Selling Solutions by Category:
SOLUTIONS
EXITING 101
W/IN 1 YR.
W/IN 2 YRS.
FAQ
DEAL ADVOCATE
MARKETPLACE
Thinking About Selling?
You have a lot of options to sell all or part of your business. External financing is likely to play a key role in your buyer’s ability to finance the acquisition of your practice. Financing options for acquisition loans has rapidly evolved over the last 10 years and even more so over the last few years.
Fortunately sellers have a lot of free resources and support available beyond what is provided in this portal. If you would rather just talk to a human that can guide you through all the financing aspects of selling your business in the most optimal way for you, then call AdvisorBox today.
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What's my timeline?
If you’re looking to sell in a few months or a few years will dictate how much time you have to get yourself and your business ready to sell. The typical acquisition loan takes about 6 weeks to close from the time a term sheet is executed by the borrower.
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Current Valuation Multiples
Understanding current valuation multiples is imperative when valuing a financial advisory business. For instance, practices with annual revenues of $2 million to $3 million are often evaluated based on these multiples. While revenue multiples serve as a useful indicator for acquiring smaller practices, they may not accurately reflect the value of larger enterprises.
SRG For the past year, we've observed a consistent revenue multiple of approximately 3 times, particularly 3.06 times recurring revenue. However, when considering these figures, it's crucial to acknowledge the complexity inherent in revenue multiples, and understand that the average of 3.06 falls within a wide spectrum.
FP Transitions offers insight from a different perspective. Statistics suggest a median valuation multiple of 2.9 times the total revenue, which is a blend typically featuring 90% recurring revenue and 10% brokerage activities. The range for valuation multiples extends from 2.48 to 3.5 for Registered Investment Advisors (RIA), and from 1.43 to 3.31 for Hybrid or Registered Representatives (RR).
When allocating the purchase price, the norm is often 93% for goodwill, 5% for consulting services, and 2% for non-compete agreements. These insights are crucial for both buyers and sellers to grasp the underlying value dynamics of financial advisory practices in today's marketplace.
So businesses doing two or 3 million in revenue and below this is a useful data point. This is what most people are going to buy or sell based on. And all of a sudden you get to five, 6 million in revenue and above revenue multiples might be useful for smaller practices you're acquiring but they're not appropriate for your business or enterprise. So we want to share that with you here today and just make sure we're all on the same page that there are revenue multiples, you're gonna see important out there republish them as do others, which also read a lot in the trade publications on those big aggregator deals where they'll talk about the 12 times the 14 times that is of your earnings, so it's a bigger multiple, usually on a smaller number. Just good to understand the market that's out there. Be because a lot of the sellers that we work with selected here, they'll hear the 12 times and they'll apply it to revenue and that map does not work. So getting back to just the simplified revenue multiples though even just that the average of 3.06 exists within a really broad range.
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How do I want to get paid?
Do you want most all of the purchase price paid as the down payment? Will you receive income for the transition period or beyond through a consulting agreement? Do you want to spread out payments over multiple years for tax purposes?
There is flexibility in how you receive the purchase price payment. Think through how you want to get paid and just as importantly when you want to get paid.
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What are the different ways to sell?
Let us count the ways…
Sell everything and retire.
Sell everything but continue to stick around for a few more years.
Sell most of your clients/assets and slow down. Hold onto your favorite clients and closest relationships until you are ready to retire and then sell.
Sell through partial client/asset tranches over time.
Sell through partial equity tranches over time.
Sell and merge. For example sell 50% of your equity or clients/assets, merge with the buyer’s business, continue working, sell the rest when you’re ready to retire.
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While there are numerous ways to structure and a lot of flexibility, the most common asset purchase structure we see generally looks like:
100% of purchase price is borrowed from the buyer through an SBA or conventional bank loan.
50% to 75% (depending on attrition or client concentration concerns) is paid to the seller at closing (wired to the seller from the bank). The balance goes into an escrow account with a clawback based on an attrition formula or schedule after 12 months.
Either all or part of the escrow funds is wired to the seller based upon the clawback provision and any balance goes back to the buyer.
If you want to be paid out over additional calendar years for tax purposes the escrow agreement can account for this as well.
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Know Seller numbers checklist
The sale of any business comes down to the buyer’s expectation of a return on their investment, so understand your financials and start preparing materials for due diligence.
Registered Reps: Put GDC on your P&L along with line items for recurring and non-recurring revenue sources and make BD costs line items as COGs.
Review your profit and loss statement, eliminate non-essential or personal expenses.
Separate owner’s compensation (owner’s salary, insurance, payroll taxes, retirement plan contributions, etc.)
Review debts of the business and long-term obligations a buyer would need to assume, including things like your lease.
Verify total assets under management, including a breakdown f where assets are held and what types of products those assets are in.
Prepare a pro forma P&L for any potential purchaser showing what expenses would look like going forward.
Review historical revenue growth rates (explain anomalies).
Review revenue sources for the last twelve months and determine if revenue is transferrable.
If you sell alternatives that will take years for a liquidity event or have annuities with long surrender charges, be ready to provide data and explain.
Be able to explain any uniqueness in your business
FAQ for Complete Asset
& Equity Acquisitions
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The U.S. Small Business Administration (SBA) was created in 1953 to assist small businesses with guaranteed loans covering many of the small business needs for most industry types. The 7(a) program is the Small Business Administration’s flagship program and all SBA data on this website is referring to loans under the SBA 7(a)program.
The mission of the Small Business Administration is "to maintain and strengthen the nation's economy by enabling the establishment and viability of small businesses and by assisting in the economic recovery of communities after disasters".
Through the SBA 7(a) guaranteed lending program, the SBA guarantees part of the business loan that a SBA approved lender provides. In the case of a loan default, the lender isn’t on the hook for all of the unpaid loan amount. This SBA guarantee results in lenders providing loans to small businesses that they otherwise would not.
See sba.gov
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Look at Financing Considerations Early in The Process
If external financing will be required for the advisor acquisition, then the deal must match bank requirements, not the other way around. Acquisition deals can implode in the end when lending due diligence isn’t done in the beginning. If the acquisition deal or structure can't get financed, what’s the point of everything else?
This scenario plays out regularly in the industry: Buyer and seller have already worked out the acquisition deal structure and terms, hired a lawyer to develop the purchase agreement, paid for a business valuation, and set the closing date. Then, after all that time, money, and effort was spent, they look into the financing only to find out that the deal can’t be financed at all, or that it needs to be re-structured in order to comply with the financing option or lender the buying advisor qualifies for and with.
If external financing will be needed for the acquisition deal to close, then external financing becomes one of the most important aspects of the acquisition deal. Buyers getting pre-qualified at the beginning of the process is critical for both buyer and seller.
External financing will heavily influence the acquisition terms and structure. External financing will dictate requirements around loan amount, cash injection requirements, promissory note amount, type and structure, closing timeline, retention provisions, and more.
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SBA Standard 7(a) Program loans are backed by an SBA guarantee of 85% for loans up to $150,000 and 75% for loans greater than $150,000. Qualified lenders may be granted delegated authority (PLP) to make eligibility determinations without SBA review. Loans provided typically on 10 year terms with a maximum loan amount of $5 million.
