For the seller to get all cash at closing, having the business qualify for bank financing is the most common technique. To qualify for a bank loan, you have to assure the bank that there is sufficient profit to repay the loan and pay the buyer a reasonable salary.
Banks will look at the last federal tax return to validate the profits of the company. This means that, as you approach the time to put your business on the market, preparation is essential. At year-end is not the time to start this process – you have to start as early in the year as possible. Having to go back and change how certain expenses have been allocated at year’s end may not make sense.
Most business loans are SBA-guaranteed, and it can be pretty painless to get these funded. The method to ensure a painless experience is for the buyer to use an SBA loan broker who deals with national lenders, knows which of the national banks are making loans and understands how the national banks want to see the loan presented. There are many factors a bank will consider in the SBA-guaranteed loan approval process. Two factors at the top of the list would be to verify Earnings Before Interest, Taxes, Depreciation and Amortization (EBIDTA), and Seller Discretionary Cash Flow (SDCF) – the amount of money the buyer will need to support a current lifestyle. The validation of EBITDA /SDCF is particularly focused on items being added to the stated operating profit of the business as seller discretionary income, so it meets the bank’s underwriting criteria.
In preparing to sell your business, it is advisable to increase profits by not expensing items on the company’s operating statement, knowing they are not going to meet the bank’s underwriting criteria as add-backs. Instead, code the non-qualifying add-backs as various forms for officer compensation on the balance sheet. The impact will be to increase the operating income. Seller discretionary income is best described as – ahem – expenses not absolutely necessary to the operation of the business. Although you will have to pay taxes on a higher income, the effect of this will add credibility to your financial reports and justify a higher price, as well as allow the buyer to qualify for a higher price, while meeting the bank’s required debt coverage ratio.
An example of what many sellers feel should be an add-back but will not meet the bank’s criteria would be owner automobile-related expenses. The explanation from the bank is that banks cannot be certain what is and is not a business expense. Other add-backs that do not meet most banks’ underwriting criteria are travel and entertainment, as well as training expenses such as attending conventions. Additionally, unless the buyer’s spouse has group health coverage for the family, the seller’s health insurance coverage will not meet the bank’s qualifying add-back criteria, nor will Costco/Sam’s Club/Best Buy expenses buried in cost of sales.
I have worked with an SBA loan broker for more than 20 years. The reason is that he tells me the way it is, keeps me informed and gets results. This loan broker helped me get a buyer funded for a company located just north of Detroit, right before GM and Chrysler went into bankruptcy. This was a $1.5M transaction. Everything I have read says that banks were not loaning to anyone during this time frame, but he got the loan funded.
If you would like a confidential, no-obligation analysis and discussion of what you can be doing now to prepare for the time when you will put your business on the market, please call (888-893-6661) or e-mail firstname.lastname@example.org. To learn more about my background, visit my LinkedIn profile at http://www.linkedin.com/in/dolansales. I look forward to helping you prepare to sell your business at highest price possible. I serve customers nationwide.