The new SBA guidelines for 2018 are published in what is called SOP 50 10 5 (J). While many of the themes and concepts are the same as the previous SBA guidelines, a few key changes affect the potential accounting and tax borrower. Those main topics center around equity requirements and seller financing.
The biggest change has to do with the amount of equity required in a transaction. Historically, the SBA has required a 25% down payment be brought into the project. That 25% was based on the purchase price of the business, and could be made up of a combination of cash from the buyer, equity from existing business, as well as seller financing. Seller financing was eligible to be counted as equity only if the note was on standby for 2 years. Interest could accrue during that time period, but the seller could not receive any payments until month 25 following the transition of ownership.
Now that you understand that structure, go ahead and throw it all out the window…
Effective January 1st, 2018, the SBA has lowered the equity injection requirement from 25% of the purchase price, to 10% of the total project cost. This will make it easier for the buyer to purchase an accounting or tax firm, as less money down will be required. Additionally, sellers will now receive more money up front, rather than delaying a portion of the payments as was typically the case before. Overall, this creates a great opportunity for buyers who do not have a lot of cash, and sellers who wish to receive the majority of the sale proceeds at closing.
How The 10% Can be Contributed:
It is now required that a minimum of 10% of the total project costs be injected into any transaction. We understand that buyers may not always have the full 10% available to bring into the project. Of the 10% required injection, at LEAST 5% must come from the buyer, or buyers of the firm. The seller is still able to hold a note to assist with the injection, but only up to 5% of the project costs, if utilized as part of this equity injection. This seller note portion utilized for equity injection must remain on standby for the life of the loan. Interest may accrue on the note, but no principal or interest payments are to be made until the SBA loan is fully paid off. It is important to note that the seller may hold a note in an amount greater than 5%, but anything over 5% CANNOT be counted towards the equity injection. Additionally, if the buyer does not have the cash available, they can use gifted funds as long as the funds were sourced for a minimum of 60 days.
Let’s run through a quick example. If it was determined that the required equity injection on a project was $100,000. Ideally, the borrower would inject this amount in cash. If $100,000 was not available to the buyer, he or she would need to come up with a minimum of $50,000. The seller would then be able to hold a note in the amount of $50,000 that would be on full standby for the life of the loan.
If an existing business is purchasing another business, Live Oak will allow existing equity (as evidenced by a current business evaluation) to be used to meet the 10% equity requirement. In such cases, the value of the preexisting firm must be greater than the equity injection requirement for the practice being acquired. The new business must become a part of the existing business and must share back office support or services.
However, if your transaction involves a buyer who has never been in business, the 10% cash injection is required.
Purchase Price vs. Project Cost:
As we previously mentioned, the SBA has lowered the equity injection requirement from 25% of the purchase price, to a minimum of 10% of the total project cost. The purchase price refers to the agreed upon sale price for the business. For example, in an asset purchase, the goodwill plus inventory will determine the sale price. Project cost on the other hand includes the sale price, plus working capital, soft costs, SBA fees and any other costs associated with the project as a whole. We estimate that this amount will typically be around 12% of the total purchase price, but will vary based on operating expenses and individual transaction needs.
We are well versed in the evolving SBA guidelines. As you may know, we have the benefit of former SBA leadership as a resource for interpreting these guidelines and how they will affect your structure from a financial and legal standpoint. In addition, our accounting and tax team understands how to structure a financing package that fits the needs of each firm and borrower. We still encourage seller notes to offset attrition risk and believe this is still a very important part of your buying negotiation and transition. Depending on whether we are analyzing an acquisition, a refinance, a real estate purchase, or a working capital loan, these new rules will apply in different ways. Our goal is to work with you to find ways to accommodate your needs.
Contact me today:
Shannon Hay, Senior Loan Officer, Accounting & Tax Lending