is 90% SBA financing bad for buyers?

May 14, 2021

by a searcher from Webster University in Westchester, Los Angeles, CA, USA

Curious what you think about this video https://www.youtube.com/watch?v=-ocQGY2LuGE

David Barnett (who I think is around here somewhere) opining that 90% financing doesn't help someone buy a business, it helps someone sell a business, and the extra leverage drives up business prices. He says that if you're buying a business which is heavy on assets, the bank loan makes sense, because if things go bad you can sell the business assets to pay off the loan. However, if you're buying a service business, then seller financing makes more sense, because it's the business "goodwill" itself that's valuable, and if things go bad you can ask for help or negotiate, and worst case the seller can take back the business which is still valuable to them. He goes on to categorize any seller who won't offer significant seller financing as 1) hiding something 2) ignorant 3) doesn't think the buyer can run the business.

Reply by a lender
from University of Missouri in St. Louis, MO, USA

This is an interesting topic from the lending side. I think the comment on this being the seller's benefit is accurate. Prior to 2018 the bank could only lend 75% with the seller and the buyer making up the other 25% (seller note was deferred for 2 years). In my opinion that was a much more bank and buyer friendly setup and the seller's and their intermediaries knew the rules and accommodated. 90% financing is achievable though. We have done these types of loans (even 95% is technically eligible with a seller deferred 5%). However, the cash flow has to work. So the percentage of the purchase price is less relevant than the debt/cash flow. If you negotiate a better deal you shouldn't be penalized. The main thing to focus on though is if you are floating your rate (which most SBA lenders require) you would want to make sure 90% financing still works at a higher interest rate. A lot of what I see getting done now works at 5.5% but would be really tight at 7%. You and your lender should be focusing on the long term risks rather than just getting the deal done. The higher leverage the higher risk you will take on as rates begin to rise at some point.

Reply by a searcher
from Webster University in Westchester, Los Angeles, CA, USA

Here's a video where David addresses the topic again https://www.youtube.com/watch?v=YhEs5CG3uGs his framework is that if you're borrowing money you should put up something of value to guarantee the loan. You can borrow against the assets the business owns (like equipment) which is fine. But if the price of the business is higher than the loan the assets justify, the remainder is "good will" or the assumption that running the business will generate money. Apparently in other countries, sellers usually need to finance that part of the purchase themselves since the buyer can't borrow against good will, but in the United States, the SBA will support 90% financing, so sellers know they can walk away with almost the entire price up front, which leaves the buyer on the hook to guarantee the good will; taking the risk if it turns out the business activities don't actually translate to a new owner.

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