpreted. She anticipates there being at least six to 12 months before things settle. While loans cannot be made under the new rules until August 1, Heather suggests discussing with lenders how the new rules might apply to a deal and seeking advice from the bank’s credit and compliance departments. Even though the new rules give more options, choosing the right bank might be more complicated over this more uncertain period of time.
Regardless of interpretation, Heather emphasizes the importance of due diligence when making a deal. While financial aspects are usually well examined, non-financial aspects could disrupt deals if they’re not properly looked at. These could include regulatory issues that make the business harder to run or riskier due to potential regulatory violations.
When asked what additional changes she’d like to see to the program, Heather mentioned that she’d like to see the maximum loan limit increase to 10 million. This would bridge the gap between regular loans and SBA loans, especially during periods of tight credit control. She also thinks a larger limit could enable bigger add-on purchases.
The recent SBA program changes could have a big impact on how people buy small businesses. Heather Endresen’s insights help us understand the new opportunities and the need for careful navigation due to the new complexities. As we navigate this changing landscape, Private Market Labs is committed to providing comprehensive and timely information to all those involved in the small business buying market. We thank Heather for her insights on these important changes to SBA lending!