SBA Express Loans are backed by an SBA guarantee of 50 percent, the lender uses its own application and documentation forms and the lender has unilateral credit approval authority as in the PLP Program. This method makes it easier and faster for lenders to provide small business loans of $350,000 or less, with SBA generally providing a loan guarantee to the lender within 24 hours of their request.
SBA Microloan Program was developed to increase the availability of small scale financing and technical assistance to prospective small business borrowers. Loans range from $500 to $50,000.
504 Certified Development Company (CDC) Loan Program provides growing businesses with long-term, fixed-rate financing for major fixed assets, such as land and buildings. A CDC is a nonprofit corporation set up to contribute to the economic development of its community or region.
Export Working Capital Loans are used to finance export sales - 90% SBA guaranty on a loan up to $5 million.
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Equity Injection If Cash Payment
The equity injection can be paid by the borrower in cash, preferably wired to the lender a week or two before the loan closing. The money can come from savings, investments, a Home Equity Line of Credit (HELOC), or as a gift (with a gift letter as proof). Lenders usually require the most recent account statement for verification.
Full Standby Note
The SBA made a big change to the full standby seller note. Now the seller can finance the full ten percent of the equity injection requirement.
No principal or interest can be paid during the first two years standby period.
This option enables the borrower to purchase a business with no money down.
Partial Standby Note
A partial standby is where interest only payments can be made for the first two years but not principal payments.
The seller can finance up to 7.5% in a partial standby note.
The SBA requires 2.5% to come from a source other than the seller.
Adequate cash flow has to support the partial standby option.
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It's only the cash flow not the ROI that matters
It's only the cash flow not the ROI that matters
The thinking that cash flow is all that matters is one of the more consequential myths in the industry. Just because a deal cash flows does not automatically mean it should be done, it only means it's a possibility on the table.
If it takes your current practice profits to make the acquisition deal cash flow then the deal doesn't cash flow on its own. If the deal doesn't cash flow on its own and needs your current practice's profits to contribute to the debt service payment then risk and return expectations are different.
Acquisition aggregation cash flow strategies are very different than an advisor who only intends to make only one or two opportunistic acquisitions in their career. Two totally different approaches to cash flow. See ROI box.
Cash down payment is always required
Reality: Most loans we facilitate involved no cash down payment from the borrower. Advisors who have a book of business rarely need cash down payments for acquisitions.
SBA always takes the house as collateral
Reality: Collateral requirements hinge on the borrower's equity in the property and the loan size. If the equity is less than 25% or the loan is under $500,000 then it is not required by the SBA.
Partial equity buy-ins are not eligible for SBA loans
Reality: This is a myth as of October 2023. new rules allow for the partial equity buy-ins. While conventional lending has dominated this lending purpose over the last decade, the SBA's new eligibility rules will cause a larger percentage of these deals to go SBA (with the much easier and flexible equity injection requirements).
Lenders always require some seller financing
Reality: While all lenders would "like" to have a portion of the acquisition in seller financing it isn't typically mandated, is decreasing in frequency and amount, and as long as the LTV requirements are met only are put in place by the seller's request, not the lender.
Valuation firms and M&A brokers don't get bank referral fees
Reality: We view a kickback when the client (you) is unaware of the arrangement and a referral fee when the client is aware. Some of these firms get kickbacks and some get referral fees but all get paid typically a 1% fee from the bank if you use the lender they recommend you use. That is why they recommended them.
Sellers have to receive all bank proceeds at closing
Reality: It's not uncommon for a seller to receive the payment over two or three years (without seller financing) by funding into escrow and distributing on designated future dates.
All SBA lenders handle M&A loans the same
Reality: SBA lenders vary greatly in terms of additional qualifying criteria, preferences, focus, criteria, and policies.
Multiple concurrent acquisition loans with different lenders is typical
Reality: Most lenders file a UCC-1 lien and insist on being in the first position, making concurrent loans from different lenders requires inter-creditor agreements and while it happens, it's not common and a completely case-by-case basis.
The bank approved the acquisition loan so it must be a good deal
Banks fundamentally differ from borrowers and investors in their approach to evaluating deals. While advisors are focusing on return on investment (ROI), banks rely on historical financial data rather than considering the net present value of future cash flows. Even if a bank conducts thorough underwriting and cash flow analysis, believing you will generate enough cash flow to meet your payments, they often disregard compound annual growth rate (CAGR) as a critical factor in their decision-making process, focusing solely on historical performance.
When a bank underwrites an acquisition they are not evaluating directly if this is a good investment, they are evaluating if you have the cash flow to afford it, risk, and require a business valuation to support price.
The bank doesn't need for the practice you're buying to cash flow on its own, they need for your business combined with the business you're purchasing to cash flow. If an advisor wants to acquire a practice that makes no profit but has some other value, the deal could easily cash flow because of combining with your current business. It's a deal that can get done, because it "cash flows", even though it doesn't.
Valuations are only ordered on seller's practice
Business valuations are only imperative for the seller's practice. Reality: When leveraging non-cash assets, both buyer's and seller's practices may need valuation. SBA loans have a buyer valuation for acquisition loans when there isn't a down payment required in part based on the estimated value of the buyer's business. Conventional lenders may require valuations on buyers for loans over $5 million but these polices are based on the lender.
1.75 or 1.50 DSCR is required for an SBA loan
Reality: This was LOB's old DSCR minimum and if LOB is the only SBA lender you work with then you may think their policies are identical to that of the SBA. SBA's minimum DSC is only 1.15 and LOB has dropped their DSCR to 1.50. Each lender has their own DSC minimum which can greatly impact the loan amount approved (a 50% difference in loan dollars qualified for between this 1.15 and 1.75 range).
Interest rate is the primary deciding factor in banks
Reality: It is obviously an important factor but other factors like qualifying criteria, deal structure, down payment requirements, can be more heavily weighted. If in ongoing acquisition mode amortization is much more important than rate. This is because there is not typically a night and day difference between lenders, just between SBA program loans and conventional.
Conventional loans are always better than SBA
Reality: The appropriateness of loan types varies according to the specifics of the borrower's situation and in many cases the opposite can be true. For deals where the borrower doesn't have a book SBA loans are always better from an acquisition equity injection perspective and for borrowers with and without a book this is often the most critical loan component. When buying bigger and especially much bigger SBA may offer the better scenario.
SBA loans can be refinanced readily with another SBA lender
Reality: Inter-lender refinancing of SBA loans is complex and not commonplace. However they are done sometimes, but it's not a typical thing.
Advisors can't qualify for a loan without life insurance
Reality: While this is mostly true with conventional lending to advisors SBA loans can get around this with rejection letter and documented (and acceptable) continuity plans.
Seller financing is always a good thing for the buyer
Reality: When too much is seller financed for too short of a term (for example 50% seller financed over 3 years) then the pressure on cash flow can cause the bank loan side not to qualify. However, when a seller's note term is 7 years or longer, then seller financing is almost always optimal.
