Financing Essentials: SBA Loans to Working Capital

In this episode, we dive into financing options with @Brandon Herbison from @Plains Capital Bank. We’ll cover the ins and outs of different loan types, including the popular SBA 7A loan, and the role of working capital to support growth after the deal closes. Brandon shares insights on loan terms, collateral requirements, and even seller financing—a tool that can benefit buyers, sellers, and banks alike. Tune in to learn what financing options might best suit your business transition goals.

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TRANSCRIPT

Welcome to Integrated Insights with ICCG. For more than 30 years, our team has

partnered with small business owners to prepare for and navigate the business

transaction process. Pull up a chair as we share stories and insights from our

experience on all sides of the M &A table. And welcome back to another episode of

Integrated insights. My name is Michael Hefner. I'll be your host today. I'm joined

again by Andrew McCoolkin from our office. Today's episode we're also excited to

welcome Brandon Herbison, vice president with Plains Capital Bank. Brandon is a

commercial loan officer with more than 12 years experience in the banking industry

and business financing. As an active community member, Brandon serves as the board

member for Community Lifetime Center and is on the board of directors for the

McKinney Chamber of Commerce. Brandon has built a reputation for supporting business

owners through complex financial decisions and with his extensive knowledge of

commercial lending and dedication to the local business community, Brandon brings

valuable insights regarding the financing options for M &A deals. Well,

today we are going to be talking about banking and trying to give business owners

just some expectations that haven't approached in the M &A deal before. So just to

get started, what are the most common financing options available for small business

M &A deals? - Yeah, absolutely, absolutely. So typically on small business lending or

any M &A type of stuff, we go more towards term debt. So you have somebody that's

got a service industry in there, You know, hey, we're looking to retire, sell our

business, say it's for a million dollars. Okay, well, you got the new, the buyer

coming in that, you know, come down with a portion of down payment as well. But

typically we'll try to amortize that over, you know, 10 or 25 years, depending on

the collateral type really is what dictates that. But you allow that the buyer to

service that cash flow over, you know, over, you know, a certain amount of time

compared to, you know, some other options, you may have some short -term work in

capital, capital pieces in there, but yeah, so for the most part, you go into the

term debt, which I'm sure we'll talk quite a bit through this piece, but it's

mostly around SBA financing, which is Small Business Administration. So SBA 7A loans

are the most common types, I would say, for a business owner coming in. Again,

that's a term debt loan. So you can't have an interest only period on the front

end of it. But what that again allows you to do is pay it pay it down and pay

it off over 10 or 25 years. So there's a lot of kind of caveats to it.

But what that option allows us in the borrower to do is kind of mitigate,

you know, a little bit of the risk within within kind of a startup or new business

owner piece to M &A deals. - Hey, Brandon, what determines the term on that,

right? So you kind of mentioned, hey, different terms for it, 10, 25, 20 years,

whatever it is, what determines that? I mean, I'm sure that there's a lot of

things, but can you give us some examples? - Absolutely, yeah, it's mainly circled

around the collateral for the deal. So if you have real estate attached to it.

That's when we're able to go out to 25 years on those deals. If there's no

collateral, if it's, you know, you get to see some that, you know, may be, hey, we

have some finish outs or we're, you know, going in and buying equipment, you know,

receivables, other, other kind of business assets. That's when you want to shorten,

shorten the AM a little bit. Most will, you know, go towards more the useful life

of the collateral piece. So through the SBA, if 51 % of the purchase price in a

merger involves the real estate, then that's where we can go on a 25 -year

amortization. - So who's typically the person that is going after,

I mean, we know SBA is a big, it's a big deal, right? And so who's typically

wanting to go after an SBA loan? - Absolutely, so I preface it all with every bank

is required to look at it conventionally before they do go through the SBA route,

but with SBA it is a good program, especially for being government run. They do a

good job where it mitigates really a big collateral or a big weakness for the bank,

whether it's a lack collateral, you'll see some blue sky type of deals within

mergers and position. So, like I said, typically lack collateral is a big piece that

the SBA mitigates for us. The other piece may be, you know, maybe the cash flow

just wasn't there. And you know, this new business owner already has something

already set up and they're just acquiring another firm that will, you know, and,

hey, here's our plan to turn around the cash flow and, you know, we're able to

mitigate the historical cash flow by using the SBA. So that's the main purpose of

it, is the SBA guarantees a portion of the debt for the banks. So that allows us

to do what would be a little bit riskier deals, and not be able to get done

conventionally, but gives us that extra arm to go out and do an SBA loan. - So

with all the options available, right? 'Cause there are limitations, but there's also

typically multiple options for everyone that comes to the table. So how does a

business owner decide which option is best based on the options available? Yeah,

absolutely. So it's mostly dictated around if it's permanent working capital, long

