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Why it matters what kind of loan your buyer qualifies for

External financing is likely to play a key role in your buyer’s ability to finance the acquisition of your practice.

Your buyer is likely going to use a conventional or SBA loan to finance the purchase. Each one has different qualifying requirements and restrictions in acquisition or equity buyout structures.

While sellers and buyers have a lot of flexibility in how a deal is structured, if financing is needed, the flexibility can’t expand beyond the allowable limits of the specific loan program and lender.

  • Buyer’s loan’s impact on payment structure options

    Your buyer is likely going to use a conventional or SBA loan to finance the purchase. While sellers and buyers have a lot of flexibility in how the deal is structured, if bank financing is needed, the flexibility can’t expand beyond the allowable limits of the specific loan program and lender.

    Payment structures allowed with a conventional loan vary from those allowed with a SBA loan. SBA loans have defined guard rails on acquisition structure types and provisions. This means that the type of loan (conventional or SBA) the buyer gets, and usually the specific lender being used, will dictate the types of payment structures available to the seller.

    If it’s important to you to have an earn-out structure, or want to sell equity in tranches over time, or want to stay in a key role years after the sale then you need the buyer to be able to qualify for a conventional loan, which has a higher qualifying bar than with an SBA loan. None of these are allowable with an SBA loan.

  • When how you get paid is as important as how much

    For many sellers, it is important not just how much money they are selling for, but also how it is paid. Most sellers want as much as possible upfront at closing. Some will want part of the payment to be received over multiple years. Others will want to include an earn-out where they receive an ongoing percentage of revenues or profits for multiple years.

    All of these payment structures are common in wealth management M&A. However, if the buyer is going to need external bank financing in order to purchase your premium priced practice, not all of these payment structures will be available to all buyers.

  • Consider buyers that qualify for the loan that allows for the deal structure you want

    If a specific loan program doesn’t allow for the structure the seller is looking for, they should consider if their potential buyer qualifies for the loan program allowing for the desired deal structure. Unfortunately, most prospective buyers don’t know.

    While there are a lot of buyers out there looking, the vast majority haven’t taken the time to prequalify for external financing. Most first-time buyers don’t know for sure if they can qualify for a conventional loan, an SBA loan, or any bank loan at all.

    Just because a “larger producer” is interested in acquiring your practice, it doesn’t mean they would automatically qualify for a loan that will allow for your desired payment structure. Some advisors and firms with sizable AUM and revenue can also have oversized overhead and debt service from previous acquisitions that limits the amount of additional debt they can qualify for.

    Just because your potential buyer has had multiple prior acquisitions they financed, doesn’t mean they would be automatically be qualified for another loan for your acquisition. Some advisors in heavy acquisition mode are now leveraged enough from previous acquisitions that it might be another year or two before they could get approved.

    If you’re considering selling your practice, consider narrowing your selection of prospective buyers to those who are pre-qualified for financing for not only what you want to get paid but how you get paid as well.

  • Seller guaranty

    If your buyer is doing a conventional loan and does not qualify on their own then a seller guaranty may be required.

    Internal successors who do not currently own sufficient equity or clients assets and employee based successors will typically require a seller guaranty. For SBA loans there is no seller guaranty but a 10% down payment.

    See Guarantors & Liens page for more details.

Seller & Buyer Red Flags

Here are the most common red flags in acquisition lending. They are divided into the seller red flags a lender looks for and the buyer red flags a seller should look out for. In this context a red flag doesn’t necessarily mean it is a deal killer but something requiring a closer look and more scrutiny. See “Obstacles & Red Flags” page for other barriers to acquisition loan approvals.

SELLER RED FLAGS

  • State of financials

    If your financials are completely unorganized, if your P&L is handwritten out or is so basic it appears only seconds were spent creating it, it will give the lender pause. If there are back tax issues that have resulted in previous year tax returns not being filed, the process can be further delayed until straightened out.

  • Too fast of an exit

    It makes a bank nervous if the seller wants to close ASAP and doesn’t want to stick around to assist in the client transfer process. Except for scenarios such as death and disability, banks would prefer to see at least 6 months of seller’s commitment in client transfer.

  • Too many add-backs

    Some add-backs are always going to be included (like your salary and/or distributions) but banks don’t like a ton or small dollar amount add-backs. Getting the financials cleaned up before a sale is helpful in maximizing what the bak will recognize as free cash flow.