The lender will always provide ongoing financing
Reality: Lender policies on additional loans for ongoing acquisitions can differ significantly. Banks who dip their toe in advisor lending may not be excited as you are about finding another great acquisition so soon after the previous one.
I read this in an article or saw it in a big study so it must be true
It may be true but it also may not be true for you. Our industry has so many different nuances, models, and terminologies for the RIA and IBD worlds and often times the distinction isn't clarified. The advice and best practices being used for multi-billion PE funded RIAs or aggregating multiple flippers, isn't always applicable or even recommended for the typical advisor who doesn't have the same resources nor in the same situation.
SBA loans involve more restrictive ongoing covenants than conventional loans
Reality: SBA loans typically require fewer ongoing covenants.
Seller financing is requisite if there is a claw-back provision
Reality: Escrow agreements have increasingly supplanted seller financing for claw-back arrangements.
Equity in the firm being acquired counts towards the SBA's equity injection requirement
Reality: Equity can count but meeting the criteria to qualify that equity is nuanced.
Borrowers directly receive acquisition funds to pay the seller
Reality: Funds are typically wired directly to the seller or held in escrow, not transferred to borrower to then be paid to seller.
Banks wont touch an advisor loan under $250K
Reality: Obtaining smaller loans, even as low as $100K, can be done through LoanBox.
Buyers "should" make a 25%-30% cash down payment on acquisitions
Reality: While M&A broker firms certainly push this and this may be their reality, this is a unicorn in our world. We believe buyers should pay the least amount as possible in a cash down payment. Any cash down payment requirement from a bank is uncommon for advisors with books of businesses.
Live Oak Bank brought SBA lending to the financial services industry
Reality: While LOB was the first to make a concentrated focus on advisor lending (AdvisorBox played a primary role in introducing them) and while LOB deserves all the pats on the back we can muster because they really did change the paradigm in advisor lending, Live Oak was only established in 2013.
Before 2013 there were 225 banks who provided 1,476 funded loans to financial advisors for a $403K average loan amount. While most loans were under $150K (1,241 of the 1,476) there were 22 SBA loans funded to advisors over $1 million prior to LOB becoming LOB. SBA lending and the wealth management industry is a decades old relationship, not a new trend.
Prior bankruptcy is an automatic denial
If you declared bankruptcy in the last three years…it isn’t a myth because it will be nearly impossible to get a lender to sign off on. And, some lenders will simply not lend to anyone with a prior bankruptcy.
But there are lenders who will make exceptions or have scenarios that will allow for lending to previous BK borrowers. Bankruptcy scenarios that can be potentially be worked around:
• If the BK is older than 10 years for some lenders.
• If the BK is older than 7 years for some lenders.
• The reasons behind the BK are important. Was it caused by a nasty divorce? Was there a serious health issue?
In all cases, if you have a prior bankruptcy a detailed letter of explanation will be required and this is something that should be prepared at the very beginning of the process.
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Expansion Loans
Business Expansion Loans do not require an equity injection. When an existing business starts or acquires a business that is in the same 6-digit NAICS code with identical ownership and in the same geographic area as the acquiring entity and they are co-borrowers, SBA considers this to be a business expansion and not a new business.
Expansion Acquisition
When an existing business purchases another established business.
There is no down payment requirement for one business purchasing another business if three conditions are met.
The target business to purchase is in the same industry
The target business to purchase is in the same geographical area as your current business
The exact same current ownership structure will be applied to the purchased business.
If all three of these conditions are met then no equity injection is required. If all three conditions are not met, then the ten percent equity injection rules apply.
FAQ for Complete Asset
& Equity Acquisitions
-
The U.S. Small Business Administration (SBA) was created in 1953 to assist small businesses with guaranteed loans covering many of the small business needs for most industry types. The 7(a) program is the Small Business Administration’s flagship program and all SBA data on this website is referring to loans under the SBA 7(a)program.
The mission of the Small Business Administration is "to maintain and strengthen the nation's economy by enabling the establishment and viability of small businesses and by assisting in the economic recovery of communities after disasters".
Through the SBA 7(a) guaranteed lending program, the SBA guarantees part of the business loan that a SBA approved lender provides. In the case of a loan default, the lender isn’t on the hook for all of the unpaid loan amount. This SBA guarantee results in lenders providing loans to small businesses that they otherwise would not.
See sba.gov
-
Look at Financing Considerations Early in The Process
If external financing will be required for the advisor acquisition, then the deal must match bank requirements, not the other way around. Acquisition deals can implode in the end when lending due diligence isn’t done in the beginning. If the acquisition deal or structure can't get financed, what’s the point of everything else?
This scenario plays out regularly in the industry: Buyer and seller have already worked out the acquisition deal structure and terms, hired a lawyer to develop the purchase agreement, paid for a business valuation, and set the closing date. Then, after all that time, money, and effort was spent, they look into the financing only to find out that the deal can’t be financed at all, or that it needs to be re-structured in order to comply with the financing option or lender the buying advisor qualifies for and with.
If external financing will be needed for the acquisition deal to close, then external financing becomes one of the most important aspects of the acquisition deal. Buyers getting pre-qualified at the beginning of the process is critical for both buyer and seller.
External financing will heavily influence the acquisition terms and structure. External financing will dictate requirements around loan amount, cash injection requirements, promissory note amount, type and structure, closing timeline, retention provisions, and more.
-
SBA Standard 7(a) Program loans are backed by an SBA guarantee of 85% for loans up to $150,000 and 75% for loans greater than $150,000. Qualified lenders may be granted delegated authority (PLP) to make eligibility determinations without SBA review. Loans provided typically on 10 year terms with a maximum loan amount of $5 million.
SBA Express Loans are backed by an SBA guarantee of 50 percent, the lender uses its own application and documentation forms and the lender has unilateral credit approval authority as in the PLP Program. This method makes it easier and faster for lenders to provide small business loans of $350,000 or less, with SBA generally providing a loan guarantee to the lender within 24 hours of their request.
SBA Microloan Program was developed to increase the availability of small scale financing and technical assistance to prospective small business borrowers. Loans range from $500 to $50,000.
504 Certified Development Company (CDC) Loan Program provides growing businesses with long-term, fixed-rate financing for major fixed assets, such as land and buildings. A CDC is a nonprofit corporation set up to contribute to the economic development of its community or region.
Export Working Capital Loans are used to finance export sales - 90% SBA guaranty on a loan up to $5 million.
-
Equity Injection If Cash Payment
The equity injection can be paid by the borrower in cash, preferably wired to the lender a week or two before the loan closing. The money can come from savings, investments, a Home Equity Line of Credit (HELOC), or as a gift (with a gift letter as proof). Lenders usually require the most recent account statement for verification.
Full Standby Note
The SBA made a big change to the full standby seller note. Now the seller can finance the full ten percent of the equity injection requirement.
No principal or interest can be paid during the first two years standby period.
This option enables the borrower to purchase a business with no money down.
Partial Standby Note
A partial standby is where interest only payments can be made for the first two years but not principal payments.
The seller can finance up to 7.5% in a partial standby note.
The SBA requires 2.5% to come from a source other than the seller.