-term working capital, or if it's short -term. So really the two main ones you see

are SBA Express Loans, which is a short -term work capital solution. I think that is

your standard line of credit. And then you have the 7A, which is more of the term

debt. So again, it's, hey, we're, we've acquired a business, you know, maybe it's,

maybe it's on the smaller side, but we just need help, you know, with some working

capital from an AR standpoint, inventory and collecting some of that stuff. We just

have a, you know, that work capital need. That's where the SBA express loan tip

comes in. It's a little bit more flexible compared to the SBA 7A where it's a term

loan and you kind of have everything already figured out from a cost standpoint on

the front end of it that you'll see. So just Brandon, with that, with Word and

Capital, I know we deal with Word and Capital, I mean that's one of our

specialties, right, in deals. And so when we talk about Word and Capital,

Normally, in most deals that we have done, if not all, there is some sort of,

okay, sellers are gonna leave some work capital. I mean, some work capital is

purchased alongside of the, alongside with the business. And so, and so what,

you know, when you're talking about those kind of loans, are those in addition to

that, or is that more, hey, there was this work capital, there's nothing that was

bought, you know, they are didn't, the account receivables, they didn't go with it.

And so what, you know, we're here to, to, to, to, to give you some sort of line

of credit to help with working capital. Is that scenario? What, you know, what,

what, what scenarios are, are, is that, you know, applicable for? That's exactly.

Yeah. So typically we see them kind of work in tandem. So you get, hey, we'll do

a seven day loan just for the acquisition of the real say equipment, overall

business assets, and yeah, there may be some working capital left over from the

seller of it. With that, you'll, you know,

we'll do calculations to see kind of how much work capital you need. Hey, maybe

we're, you know, it's a $5 million revenue business today, but we're looking to take

it at $10 million, you know, in the next year. Well, that's going to take some

work capital. And so what we typically see on that is So we'll do a 7A loan and

also at the same time do an SBA express loan. So the term loan just starts

amortizing day one, going to principal and interest payments from there. And then

that SBA express loan kind of allows a little bit more of the dry powder, if you

will, kind of store up, hey, you know, it's, you know, took a little while to

collect receivables or whatever it may be on this month and, you know, we need, you

know, $50 ,000 drawn on it just to keep our bills paid and things like that. So

it's typically see them quite often. So on the banking side, we will underwrite kind

of all of that. So we'll say, okay, yeah, what is your work capital analysis look

like on the back end of it? Hey, maybe the business has plenty of cash liquidity

into it. You know, we're looking to just kind of keep it at the same level. Okay,

great. You know, maybe you don't need that as the express. But again, hey, we're

looking to grow it. You know, that that costs money a little bit on the front end

with payroll and again collecting the receivables and that timeline to get those in.

So, that's where the ASB Express is a pretty good partnership at the same time with

those initial term loans. Yeah, we always, you know, one of the things that a lot

of people don't expect is that post -transaction, the buyer will experience some sort

of line for a period of time before it really kind of comes back. And that,

depending on the business, it can last a couple months, it can last, you know, a

year, whatever that that low period is. And so, and so it,

it can be very beneficial to have that kind of line of credit just to assist with

growth plans that a buyer may have. And so, And so that's definitely helpful,

very huge for what I know we've seen. Yeah, absolutely. Yeah, just to kind of

finalize that piece, I typically encourage people to go ahead and look at doing an

SBA loan. Again, everybody's got their projections and they're showing that, hey,

we're going to make a bunch of money well. Obviously, everybody's projections just

don't hit. Normally, we're selling businesses that go like that right and so they

are expecting which is going to happen but there's probably just with the transition

natural it's just going to decline for a moment. Yeah as a new business owner is

getting their feet wet in the business and kind of ramping up revenues understanding

it you know kind of ins and outs of it all again it's always easier to ask for a

loan before you need it so if you know we did did a loan and then we come back

and oh my Oh my God, six months, we're not gonna make payroll this week. Well, you

know, have not really, you know, great news for the banker and all that, then it

puts them in a little more desperate situation. So that's why we try to cross that

bridge on the front end of it to say, okay, well, let's run through the scenario,

see what that looks like. - So you would advise somebody that is kind of thinking,

you know, they're about to buy this company and they're thinking, okay, what other

things do I might need to look at a loan for. Okay, that might be an option.

