Financing the Small Business (Part 1 of 3)

Financing the Small Business (Part 1 of 3)

There are two questions on our latest survey having to do with financing the sale of a business. They are as follows:

Q.  What do you think were the biggest reasons for the decline in number of deals, sales, dollar volume, etc.?
(The state of the economy is a given.)

A.   #1 = Lack of financing

Q.   What was the main obstacle that caused pending sales from closing?

A.   Financing 44%

The responses to the above questions should leave no doubt that financing is a major reason, if not the main reason, that more deals are not made. Now I realize that the term outside financing as opposed to seller financing is not mentioned. My guess is that seller financing is not an issue or a reason for very many sales not closing.

What is left is bank and SBA financing. I have written about this before, but I’m still not sure where the issue of financing began. It was never an issue years ago. Banks never did finance the sale of small businesses. Sure, there were some exceptions. Experienced buyers could borrow to buy a second unit, or if they had bank connections, they could get financing to purchase a business. But, well over 90 percent of small business sales were financed by the seller. The SBA, although it existed, really played no part in lending or guaranteeing business loans from other sources.

About 15 years ago (a guess), a company started in California called The Money Store that started to make small business loans guaranteed by the SBA. These were what are called SBA 7a loans and were designed to be used for the purchase of a small business. They were quite successful and in order to create more business, they went to the business brokerage field and told them they had a way for deals to be financed. Everyone benefitted!

The banks saw what was happening and couldn’t resist getting into the business. After all, where else could the bank make a loan in which approximately 90 percent of it was guaranteed by the US government and even the remaining 10 percent was secured by the borrower’s house, car, first born or something else very tangible to cover it. In effect, the entire loan was essentially guaranteed and the bank got fees, interest, etc.

What happened? Well the Money Store knew how to play the game – they did a great job because they had qualified people who knew what they were doing. They wanted the business and, well, they weren’t bankers. The bankers had to be bankers. A bank subsequently bought the Money Store and took it right down the drain. One other interesting point, I have read that these government guaranteed loans were bundled into securities and then sold to investors – sound familiar.

As more and more banks and other lenders got into the game, business brokers (a) started to take them for granted and would readily tell a potential seller that he or she would get all cash at closing because their business looked like it was an SBA guaranteed loan sure thing; and (b) business brokers took these loans for granted and assumed they would never end.

Sellers, even if they went with another business broker, just assumed that they would get all cash since their business would qualify for an SBA backed loan. Business brokers would even try to get these businesses “pre-qualified” for SBA loans. I suspect that many business brokers quit the business when the SBA and the banks got tougher and raised the requirements. Seller financing never crossed their minds. The old timers, at least, know brokerage before SBA loans. Years ago, SBA lenders filled the sales booths at the IBBA conferences; now there are just a few.

So, where does that leave us? 

Tomorrow’s posting will continue this article with a response to the above question.  Thursday’s posting will complet the article with a response to “Where is the SBA going?”