Adequate cash flow has to support the partial standby option.
-
It's only the cash flow not the ROI that matters
It's only the cash flow not the ROI that matters
The thinking that cash flow is all that matters is one of the more consequential myths in the industry. Just because a deal cash flows does not automatically mean it should be done, it only means it's a possibility on the table.
If it takes your current practice profits to make the acquisition deal cash flow then the deal doesn't cash flow on its own. If the deal doesn't cash flow on its own and needs your current practice's profits to contribute to the debt service payment then risk and return expectations are different.
Acquisition aggregation cash flow strategies are very different than an advisor who only intends to make only one or two opportunistic acquisitions in their career. Two totally different approaches to cash flow. See ROI box.
Cash down payment is always required
Reality: Most loans we facilitate involved no cash down payment from the borrower. Advisors who have a book of business rarely need cash down payments for acquisitions.
SBA always takes the house as collateral
Reality: Collateral requirements hinge on the borrower's equity in the property and the loan size. If the equity is less than 25% or the loan is under $500,000 then it is not required by the SBA.
Partial equity buy-ins are not eligible for SBA loans
Reality: This is a myth as of October 2023. new rules allow for the partial equity buy-ins. While conventional lending has dominated this lending purpose over the last decade, the SBA's new eligibility rules will cause a larger percentage of these deals to go SBA (with the much easier and flexible equity injection requirements).
Lenders always require some seller financing
Reality: While all lenders would "like" to have a portion of the acquisition in seller financing it isn't typically mandated, is decreasing in frequency and amount, and as long as the LTV requirements are met only are put in place by the seller's request, not the lender.
Valuation firms and M&A brokers don't get bank referral fees
Reality: We view a kickback when the client (you) is unaware of the arrangement and a referral fee when the client is aware. Some of these firms get kickbacks and some get referral fees but all get paid typically a 1% fee from the bank if you use the lender they recommend you use. That is why they recommended them.
Sellers have to receive all bank proceeds at closing
Reality: It's not uncommon for a seller to receive the payment over two or three years (without seller financing) by funding into escrow and distributing on designated future dates.
All SBA lenders handle M&A loans the same
Reality: SBA lenders vary greatly in terms of additional qualifying criteria, preferences, focus, criteria, and policies.
Multiple concurrent acquisition loans with different lenders is typical
Reality: Most lenders file a UCC-1 lien and insist on being in the first position, making concurrent loans from different lenders requires inter-creditor agreements and while it happens, it's not common and a completely case-by-case basis.
The bank approved the acquisition loan so it must be a good deal
Banks fundamentally differ from borrowers and investors in their approach to evaluating deals. While advisors are focusing on return on investment (ROI), banks rely on historical financial data rather than considering the net present value of future cash flows. Even if a bank conducts thorough underwriting and cash flow analysis, believing you will generate enough cash flow to meet your payments, they often disregard compound annual growth rate (CAGR) as a critical factor in their decision-making process, focusing solely on historical performance.
When a bank underwrites an acquisition they are not evaluating directly if this is a good investment, they are evaluating if you have the cash flow to afford it, risk, and require a business valuation to support price.
The bank doesn't need for the practice you're buying to cash flow on its own, they need for your business combined with the business you're purchasing to cash flow. If an advisor wants to acquire a practice that makes no profit but has some other value, the deal could easily cash flow because of combining with your current business. It's a deal that can get done, because it "cash flows", even though it doesn't.
Valuations are only ordered on seller's practice
Business valuations are only imperative for the seller's practice. Reality: When leveraging non-cash assets, both buyer's and seller's practices may need valuation. SBA loans have a buyer valuation for acquisition loans when there isn't a down payment required in part based on the estimated value of the buyer's business. Conventional lenders may require valuations on buyers for loans over $5 million but these polices are based on the lender.
1.75 or 1.50 DSCR is required for an SBA loan
Reality: This was LOB's old DSCR minimum and if LOB is the only SBA lender you work with then you may think their policies are identical to that of the SBA. SBA's minimum DSC is only 1.15 and LOB has dropped their DSCR to 1.50. Each lender has their own DSC minimum which can greatly impact the loan amount approved (a 50% difference in loan dollars qualified for between this 1.15 and 1.75 range).
Interest rate is the primary deciding factor in banks
Reality: It is obviously an important factor but other factors like qualifying criteria, deal structure, down payment requirements, can be more heavily weighted. If in ongoing acquisition mode amortization is much more important than rate. This is because there is not typically a night and day difference between lenders, just between SBA program loans and conventional.
Conventional loans are always better than SBA
Reality: The appropriateness of loan types varies according to the specifics of the borrower's situation and in many cases the opposite can be true. For deals where the borrower doesn't have a book SBA loans are always better from an acquisition equity injection perspective and for borrowers with and without a book this is often the most critical loan component. When buying bigger and especially much bigger SBA may offer the better scenario.
SBA loans can be refinanced readily with another SBA lender
Reality: Inter-lender refinancing of SBA loans is complex and not commonplace. However they are done sometimes, but it's not a typical thing.
Advisors can't qualify for a loan without life insurance
Reality: While this is mostly true with conventional lending to advisors SBA loans can get around this with rejection letter and documented (and acceptable) continuity plans.
Seller financing is always a good thing for the buyer
Reality: When too much is seller financed for too short of a term (for example 50% seller financed over 3 years) then the pressure on cash flow can cause the bank loan side not to qualify. However, when a seller's note term is 7 years or longer, then seller financing is almost always optimal.
The lender will always provide ongoing financing
Reality: Lender policies on additional loans for ongoing acquisitions can differ significantly. Banks who dip their toe in advisor lending may not be excited as you are about finding another great acquisition so soon after the previous one.
I read this in an article or saw it in a big study so it must be true
It may be true but it also may not be true for you. Our industry has so many different nuances, models, and terminologies for the RIA and IBD worlds and often times the distinction isn't clarified. The advice and best practices being used for multi-billion PE funded RIAs or aggregating multiple flippers, isn't always applicable or even recommended for the typical advisor who doesn't have the same resources nor in the same situation.
SBA loans involve more restrictive ongoing covenants than conventional loans
Reality: SBA loans typically require fewer ongoing covenants.
Seller financing is requisite if there is a claw-back provision
Reality: Escrow agreements have increasingly supplanted seller financing for claw-back arrangements.
Equity in the firm being acquired counts towards the SBA's equity injection requirement
Reality: Equity can count but meeting the criteria to qualify that equity is nuanced.
Borrowers directly receive acquisition funds to pay the seller
Reality: Funds are typically wired directly to the seller or held in escrow, not transferred to borrower to then be paid to seller.
Banks wont touch an advisor loan under $250K
Reality: Obtaining smaller loans, even as low as $100K, can be done through LoanBox.
Buyers "should" make a 25%-30% cash down payment on acquisitions
Reality: While M&A broker firms certainly push this and this may be their reality, this is a unicorn in our world. We believe buyers should pay the least amount as possible in a cash down payment. Any cash down payment requirement from a bank is uncommon for advisors with books of businesses.
