SMB Roll-Up, Debt Snowball Thought Question
May 02, 2023
by a searcher from Baruch College-The City University of New York - The Zicklin School of Business in New York, NY, USA
Hi everyone,
I currently own 1 SMB and am in the process of acquiring a second in the exact same space via SBA 7(a) loans so adjustable rates. Obvious cost synergies are backend accounting, technology, banking, etc.
The company I own now is an S-corp and the new acquisition will be location #2. Right now, location 1 is semi-absentee while the new location would basically be absentee given the seller's involvement post sale.
While the cash flow of the first location grants me the salary + some ordinary income, the second location would basically just be adding to the bottom line (ordinary income) without increasing my "salary" (tax benefit).
The question:
If the companies are stable (required services), cash flowing, and produces significant ordinary income, what option would you pick as the owner?
1. Use cash flow to continue rolling up other locations and just keep paying debt on a normal schedule?
2. Use cash flow to pay down debt first, continue to work out kinks post-acquisition and focus on integration + growth?
3. Something else
Trying to understand opportunity cost here when it comes to capital allocation. Think there's a lot of brain power on this site so hopefully some good responses!
from Ivey Business School at Western University in Toronto, ON, Canada
Re how much debt to pay down - Run some scenarios regarding impact to cash flows should the economy worsen, if interest rates continue to climb, etc.
However, it’d be helpful to understand your strategy and investor base more. If you’re pursuing an aggressive consolidation strategy and have a longer term hold, it wouldn’t be abnormal to fully or largely equitize the first handful of deals until you’ve built a sizeable enough platform that can then take on significant amounts of leverage for future deals (given you could lever on a consolidated basis), thereby ‘organically funding’ any future tuck-ins, I.e no need to inject equity for future deals. When your platform has organic funding ability returns will be juiced heavily - this is the optimal state. However if you’re looking at a shorter term play and don’t plan to pursue acquisitions aggressively, I’d imagine it’d be very difficult to hit good returns if you plan on never using debt proceeds to fund additional acquisitions, unless they’re at a fantastic multiple or make significant strategic sense. In this case I’d refer back to my original statement in the first paragraph re using a mix that provides enough breathing room.
Forgive me for any typos as I’m using my phone.
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
The biggest issue with refinancing from an SBA 7A loan to a conventional loan is most conventional lenders are going to be a maximum term of 5 to 7 years. So you are going to look at much shorter amortizations. In addition, the DSCR requirements are typically much higher for conventional financing than SBA financing if the deal is not fully collateralized by hard assets. In fact many lenders will not do goodwill exposure at all unless the holding company has substantial cash flow or there is a strong guarantor.
Again, I would be more than happy to discuss long-term financing strategies. That might help you decide what to do going forward and is certainly something you should consider when planning. You can ping me here or directly at redacted Good luck.