  • Too premium of a price

    SBA lenders will only lend up to the business valuation price. Any amount over this would have to be paid in cash by the buyer (hardly ever happens) or put into a seller note (typical) that is subordinated to the bank.

    Some conventional lenders can lend for an acquisition amount that is higher than the valuation if the LTV (Loan To Value) is still within their parameters (usually 75% to 85%).

  • Too much client concentration

    If more than 50% of your assets and/or revenue comes from your top 10 clients then the bank may have concern about client concentration risk and want to see that the buyer has accounted for this risk specifically in a clawback provision.

    If one, two, or three clients make up a significant part of the revenue you’re selling then the lender will typically request or even require that those specific clients have a clawback period that extends beyond the first year. Typically two to three years in these cases.

  • Too much transactional revenue

    Many lenders will discount some or all of the commission revenue and only focus on recurring revenue for their cash flow analysis.

BUYER RED FLAGS

  • Wants too much in seller financing

    The often quoted 50 to 1 buyer to seller ration would be 1,000 to 1 if seller’s just seller financed all of the deal.

    Deals where the buyer only comes up with 20% to 30% cash and the seller finances the rest was common 10 years ago but not today. In full disclosure at AdvisorLoans those kinds of deals we wouldn’t see anyway.

    There are plenty of buyers who have the cash or the ability to finance the acquisition with a bank loan without you seller financing most (or any) of the deal.

    If a buyer has the cash to pay for your business why would you take on most of the risk seller financing? If a buyer can’t get a loan in today’s lending world to buy you out without seller financing (or a smaller amount like 10%-25%) then perhaps their level of experience or personal money management skills is insufficient for you to trust with a seller note.

    In today’s environment sellers by large do not need to seller finance any portion of the purchase price. So if a seller doesn’t have to do this a seller should have solid reasons of why they would be willing to do so.

  • Wants clawbacks for years

    Some inexperienced buyers will try to get three to five year clawbacks not because the deal warrants it but because they are being extra cautious and are nervous about buying a practice that is so big (at least to them).

    Most clawbacks only go out for the first year. If there is a client concentration issue like $10 million of your $50 million in AUM is with one client then the clawback provision for that single client should exceed one year.

  • Too many disclosures

    We all know many of the disclosures on an advisor’s BrokerCheck are bogus. The advisor didn’t do anything wrong but a client lost money and a lawyer told them they could try to get it back for them.

    However, there are disclosures that should cause concern and a seller will know what they are when they see them.

    A seller should always look up a buyer they are considering on BrokerCheck to see what’s there. The bank is going to some portion of your clients will as well.

    Multiple recent high dollar settlements can be a concern. While banks don’t care if the buyer got arrested for public drinking 30 years ago in college, a DUI 6 months ago can be an issue with a lender.

    Any disclosures that reveal unethical behavior, especially towards their clients in the last 10 to 20 years can give a lender pause and if you don’t personally know the advisor well and well for a long time, should give you pause as well. Not necessarily killing the deal but exploring further to understand that this does not accurately reflect who the advisor is today.

  • Can't qualify for a loan

    If an advisor can’t get qualified for an acquisition loan then we don’t think it is too bold to state this might not be the right advisor to be the new owner of your business.

    There is a small percentage of 1099 advisors with a book who wouldn’t qualify for all or nearly all of an acquisition.

    Here is an eye opener, a 1099 advisor with $250K in GDC can get a $5 million acquisition loan with no down payment required if they meet all of the other minimum criteria.

    In our biased opinion, making room for exceptions to the rule, if a buyer can’t qualify for the loan then it’s best to find another buyer who can qualify (they’re everywhere) than to become the bank yourself and seller finance the deal.

  • Too different from you & clients

    While this is an obvious red flag, many sellers don’t dive deeply enough into this screening of a prospective buyer.

    If part of your purchase price is going to be determined from a clawback based on attrition, then selling to an advisor that has a completely different investment philosophy, personality, and age bracket should be carefully navigated.

  • No service model synergy

    Every advisor approaches client servicing slightly different and there are multiple right ways to do it. However, if there is a night and day difference to the side that the buyer’s service is far inferior than what you have provided, then there will likely be higher client attrition.

    If you’re client s are used to in-person meetings twice a year and your buyer does Teams/Zoom calls (instead of in-person meetings) once a year there is going to be client attrition.

    Make sure that your buyer’s service model is semi-similar (or better) to what your clients have been receiving from you.