Live Oak Bank brought SBA lending to the financial services industry
Reality: While LOB was the first to make a concentrated focus on advisor lending (AdvisorBox played a primary role in introducing them) and while LOB deserves all the pats on the back we can muster because they really did change the paradigm in advisor lending, Live Oak was only established in 2013.
Before 2013 there were 225 banks who provided 1,476 funded loans to financial advisors for a $403K average loan amount. While most loans were under $150K (1,241 of the 1,476) there were 22 SBA loans funded to advisors over $1 million prior to LOB becoming LOB. SBA lending and the wealth management industry is a decades old relationship, not a new trend.
Prior bankruptcy is an automatic denial
If you declared bankruptcy in the last three years…it isn’t a myth because it will be nearly impossible to get a lender to sign off on. And, some lenders will simply not lend to anyone with a prior bankruptcy.
But there are lenders who will make exceptions or have scenarios that will allow for lending to previous BK borrowers. Bankruptcy scenarios that can be potentially be worked around:
• If the BK is older than 10 years for some lenders.
• If the BK is older than 7 years for some lenders.
• The reasons behind the BK are important. Was it caused by a nasty divorce? Was there a serious health issue?
In all cases, if you have a prior bankruptcy a detailed letter of explanation will be required and this is something that should be prepared at the very beginning of the process.
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Expansion Loans
Business Expansion Loans do not require an equity injection. When an existing business starts or acquires a business that is in the same 6-digit NAICS code with identical ownership and in the same geographic area as the acquiring entity and they are co-borrowers, SBA considers this to be a business expansion and not a new business.
Expansion Acquisition
When an existing business purchases another established business.
There is no down payment requirement for one business purchasing another business if three conditions are met.
The target business to purchase is in the same industry
The target business to purchase is in the same geographical area as your current business
The exact same current ownership structure will be applied to the purchased business.
If all three of these conditions are met then no equity injection is required. If all three conditions are not met, then the ten percent equity injection rules apply.
FAQ for Partial Equity Buy-ins
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The U.S. Small Business Administration (SBA) was created in 1953 to assist small businesses with guaranteed loans covering many of the small business needs for most industry types. The 7(a) program is the Small Business Administration’s flagship program and all SBA data on this website is referring to loans under the SBA 7(a)program.
The mission of the Small Business Administration is "to maintain and strengthen the nation's economy by enabling the establishment and viability of small businesses and by assisting in the economic recovery of communities after disasters".
Through the SBA 7(a) guaranteed lending program, the SBA guarantees part of the business loan that a SBA approved lender provides. In the case of a loan default, the lender isn’t on the hook for all of the unpaid loan amount. This SBA guarantee results in lenders providing loans to small businesses that they otherwise would not.
See sba.gov
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Partial Equity Buy-in Considerations
DEAL GUARD RAILS
There are few guard rails in deal structure for qualifying equity buy-in loans as long as they make sense to the (experienced) lender.SELLER CONSULTING
Ongoing seller involvement is a given in equity buy-ins.GUARANTORS
While a case-by-case basis the equity owners with 20% or more will execute grantor agreement with the lender. The borrower is a personal guarantor and 20% partners have a grantor agreement.COLLATERAL
No personal property collateral but there is a UCC lien on all current and future business assets of the entire entity.
DSC CASH FLOW
When a W2 advisor or internal manager (not owning a book or practice) are buying into a practice with an equity buy-in the cash flow is based on the net distributions received against the annual debt service.BANK ACCOUNT REQUIREMENT
While moving your bank operating account to the bank providing a business loan under $5 million isn’t typical in the advisory lending niche, it is even less common in a buy-in loan where the borrower may be only purchasing 5% or 10% of the equity. -
SBA Now Allows for Equity Buy-ins
New or existing shareholder purchasing a portion of equity from a partner.
Partial Equity Acquisitions
The SBA now recognizes and allows partial equity acquisitions. This flexibility means that interested buyers can acquire a share of an existing business without needing to purchase the entire organization.
Eligibility Requirements
For a buyer to qualify for an SBA loan financing a partial equity acquisition, they must acquire at least 20% ownership interest in the business. Simultaneously, the existing owner(s) need to retain a minimum of 20% ownership interest in the business.
Equity Injection Requirements
The equity injection requirement for partial equity acquisitions is waived if the new owner contributes at least 50% of the equity in the business.
Guaranty Requirements
All owners holding 20% or more of the business must provide a full, unlimited guarantee for any SBA loan financing the business's purchase. This requirement applies regardless of whether it is a complete or partial partner buyout.
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Partial Equity Buy-in Considerations:
DEAL GUARD RAILS
Key guard rails are earn-out structures are ineligible. The inability to maintain seller as an employee post-sale isn’t relevant in equity buy-ins.SELLER CONSULTING
Ongoing seller involvement is a given in equity buy-ins.GUARANTORS
The borrower plus any 20%+ remaining partner is a personal guarantor and subject to any applicable personal property collateral requirements.COLLATERAL
A UCC lien on all current and future business assets is placed on the business. Personal property can be required for loans over $500,000 and when having 25% equity in the property.
DSC CASH FLOW
When a W2 advisor or internal manager (not owning a book or practice) are buying into a practice with an equity buy-in the cash flow is based on the net distributions received against the annual debt service.BANK ACCOUNT REQUIREMENT
This isn’t typically required or an issue anyway but especially in equity buy-ins. -
0% or 10% SBA EQUITY INJECTION
The equity injection requirement for partial equity acquisitions is waived if the new owner contributes at least 50% of the equity in the business.
Complete Partner Buyout
For the complete partner buyout there is a 10% cash down payment requirement unless two conditions are met:1 - The borrower must have been active in the operations of the business and has been a ten percent or more owner over the last two years. This needs to be attested to by both the borrower and seller.
2 - The second requirement is a Maximum Debt-to-Equity of nine-to-one. This is determined based on the business balance sheet over the most recent year and quarter.
Partial Partner Buyout
This loan also requires a ten percent cash injection unless two key requirements are met.1 - There is also the same nine-to-one maximum debt-to-worth condition.
2 - The second condition is any remaining owners of the business who have twenty percent or more in equity, are subject to the SBA guarantor requirements. This includes the personal guaranty and the property collateral requirements.
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What Remaining 20% Partners Need to Know About Equity Buy-in Loans
Different conventional lenders approach partial equity purchases or buy-ins differently. For partner buy-ins there is still the cash flow and LTV considerations that a partner buyout have but often the issue for partner buy-in loans is the lender’s guaranty and lien requirements.
A lien is placed on the entire business
The bank will place a lien on the entire business even though it is lending for an equity buy-in of only 1% of the business. So if only one is getting a loan, the lien is going to encompass the equity of the non-borrowing partner has as well.
It's a blanket UCC lien and covers all equity and client assets, now and in the future, and this stays in place the duration of the loan.
Equity Injection is either 0%, 10%, or 25%
The equity injection, which includes the cash down payment and/or seller financing required for the loan, will range from 0% if the SBA's 9:1 ratio is met, to 10% if it is not. In this scenario, seller financing is not allowed, necessitating a 10% cash down payment.
Conventional loans typically require a 25% equity injection, with a maximum loan-to-value (LTV) ratio of 75%.
20% Partners = personal guaranty on SBA Loans
SBA mandates that all partners with at least a 20% stake provide personal guarantees and comply with collateral requirements. A significant concern lies in the collateral requirements related to personal property.
If the buying advisor does not have equity in their home equivalent to the loan amount—an issue that occurs approximately 99.99% of the time—then for loans exceeding $500,000, a 20% partner with 25% equity in their home (outside of Texas) would face a junior lien placed on their property to secure the loan for the other buying advisor.
20% Partners = grantor on conventional Loans
For conventional loans then a corporate guaranty or grantor agreement would be required. The grantor agreement (or equivalent) is where the non-borrower equity owners personally grant the business collateral to the lender.
Some conventional lenders based on the buyer and overall loan scenario may also require one or more personal guaranties from existing partners. Conventional lenders are very case-by-case basis on these types of deals but personal guaranties are not common.
Seller Primary Items & Information Needed
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LOI or Deal Terms
There doesn’t need to be an executed LOI to get a term sheet. The outline of the key terms that will be in a LOI are needed. Price and loan amount are the key variables. If seller financing is involved, then how much and for how long also needs to be known.
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Pro Forma
The buyer usually has to show projections. The bank wants to see that after combined revenues, and expenses, there is enough cash flow to make the loan payment and have room left over. Provide the buyer with any significant add-backs from your P&L that the buyer would not have as an expense after the acquisition is closed.
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AUM and Revenue
The lender wants to see a custodian or broker dealer generated report showing assets managed and trailing 12 months revenue.
For a partial client/asset acquisition an SBA lender needs to verify that the assets being acquired is indeed a partial (less than 50%) of your client assets.
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Tax Returns, P&L, and Balance Sheet
Last 3 years tax returns.
If 2022 tax returns are on extension then a P&L for 2022 is needed. A P&L is also needed for 2023 YTD.
Some lenders will want to see a YOY (Year Over Year) YTD P&L comparison as well.
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4506-T
Execute IRS form that allows bank to pull tax transcripts.
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Wiring Instructions
The bank wires seller funds directly to the seller at closing.
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Lien Payoffs
Payoff notices for any existing seller debts with a lien on the business.
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Purchase Agreement
Executed purchase agreement and any seller notes, seller subordinations, exhibits and escrow agreement (if applicable).
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Equity Documents:
Stock Certificates
Resignation Letter (if 100%)
Articles of Incorporation or Organization
Bylaws or Operating Agreement
Partnership Docs (if applicable)
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Interim Financials
Banks will need to see YTD financials typically within 120 days of closing.
About Equity Injections
Equity injections are basically skin in the game from the lender's perspective for an acquisition loan.
The equity injection has nothing to do with an asset or equity structured purchase, it is referencing the equity of either cash, assets, or a seller note injected into the deal.
An equity injection can be provided by the buyer through a cash down payment or waived based on their current book of business value.
A seller can inject equity into the deal by providing a seller promissory note for a portion of the purchase price.
And equity injections can be satisfied through a combination of buyer down payment and a seller note.
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What is an equity injection?
This is basically skin in the game from the lender's perspective for an acquisition loan. The equity injection has nothing to do with an asset or equity purchase, it is referencing equity to mean that either cash or assets are injected into the deal. An equity injection can be provided by the buyer through a cash down payment or waived based on their current book of business value. A seller can inject equity into the deal by providing a seller promissory note for a portion of the purchase price. And equity injections can be satisfied through a combination of buyer down payment and a seller note.
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It's all about the LTV - Loan to Value
While a borrower's personal financial situation and credit scenario impacts this the primary equity injection requirements from conventional lenders comes down to the LTV. Conventional lenders have maximum LTV requirements typically at 75% but some can go to 85%.
Given that LTV is calculated by combining the value of the buyer's and seller's practices, acquisition deals generally bypass LTV qualification hurdles. However, LTV ratios become a crucial challenge in conventional loans when the buying advisor’s practice is valued at or below 33% of the selling practice’s value. In such scenarios, the loan agreement could breach the LTV maximums set by conventional lenders, pushing the need towards an SBA-backed loan.
For SBA loans, the threshold of concern is when the buyer’s practice is worth approximately 11% of the seller's; this figure is a trigger point for exceeding conventional LTV limits, necessitating the pursuit of an SBA lender for financing.
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Understanding the New SBA Equity Injection Rules
The SBA equity injection rule stipulates a ten percent equity injection on loans that lead to a change of ownership. This rule applies to the total project costs and not the loan amount. The 10% equity must come from a source outside the business's existing balance sheet.
Change of Ownership Loans
These loans entail acquiring a business, assets, or equity, where the ownership is entirely transferred from the seller to the buyer. These loans include new business purchase loans, expansion business purchase loans, and complete and partial partner buyouts.
In terms of Equity Injection for a Business Purchase, there are three ways to meet the equity injection requirement: 10% Cash, Full Standby Note, and Partial Standby Note. If choosing a Standby Note, the borrower will have two loans: an SBA loan with the lender, and a promissory note with the seller.
For changes of ownership resulting in a new owner (complete change of ownership): At a minimum, SBA requires an equity injection of at least 10 percent of the total project costs, (all costs required to complete the change of ownership, regardless of the source of funds) for such transactions.
Seller debt may not be considered as part of the equity injection unless the seller’s loan does not include a balloon payment and, for the first 24 months of the 7(a) loan, the seller debt is on either (a) full standby; or (b) partial standby (interest payments only being made) and the Applicant’s historical business cash flow supports the ability to make the payments, and at least a quarter of the SBA-required equity injection is from a source other than the seller.
What are change of ownership loans?
A loan resulting in a change of ownership is when you are purchasing a business, assets or equity, whereby 100% of the ownership transfers from the seller to the buyer.
These include:
A new business purchase loan
An expansion business purchase loan
And complete and partial partner buyouts.
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Equity Buy-in Equity Injection
The partial partner buyout is when a borrower is purchasing part of the equity owned by a partner. The partner who is selling will remain on as a partner since they are selling just part, and not all, of their equity.
This loan also requires a ten percent cash injection unless two key requirements are met.
A Maximum Debt-to-Worth of nine-to-one (9:1). This is determined based on the business balance sheet over the most recent year and quarter.
Any remaining owners of the business who have twenty percent or more in equity, are subject to the SBA guarantor requirements. This includes the personal guaranty and the property collateral requirements.
Calculate the 9:1 ratio
The 9:1 ratio for equity injection in SBA SOP for partner buyout loans is a measure of a business's financial health. This ratio compares the business's debt to its equity, which represents the amount of capital invested in the business by its owners. A lower debt-to-equity ratio indicates that the business has more equity and is less reliant on debt, while a higher debt-to-equity ratio suggests that the business is more heavily indebted.
Calculating the 9:1 Ratio: To calculate the debt-to-equity ratio, divide the business's total debt by its total equity. For example, if a business has $500,000 in debt and $100,000 in equity, its debt-to-equity ratio would be 5:1.
