Know Your Financing Options
Originally published: 09.01.19 by Brandon Bolen
Financing the acquisition of another company is actually quite easy, if you do your homework and know what’s available to you.
Access to loans can be difficult for many businesses, particularly for service-based companies such as HVACR contractors. Luckily, there are accessible lending options available today.
Most banks seek collateral to approve a loan request, therefore HVACR contractors are often left with limited or expensive lending options due to the lack of available assets to be used as collateral.
For example, the opportunity to acquie another residential HVACR service company presents itself to an ambitious owner who turns to his local bank to inquire about a loan to purchase this company.
The bank will typically ask 10 percent to 25 percent cash down to buy the business and for the deal to be secured by collateral. If the business is being sold for $1,000,000, that is a significant amount of cash being used as the down payment, one which can eat into seasonal cash reserves.
The company being acquired might only have six or seven vehicles in the way of hard assets with the rest of the value coming from the customer lists, brand equity and cash flow. In this example there are not enough hard assets to meet the collateral requirements.
The bank’s approach in this example ultimately leads to an impasse and the only option available to buy the business is if the seller is willing to hold a seller note. If the seller is unwilling to do so, then there is a good chance the acquisition doesn’t take place at all.
A Better Way
There is an option available, however, where the approval of the loan is focused on the profitability of the business, resume and character of the owner that makes this $1,000,000 acquisition approvable without needing to be fully secured by collateral.
Knowing the financing options available as a business owner gives you the opportunity to plan appropriately for growth by picking and choosing the best available financing options for your business, whether that is a line of credit, a long-term bank loan or a commercial mortgage.
The most advantageous lending option for HVACR service companies is a Small Business Administration government guaranteed loan using the 7(a) program or what is more commonly referred to as an SBA loan.
Banks that know how to use the SBA program can offer owners the opportunity to leverage their personal experience, personal character, business profile and cash flow of their HVACR service company to obtain a bank loan to grow their company in a variety of ways.
An SBA loan is a loan administered by the United States Small Business Administration that enables banks to lend to small businesses up to $5,000,000 through one or multiple loans until a business has reached their SBA limit.
A contractor that applies for an SBA loan is not borrowing directly from the government. Instead, the SBA guarantees (insures) bank loans to small businesses that meet the SBA’s size criteria for that industry.
This guarantee allows banks to lend to businesses where the emphasis of approval is on the resume and character of the owner, as well as the business’ ability to repay existing and proposed debt, as well as paying the owner a comfortable salary to maintain their personal lifestyle.
The emphasis of approval is not on collateral.
SBA loans can be used for a variety of reasons including;
- Finance an Ownership/Partner Buyout
- Purchase an Existing HVAC Business
- Purchase Business Real Estate
- Finance Construction/Expansion of Business Real Estate
- Working Capital
- Refinance Debt
The goal of the program is to provide financing to small businesses throughout the United States to enable them to maintain and grow their companies to provide services to the communities they serve, as well as opportunities for increased and sustained employment.
Not So Small Business
Although the term used is small business, many service contracting businesses that use this program are worth millions of dollars.
These are not “small businesses” and are quite valuable providing many employment opportunities for the local community.
The revenue size criteria for a service contracting business is $15 million or less, but even if your company is doing more than that, there is an alternative size standard under which you can qualify for an SBA loan.
The most apparent benefit of an SBA loan is the lower hurdles to bank approval by focusing on the cash flow coverage of the business versus collateral coverage. If you are an experienced owner with a profitable business looking to expand, an SBA loan can be the right option for your business.
An SBA loan also offers several other benefits that are improvements upon what conventional bank loans may provide.
The down payment requirements for business acquisitions and real estate purchases are much more attainable than conventional bank loans and allow businesses the opportunity to expand without a large amount of cash injected.
The same can be said for first time buyers, like an employee or partner considering buying out the retiring owner of the company they work for.
Terms are generous, up to 10 years on a loan for a business acquisition or working capital and up to 25 years for one involving real estate.
Any loan with a term of 15 years or less has no prepayment penalty, which means you can pay down your loan as quickly as possible.
Balloon payments are not allowed with SBA loans, which means your loan is paid back over the course of 10 years and at the end of 10 years, it will be paid back in full.
This means that your monthly payments are reasonable amounts that do not constrict the cash flow of your business and can allow you to grow your business operations while also paying back the SBA loan.
There are no covenants that will restrict your business’ growth as long as the loan is paid back as agreed. A covenant is a condition in a loan that requires the borrower to fulfill certain conditions or doesn’t allow the borrower to undertake certain actions.
An example of a loan covenant may be reducing the amount of dividends or distributions per year, but an SBA loan does not have any financial covenants.
Many banks may offer SBA loans, but may not be adept at handling the paperwork or truly understanding the variables and parameters involved in SBA financing. When seeking an SBA loan, it is important to know if the bank understands the SBA program to leverage the opportunity of an SBA loan to its maximum for your business.
When used at the right time, long term debt can be used to elevate your business to the next level or allow you to transition into retirement and understanding the options available to your business is an important part of managing your business strategy.
Knowing the terms of a loan and the different variables that go into a bank’s decision will enable you to plan accordingly and make the right financing decision for your company when necessary.