Media Center

August 29, 2017
Publications

by Nicole Stezar Kaylor

Loans guaranteed by the Small Business Administration (“SBA”) can be a valuable tool for buyers interested in acquiring businesses that do not have sufficient hard assets to meet the collateral requirements of traditional bank financing.  While the SBA itself does not provide the financing, the SBA guarantees a portion of the loan obtained from any bank offering SBA financing.  This SBA guaranty allows banks to provide financing that may be riskier and/or not typically offered via ordinary channels.

One of the SBA’s loan programs, the 7(a) loan program (the “Program”), allows loan proceeds to be used for general corporate purposes including:

• To provide long-term working capital to use to pay operational expenses, accounts payable and/or to purchase inventory;
• Short-term working capital needs, including seasonal financing, contract performance, construction financing and exporting;
• To purchase equipment, machinery, furniture, fixtures, supplies or materials;
• To purchase real estate, including land and buildings;
• To construct a new building or renovate an existing building; and
• To establish a new business or assist in the acquisition, operation or expansion of an existing business.

While there are many favorable benefits associated with using the Program for acquisitions, there are also specific requirements that must be met.  Moreover, the SBA approval process requires substantial paperwork and may have a longer approval process and waiting period than typical lending.  If you are planning on using the Program for an acquisition, understanding the requirements upfront and planning for them in your proposal will protect you against having to re-negotiate terms, sometimes very unfavorably, later in the acquisition process.

In order to use the Program to acquire a business, the buyer must be purchasing a currently operating for-profit business.  The potential target business must also be “small” (as defined by SBA guidelines) and be engaged in or doing business in the United States.  SBA financing cannot be used to purchase businesses with existing tax liens.  The Program can be used for either asset or stock/equity acquisitions, but 100% of the business must be purchased.  In addition, any business owner who will own more than 20% of the target business must sign a personal guarantee.

Many times an acquisition is structured with a portion of the purchase price payment paid as an earn-out for future performance of the target business.  When using SBA financing, an earn-out, and other types of post-closing payments, cannot be paid to the seller of the business.  Also, if the seller is providing financing to the buyer in the form of a seller note, the note must be subordinate to the SBA financing and no payment of principal or interest can be paid for two years after closing.  Further, the seller cannot remain as an officer, director, shareholder or key employee of the selling business.  Therefore, offering an employment agreement or other post-closing benefits is restricted.  If needed, the buyer can offer the seller a consulting agreement, but the term cannot exceed twelve months (including extensions).  The Program can be utilized to finance goodwill in an acquisition. However, if the transaction is valued over $500,000, the buyer and seller must provide an equity injection of at least 25% of the value of the transaction for the loan to be processed under delegated authority.  The injection can be in the form of cash or seller financing, subject to the restrictions regarding seller notes listed above.

If you are considering using the Program for an acquisition, having an understanding of the restrictions mentioned above will enable you to develop an initial proposal that accounts for both the pros and cons associated with SBA financing and will protect you from having to re-negotiate material terms later in the process.

Nicole Stezar Kaylor is a member of the McNees Corporate & Tax Group where her practice focuses on mergers and acquisitions.  Ms. Kaylor counsels businesses throughout the transportation, service, and financial services, and healthcare industries in structuring, negotiating, and implementing a wide variety of merger and acquisition transactions.

© 2017 McNees Wallace & Nurick LLC
Corporate & Tax Client Update is presented with the understanding that the publisher does not render specific legal accounting or other professional service to the reader. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using this material must always research original sources of authority and update this information to ensure accuracy and applicability to specific legal matters. In no event will the authors, the reviewers or the publisher be liable for any damage, whether direct, indirect or consequential, claimed to result from the use of this material.