Interpretation of the 9:1 Ratio: The SBA considers a debt-to-equity ratio of 9:1 or higher to be indicative of financial risk. When a business's debt-to-equity ratio exceeds this threshold, it may be required to inject additional equity into the business to demonstrate its financial stability and reduce the risk of default on an SBA loan.
Example of a Business Below the 9:1 Ratio: Suppose a business has $750,000 in debt and $150,000 in equity. Its debt-to-equity ratio would be 5:1, which falls below the 9:1 threshold. In this scenario, the business would not be required to make an equity injection as it is considered financially stable.
Example of a Business Above the 9:1 Ratio: If a business has $1,200,000 in debt and $100,000 in equity, its debt-to-equity ratio would be 12:1, exceeding the 9:1 threshold. In this case, the business would likely be required to inject additional equity into the business to lower its debt-to-equity ratio and meet the SBA's requirements.
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Equity Injection If Cash Payment
The equity injection can be paid by the borrower in cash, preferably wired to the lender a week or two before the loan closing. The money can come from savings, investments, a Home Equity Line of Credit (HELOC), or as a gift (with a gift letter as proof). Lenders usually require the most recent account statement for verification.
Full Standby Note
The SBA made a big change to the full standby seller note. Now the seller can finance the full ten percent of the equity injection requirement.
No principal or interest can be paid during the first two years standby period.
This option enables the borrower to purchase a business with no money down.
Partial Standby Note
A partial standby is where interest only payments can be made for the first two years but not principal payments.
The seller can finance up to 7.5% in a partial standby note.
The SBA requires 2.5% to come from a source other than the seller.
Adequate cash flow has to support the partial standby option.
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Advisor Expansion Through Acquisition
Expansion Loans
Business Expansion Loans do not require an equity injection. When an existing business starts or acquires a business that is in the same 6-digit NAICS code with identical ownership and in the same geographic area as the acquiring entity and they are co-borrowers, SBA considers this to be a business expansion and not a new business.
Expansion Acquisition
When an existing business purchases another established business.
There is no down payment requirement for one business purchasing another business if three conditions are met.
The target business to purchase is in the same industry
The target business to purchase is in the same geographical area as your current business
The exact same current ownership structure will be applied to the purchased business.
If all three of these conditions are met then no equity injection is required. If all three conditions are not met, then the ten percent equity injection rules apply.
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What down payment sources qualify for SBA loans?
Savings
Liquidating from investment account(s)
Gift (gift letter must be provided)
HELOC
What is the process of making payment?
For SBA loans the typical way it works is the down payment is wired to the bank. The bank is required by the SBA to see statements that show the amount was in that account for two full months before the down payment was sent. If the money was pulled from multiple accounts then multiple account statements will have to be provided.
Selling to Successor
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Can I spread out payments over multiple years without seller financing?
Yes. Part of the purchase can be placed into escrow and then disbursed over multiple years.
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Can they get a loan for the down payment and then do an earn-out for the rest?
If they qualify for a conventional loan they can. Any form of an earn-out is not allowed with an SBA loan.
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Can I help my successor avoid a down payment?
Other than guarantying the loan, they would need to be 1099 for one year prior to the purchase and own enough assets to value at just over 10% of the purchase price.
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Can I lend successor money for a down payment?
You can’t lend it to them.
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Can they use the phantom stock I gave them as a down payment?
Conventional: If the buyer is doing a conventional loan, no problem.
SBA: The equity owned needs to be reported on their last two years tax returns to qualify. If the equity is phantom stock, a verbal agreement, or equity that you gave that has no benefit unless you sell someday, then lenders typically will not view that as eligible equity ownership that could be applied as the down payment.
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What's this SBA equity injection seller financing all about?
For advisors with no equity ownership, no 1099 income, and no clients owned, then a 10% down payment would be required. Of this you can choose to seller finance 5% but the note would be on a 10 year standby note.
This means that while interest can accrue the buyer would not be able to make any P&I payments on that 5% note while the SBA loan is still active. SBA acquisition loans (without property) are 10 years.
For a lot of internal successors there is a big difference in their ability for coming up with a 5% down payment vs. coming up with 10%. With a little planning you can help your internal successor in this situation either prepare for a down payment or avoid a down payment all together.
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Should I ever consider guarantying the loan?
As a general rule, no. However, there are circumstances that could warrant it. If you do guaranty then you will likely only be able to protect yourself in clawing back the equity that was sold.
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What does it cost to see if my successor qualifies?
Nothing, AdvisorLoans provides pre-approvals for free.
Earn-out Notes
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Earn-outs involving conventional and SBA loans
Conventional loan - As long as the projected earn out terms cash flows, most conventional lenders accept earn-out structures. From a lender’s perspective, earn-outs provide some short-term protection for their borrower from a significant downside turn in revenues after the loan closing. And, as with a seller promissory note or escrow agreement provision, earn-outs provide some protection for higher than anticipated attrition. Also similar to seller financing, earn-outs provide the lender with a low LTV, while still being in first lien position with the earn-out subordinated to the lender.
SBA loan - The SBA prohibits earn-out structures. Earn-out promissory note structures are not allowed in SBA lending. If it looks like, or smells like a “revenue share” arrangement, the SBA lender won’t approve the purchase agreement. If a seller is set on having an earn-out structure and the buyer needs a bank loan for the down payment, they will need to qualify for a conventional loan.
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Earn-out Note Subordination
In most cases, the earn-out note is required to be subordinated to the lender if a bank is involved in the transaction. This means that the seller's right to receive earn-out payments would be secondary to the lender's rights and repayment priority. The subordination ensures that the lender has first claim to the borrower's assets and cash flows, including any earn-out payments, in the event of default or financial challenges. This is similar to how a seller promissory note would also be subordinated to the lender's interests.
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More complicated legal and tax considerations
Earn-outs generally have more complex legal structures compared to other payment arrangements. They involve detailed terms and conditions that are contingent upon future performance and can include various provisions, such as revenue targets, financial milestones, or clawback provisions for revenue attrition. The complexity arises from the need to define and agree upon specific metrics, timelines, and conditions for determining the earn-out payments. Additionally, legal documentation is required to outline the terms of the earn-out, including the calculation method and the rights and responsibilities of both the buyer and the seller.
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When seller is retiring during the earn-out term
If a licensed financial advisor seller retires during the earn-out period, it is important to address this situation in the purchase agreement. The retiree's retirement may impact the terms and conditions of the earn-out structure. The lender's lawyer reviewing the deal would typically want to ensure that the retirement is accounted for in the language of the purchase agreement.
Depending on the advisor's model and affiliation, different rules and regulations may apply to a buyer paying part of the practice's revenue to an unlicensed individual, such as a retired seller. Custodians usually allow for this by qualifying the seller as a "solicitor," enabling ongoing payments even when the seller is not licensed. However, it is crucial to consult with the Independent Broker Dealer (IBD) and custodian early in the process to determine and account for any earn-out requirements in the event of the seller's retirement.
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When seller is continuing to work throughout the earn-out term
If the seller of a financial advisor business is staying licensed throughout the earn-out period, there are generally fewer complications compared to when the seller retires. In this scenario, there would be no issue with the seller continuing to receive earn-out payments directly.
