[Feedback Wanted] Valuation under SBA 7(a) ... and how easy it can blow up
November 05, 2022
by a searcher from Western Governors University in Atlanta, GA, USA
As often discussed here, Buy Then Build promotes using the SBA 7(a) loan to buy a business with very little money down and reap exciting rewards.
I thought that capital structure would automatically dictate how much you can pay for a business if you want to use maximum leverage. After interviewing an SBA-preferred lender in my region, I built a simple model to test these assumptions.
I wanted to offer this model for a stress test and solicit feedback from the community.
Link To Model Here: https://tinyurl.com/searchfundmodel
Key conclusions:
1) If you want to use the traditional 90% SBA + 5% Seller Standby note, you cannot pay more than 2.55x and qualify under the SBA's min debt service coverage (DSCR) ratio of 1.25x (Some banks will allow 1.15x, but the guy I talked to won't.)
2) With this leverage a 10% decline in revenue in year 1 is the most the business can withstand before running into trouble
Key assumptions (these I developed after interviewing my bank):
-SBA debt is ten years amortizing.
-The interest rate is WSJ Rate (currently 7%) + 300 BPS; note that I used the FOMC forecast rate of change for interest rates for the following years into the WSJ rate
-Seller finances 15% of the purchase price on full standby
-Balance sheet has 10% of the purchase price in cash on day one
-Fairly standard operating assumptions, which should not materially affect the conclusions if +/- 10% different
Key things I'm still unsure about:
-The SBA guarantee fee is 3.75% is paid at closing. Maybe added on to the debt balance
-If I captured all deal fees
-How to treat the assumption of 'reasonable owner salary' included at DSCR
-Exact definition of DSCR [EBITDA - taxes - owner salary - owner life insurance] /[Intrest + Amort]
Here is what I see:
- you cannot pay more than 2.55x time EBITDA and achieve a year 1 DSCR of 1.25x
-If revenue declines 10% in year 1 (and then grows 3% every year after that, you don't have any cash left at the end of year five, so the business does BK if you don't sell it.
Let me know your thoughts or if you see any errors in my model! Thanks.
from The University of Chicago in Chicago, IL, USA
2. You may want to consider amortization of goodwill which will reduce taxes. (Assuming Asset sale).
3. Not clear how you are accounting for WC.
4. It seems you are putting 10% of the price as cash on day one on the balance sheet. This seems high if WC is included in the price.
5. Your model shows that price is determined by debt service, not by expected ROI. I totally agree. "Debt service" as a variable is absent in corporate finance.
6. I have developed a model that you may want to check out. www.BVXpress.com.
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA