The Small Business Administration (SBA) recently made a number of changes to its loan guaranty programs that could fuel small business lending. Its flagship lending program, the SBA 7(a) loan, is widely known as an excellent way to establish a new business, as well as finance the acquisition of an existing business. Yet until recently, the requirements for this loan program have been challenging.
In an effort to better streamline the process and make SBA loan programs more appealing, the SBA recently issued a series of modifications to its standard operating procedure (SOP 50 10 5(J)), which became effective January 1, 2018. Among these SOP modifications are substantial changes to rules involving SBA 7(a) loans used for acquisition financing, as well as financial assistance for franchises.
Lower equity requirements for acquisition loans.
Under the old rules for acquisitions loans, deals with over $500,000 in goodwill required 25 percent seller note/buyer equity, while deals less than $500,000 in goodwill required 20 percent seller note/buyer equity. The SBA has now slashed equity injection requirements to 10 percent, so banks will be able to finance up to 90 percent of the deal. Now, just 10 percent equity must come from the buyer and/or a seller note. Out of that
10 percent, at least 5 percent must come in the form of cash from the buyer, while the remaining 5 percent equity can come in the form of a seller note. These new rules are expected to make small business acquisition financing more accessible.
Seller standby rule is extended to the life of the loan.
If the equity injection is through a seller note, the standby now extends through the life of the loan (instead of two years). In other words, the seller debt may not be considered part of the equity unless it is full standby (no payment of principal or interest for the term of the SBA guaranteed loan). Buyers may find it difficult to get sellers to agree to this new 10-year standby, yet the advantage of this new rule is that the full standby is only on the equity portion of the deal. In many cases, a deal can be structured with a second seller note with the buyer making payments to the seller starting on day one.
While both rule changes to the 7(a) loan program are significant, the SBA has only established minimum requirements for what is necessary to preserve the government guarantee. Ultimately, each lender will have its own rules regarding risk tolerance and may require a higher amount of buyer/seller equity injection.
New SBA franchise directory listing franchises eligible for SBA financial assistance.
SBA loan programs typically limit their lending to independent small businesses. Because many franchisees are subject to certain controls under their agreement with the franchiser, the SBA would consider them an affiliate and ineligible for a loan. In an effort to resolve these concerns, franchisers would have their brand listed on FranData, a third party registry, along with a pre-negotiated amendment to their agreement that enables them to be eligible for SBA financing.
In an effort to streamline the process, a franchiser must now appear on a centralized list of franchisers that are eligible to receive SBA guaranteed loans. To get started, the franchiser must first complete a standard franchise-agreement addendum form to achieve loan eligibility. The directory includes four columns with the franchise brand's SBA Franchise Identifier Code, as well as whether the brand meets the definition of a franchise, if an addendum is required, and any other issues the lending institution should consider.
New SBA Rules and Pro-Business Environment Expected to Fuel Small Business Expansion.
There are many reasons for small business owners to be optimistic these days. BizBuySell data shows owners are expecting to benefit from President Trump's loosening business regulations and new tax cuts. Furthermore, with rising interest rates from the Federal Reserve, banks have greater incentive to offer loans, especially with adjustable interest rates.
Small business lending has been increasingly active. According to a recent SBA Loan Performance Report, overall volume of SBA 7(a) loans has set records over the past three years, reaching $25.8 billion in 2017, with the first fiscal quarter of 2018 reporting a surge of ~20 percent year-over-year. This number is expected to grow even higher with more streamlined loan processing and flexible equity standards.
This increase in activity is further demonstrated by a record number of small businesses changing hands in 2017. According to BizBuySell's Insight Report, small business transactions exceeded previous highs set in 2016 by 27 percent. Since 2013 closed, business-for-sale transactions have steadily increased, yet 2017 represented a significant bump, with 9,919 transactions reported compared to 7,842 the previous year. Transaction data also showed stronger financials and faster sales.
With these new SBA rules and guidelines along with a more pro-business administration and a stronger economy, lenders are facing a dramatically different environment than they did nearly a decade ago. Many businesses that have previously held off on acquisitions and expansions are expected to move forward going into 2018 as a result.