By Paul Chambliss CBI
Once again, the right hand of the Government is not communicating with the left hand. While the President is busy expanding the money available to buy businesses, the Small Business Administration is doing its best to stop those sales from happening.
The SBA 7(a) Loan Program is the primary financing vehicle for small business purchases. Loans can be issued for up to $2 million, which covers the majority of transactions. Until recently, funds have been readily available and repayment terms have been favorable, with 10-year loan periods and interest rate caps.
The President’s recent American Recovery and Reinvestment Act provides $730 million to the SBA for, among other things, eliminating the borrower’s upfront fees for 7(a) loans, increasing the federal loan guarantee from 75% to 90%, and adding staff at the SBA. These provisions make it easier for banks to lend and for businesses to borrow.
Now, here is the catch. The SBA has changed its procedures to make it harder for small businesses to borrow this money. In the past, the SBA based its loan approval on the profitability of the business, also known as “Goodwill Value.” Recently, they have changed the procedure to base the loans primarily on physical assets, not goodwill. In the case of businesses with few assets, but high profitability, there is no longer a basis to make a loan.
The average sale price for most businesses is more than twice the value of the physical assets, and the balance of the price is made up of the goodwill value. This new policy from the SBA severely constricts the primary financing available for business sales. Another little known fact is that the SBA also discounts the value of the physical assets by 50% to calculate the loan amount. Combine these restrictions and a business buyer can only get financing for 25% of the value of the business. This means the buyer has to come up with a 75% down payment. Before this change in policy, it was normal to see only a 10-25% down payment with SBA loans financing the rest.
Buyers cannot afford the higher down payments. As a result, they will offer lower prices for the businesses and sellers will be asked to finance the purchase with a seller carryback note. The result is there will be fewer sales and lower prices; and sellers may decide to stay with their businesses until conditions change. Business sale transactions are going to slow down considerably, which will impede growth in the economy. Already, the Colorado Association of Business Intermediaries has heard anecdotal evidence of a slowdown. Of 12 recent transactions reported to CABI, only one had bank financing. One transaction had no down payment, with the seller financing 100% of the purchase price.
It will now be a challenge for sellers to get the full value for their business. Business expansion and job growth that normally comes from these business sales are being put at risk. It is time for the SBA to get back to the former policy of financing profitable businesses.
The President is trying to get the economy moving ahead, but the SBA is putting up a roadblock. What are the nine most dreaded words in the English language? “I’m from the government and I’m here to help.”