Reported Income on Tax Returns and Lending Issue

July 20, 2021

by a searcher from University of Massachusetts Amherst - Isenberg School of Management in New York, NY, USA

I'm writing an offer on a company that is otherwise very attractive, but is being run "to minimize the owner's taxes". The owner is very hesitant to accept an offer with bank financing involved, so it's likely my offer won't be accepted. The broker in this case is agreeing with the seller, as he said he has seen deals approved by the banker, but were then denied by underwriting after jumping through all the hoops and providing all required information to back up the stated financials.

Assuming the numbers are as stated, and all verifiable. How would an underwriter look at something like this? Should these type of companies be avoided during a search?

Thanks!

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Reply by a lender
in United States

I concur with what most have stated regarding owners minimizing taxes in this post thread here ^redacted‌. There is a lot to unpack, determine and prove.

I want to add that the SBA lending industry is experiencing seasoned (some would call us old) retiring from the field, as most were raised in SBA many years ago. Banks have no alternative but to hire brand-new front-line SBA lenders. Over the years, I have worked for loan shops. I witnessed many young lenders hand out term sheets and SBA-prequalified letters to business brokers based on the CIM and no actual financials/tax returns or proof of 1x large discretionary seller addbacks.

Sadly, many buyers are being sold up front, going through the long journey to complete the loan application package only to have the door slammed shut with a decline once the package hits the underwriter's queue.

We often hear that many SBA loan shops have long turnaround times for credit approval. Most of the reason is poor management of front-line SBA lenders and incomplete or poor packages submitted by rookie front-line SBA lenders.

Lastly, if the seller and broker tell you add-backs are 'all verifiable,' trust them, but you better verify now. The underwriter won't even consider it until they can review the add-backs and ensure the proof the seller-provided is bank-eligible for add-back. This alone can be a mountain to climb with sellers. I've been a sucker years prior, trusting and not verifying from both broker and seller. Burned and learned the hard way.

Reply by an intermediary
from Boise State University in 800 W Main St, Boise, ID 83702, USA

Hi Ken, I agree with the others regarding the type of add-backs. However, it depends. I was a commercial/SBA lender for over 20 years and have been business broker/appraiser for 10 years. While the bank typically doesn't accept addbacks for personal expenses run through the business, they "may" allow adding back non-recurring or demonstrably discretionary items. However, it has been my experience that if the historical cash flow (as banker's calculate it which is Net Profit before tax (and after an adjustment for a reasonable owner salary) + Depreciation/Amortization + Interest expense) won't show debt service coverage of at least 1.25 times, you as the buyer need to prepare a business plan with projections with reasonable assumptions to tell the "story" of how you are are going to run the business and why the cash flow will work in the future. With the right lender, I've been able to get these deals done but again it just depends (upon the buyer, the add-backs, the bank, the industry, the deal structure). Hope this helps.

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