While most Independent Broker Dealers (IBDs) permit such direct payments, it's important to note that there might be certain IBDs that have specific rules and compliance requirements. Some IBDs may insist on establishing a team ID rep code, whereby a portion of the compensation is paid to the buyer's rep code and the remaining portion to the seller's rep code.
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Buyer pre-qualification even more important with earn-outs
Borrower pre-qualification becomes even more important when the seller wants both a big down payment and an earn-out structure. In such cases, the buyer needs to be strong enough to qualify for a conventional loan to finance the down payment portion. If the buyer does not meet the criteria for a conventional loan, they may not be able to obtain financing for the down payment and, consequently, the entire deal may fall apart.
By going through the pre-qualification process for an acquisition loan beforehand, the buyer can determine the loan amount they can target and assess the deal structures that are feasible for them. This helps avoid situations where the buyer and seller agree on terms, sign agreements, and set an acquisition date before realizing that the buyer does not qualify for the necessary financing.
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Earn-out workarounds
When using an SBA loan, earn-out structures are generally not allowed. However, there are workarounds that can be utilized to achieve a similar outcome. Instead of relying on an earn-out structure, advisors can explore alternative options to get the deal done. Here are a few possible workarounds when using an SBA loan:
1. Seller Promissory Notes: The seller can provide a promissory note, where the payment is structured over multiple years and can be adjusted based on revenue attrition. This allows the seller to receive payments over time, contingent upon the performance of the business.
2. Escrow Agreements: Similar to seller promissory notes, an escrow agreement can be structured to distribute payments to the seller over a period of time. Clawback provisions can be included to account for any revenue attrition.
3. Premium Price with Seller Note: The buyer and seller can agree on a premium price, where the difference between the business valuation and the purchase price is covered through a seller note. The seller can then receive a fixed dollar amount over time, adjusted based on predetermined benchmarks.
Business Valuations When a Bank Loan is Involved
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When in the loan process the valuation is needed
Valuations are NOT needed before the acquisition loan gets rolling. There are of course circumstances where the advisor will want the valuation sooner than later but banks will almost always approve the loan without a valuation but requiring it as a closing item. In scenarios where the valuation is not expected to be an “issue” it’s not unusual for an advisor to wait until they receive loan approval before they order (or have the bank order for SBA loans) the valuation(s).
Circumstances where a valuation should be ordered early instead of later in the loan process include:
SBA loan buyer: where buyer’s estimated value is right at or close to the needed value required not to make a cash down payment. Any advisor with $300,000 in GDC with no business debt will value enough for a $5 million SBA acquisition loan. But an advisor with $100,000 acquiring a $2.5 million practice should value high enough but it’s not a given. In this case a valuation should be ordered right away on the buyer’s practice because you don’t want to find out at the end of the loan process that you’ll have to come up with $250,000 cash down payment or renegotiate the price of the deal.
SBA or conventional loan seller: where the price appears to be at such a premium that there is reasonable doubt that the third party valuation won’t be as high as the purchase price. For SBA loans the loan amount for the acquisition cannot exceed the valuation amount. For conventional loans, in most cases, the valuation can be less than the purchase price if it seems reasonable and doesn’t trigger the lender’s LTV requirements.
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Which comes first loan pre-qualification or the valuation?
The loan pre-qualification term sheet absolutely comes first. While it is nice to have the valuation before an offer is even made that’s not the norm. For the buyer who needs a loan for the purchase it doesn’t really matter what a seller’s practice values at if they can’t get a loan for the purchase price.
For most buyers, before they start bidding on practices they should first find out how big of a practice they can get a loan to buy. It’s smart to get an Loan Pre-Approval letter that shows how much in acquisition loan dollars the advisor can qualify for and if they would qualify for a conventional or an SBA loan.
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When a valuation is required on the buyer:
SBA Loans
For most SBA acquisition loans where the buyer already has an advisory business there is a valuation completed on the buyer’s business. The short explanation is that in an advisor expansion loan scenario where the buyer already owns an advisory business and is buying another advisor’s business they don’t have to pay a cash down payment. But the value of the buyer’s advisory business minus any business debt must value at just over 10% of the purchase price. To “prove” this the bank orders a valuation on the buyer.
To explain further, the SBA has a an equity injection rule for 100% ownership transfer acquisition loans. The buyer can pay a minimum of 10% cash down payment on the total amount of the purchase (not the loan amount) or the advisor can use “assets other than cash” option the SBA allows. The “asset” the advisor has other than cash is the value of their advisory business.
The lender needs to justify the value of the buyer’s practice to meet the equity injection requirement. In most acquisition scenarios with SBA 100% financing loans, third party valuations on both the buyer’s and seller’s practice will be required.
Conventional Loans
Requirements vary by lender but not usually for loans under $5 to $10 million (again depending on the lender).
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Ordering the valuation(s)
Conventional lenders will typically accept any recent business valuation created by a known valuation firm in our industry like FP Transitions, Succession Resource Group, Key Management Group, and Truelytics.
SBA lenders however, must be the ones that order the valuation and do so using only the valuation firms who are on their SBA certified valuator vendor approval list.
The SBA also requires that the lender orders the valuation and that the valuation is prepared for the lender. The SBA specifically prohibits a lender from using a valuation that was prepared for the buyer or seller. For SBA loans be prepared to pay a deposit to the lender before they’ll order the valuations.
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Who pays for the valuation and how
SBA Loan
The SBA lender is required to order the valuation. Most SBA lenders will not do this without a deposit from the borrower. The buyer can pay the deposit (usually around $2500) to the lender when they execute the term sheet or after they receive the approval. If the buyer wants the valuations completed sooner than later the deposit is paid early instead of later in the process.
Conventional Loan
Conventional lenders typically do not order the valuation and do not care if the valuation was paid for by the buyer or seller. If the seller already has a recent (less than 6 months old) valuation in hand then this can be accepted. If there is no valuation in place then one needs to be ordered.
Who orders and pays for the valuation for conventional loans is on a case-by-case basis decided upon between the buyer and seller. Sometimes the seller will pay for the valuation considering that if the buyer can’t qualify they will have the valuation they can use for a different buyer. Sometimes the buyer pays for the valuation to expedite the process with confidence they will be able to qualify for the loan to purchase it.
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When the valuation is below the asking price
While conventional lenders have flexibility for this scenario, SBA lenders will not lend for an acquisition amount that is higher than the valuation. If the valuation is lower than the purchase price then the buyer needs to decide if they are still willing to pay the purchase price. If they are willing then the difference needs to be paid in cash (rarely happens) or the difference can be paid through a seller promissory note (almost always what happens). Depending on the size of the difference gap the seller note may be able to be for one to three years or for a longer period like three to seven years depending on the impact to the deal’s cash flow.
For conventional loans it is usually more about the impact to LTV or loan to value. Since the value of the buyer and seller’s practice is combined when LTV is calculated the discrepancy between the valuation and purchase price would have to be significant to throw a monkey wrench into the approval.
Why it matters what kind of loan your buyer qualifies for
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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.
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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.
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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.
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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.