THE LENDING ENVIRONMENT HAS CHANGED
Like most things, the lending environment has changed recently due to COVID-19, and it is taking buyers and sellers by surprise. Underwriting timelines are being impacted and loans are taking longer to process. Banks are now less likely to flex their requirements to help people qualify for a loan. Why is this happening? There are several reasons.
1. Earning and revenues are coming down and banks are weary.
2. Few lenders process loans under $150,000 and those few lenders are now getting inundated with volume.
3. Because the same people that processed PPP loans are also processing business loans, this is impacting banks' ability to assess and close on new 7A loans.
4. Banks now have a lot of capital tied up in PPP loans.
5. Banks are now doing more due diligence and requiring more documentation, so underwriting is taking longer than in the pre-COVID environment.
6. Staff are being impacted by COVID and distancing guidelines so there are fewer people on location to work with underwriters and get loans processed.
7. We now have less than 40 business days before the September 27th deadline to take advantage of the SBA principal and interest payment benefit so loans not currently in process will likely not meet that deadline.
8. Banks want collateral in the form of equity in real estate.
9. Banks are looking for more post-closing liquidity.
10. Banks are looking for industry experience.
11. Banks are looking MORE at the 5 C's: Collateral, Credit, Capacity, Character, and Cash.
12. The strength of a buyer from a financial perspective is really important right now.
How deals are being financed
Both buyers and sellers will benefit from understanding the changing lending environment and prepare themselves by consulting an Advisor and considering other options for working together. Across the country, we are seeing a 30% increase in seller financing. Average down payments have increased by 63%. In future at least 8% of deals will include a seller earn-out and only 19% of deals will include SBA financing, compared to 60% pre-COVID. On average, businesses are now selling for 73% of asking price in an all cash transactions, and 87% of asking price with seller financing. Percentage wise, sellers will get a lot more money for their business if they are willing to help the buyer finance the sale, and their business will also sell faster. Seller financing shows that sellers have confidence in , and are standing behind, the business. In situations where banks are hesitant to loan in a specific industry, we are seeing 90% of deals getting done with 100% cash or combination cash and seller financing or earn-out.
A new reality requires new thinking
Buyers and sellers must bridge the gap in their perception of the businesses' value. Seller's have a 2019 idea of their businesses value and buyers have a 2020 idea of the businesses' value. There are several ways buyers and sellers can partner to bridge that gap.
1. Higher buyer down payment. Buyers have to have enough skin in the deal to be motivated to make the business work.
2. Seller Financing - we are seeing deals continuing to go up in value if the seller is willing to carry paper. Sellers benefit from interest they earn on their money, typically a higher rate than they can get investing in more traditional vehicles. Advisors can help structure the sale to lesson risk from buyer default.
3. Earn Out - this is a way of bridging the gap between seller's expectation of value and the buyer's expectation of risk. We recommend basing an earn-out on Gross Profit (revenue less cost of goods sold to include labor, materials and shipping) because neither party can manipulate the numbers. We recommend the earn out to last for a one or two year period. Earn outs allow the seller to continue to work as a consultant to help make revenue for the company. Deal structures that allow the seller an upside work best (the higher the revenue, the more the seller will make). Seller has to have access to the books, and buyer and seller will have to agree on a way of mediating if issues arise.
4. 401K ROB - there are third party administrators such as Benetrends, Guidant and Franfund that help buyers use their retirement funds to buy a business without paying taxes or penalties. It is a great vehicle, but there are things a buyer has to understand when using a 401K Rob that the administrators can explain. It's not something a buyer should do without having all facts.
Only 20% of businesses listed for sale will sell. Sellers - if you want to sell your business, you have to price it and put terms on it that will make it sell. Otherwise you are in the 80% that are just putting their business up for sale.