I don't think I need it, but it might be an option. So what kind of steps in the

process do you really go through before they say yes,

I need that kind of loan? - Yeah, absolutely. So yeah, I mean, we'll just have

those conversations with them. Again, we'll kind of run our own analysis. We've got

kind of your capital formulas, if you will, it's, and it's unfortunately, it's all

historical. You can, you know, try to calculate a little bit more off projected cash

flow needs. Um, but again, it's okay. Hey, the, if, you know, your revenues are at

5 million right now historically, but you know, what happens if it, if it, if it

dips or, you know, on the other side of it, what happens, you know, again, we want

to, want to grow to $10 million. Okay. Well, you're going to have to hire more

people and, and do you have to go into into another facility at least that there's,

there's a lot of kind of upfront costs, you know, everybody, that's probably one of

the biggest things I hear from, uh, from a lot of small business owners is like,

you know, Hey, we started up, uh, you know, XYZ business and I'm really good at

that. Well, 80 % of my time is just going and collected receivables and trying to

keep up with cash flow and that becomes such a huge piece of it. So we, we try

to alleviate that, uh, that issue obviously on the front end of it. And, uh, Again,

it doesn't cost you anything to have it out there necessarily outside of initial

closing costs. You only pay interest on the outstanding balance. So again, better

have that out there, better safe than sorry, if you will. Brandon, one question, I

know over the last few years we've had really high interest rates, right? And

hopefully those are going to start coming down here, but we've seen a lot of deals

that have had seller financing as part of the financing, right? How does that affect

or change the options for business owners? Yeah, absolutely. So the SBA has actually

done a big favor. Again, from a government program, at the same point, the SBA has

done a good job and really tried to make it

advantageous for the borrowers. Again, kind of crazy to see a government entity that

actually does what they said they're supposed to do. Wow, you're complimenting a

government agency. Wow,

to cut that from the podcast when my political career is over now.

But this is probably for the best anyways. But yeah, so I mean, yeah, obviously

interest rates and all that, hopefully, you know, Jerome Powell kind of helps out a

little bit and make it a little bit easier on the borrower. Quite honestly, even

the bank side of things, it's, it's been by design a little more challenging over

the last, you know, year and a half, two years now since we've been been raising

some interest rates and trying to lower that demand for for financing but on the

other side of that is you know you do have some seller financing options that are

can be beneficial to both the seller to the buyer and even the bank so certainly a

lot to kind of dive in through that but one of the changes that the SBA did come

through that helps the seller. In the past, they wanted the seller financing to be

fully on full standby. So it can accrue interest, but it doesn't want the buyer to

pay anything back to the seller until the SBA and the bank gets paid back. So,

you know, you could look it out over 10 or 25 years. Well, that's, you know, that

doesn't help me out as a seller necessarily, unless we to get desperate and need

that last 20 % to get the deal done. But now the SBA allows the borrower,

we basically underwrite that to make payments to the seller under a note.

So we may subordinate that note officially, but again, that allows the sellers like,

okay, hey, I'm fine selling the business for 80 % of the value today. I'll collect

that and I'll just put on a five your note with the buyer and allow them to come

up with, you know, maybe another 10 % and that way the borrower only has come up

with with the remaining 10%. So quick kind of note on that piece, if it we are

able to use that as equity within the deal, if it is on full standby, if it's

not, then it's kind of just a whole piece of the puzzle.

Yeah, so again, so it can accrue interest, but for it to count as equity, you're

not allowed to make any payments to the seller at that time. So it gets pushed all

the way back loaded till basically the loan is paid off. And that again,

just to clarify, I guess that only counts it as equity for our deal. So quickly

kind of hit on SBA. So the bare minimum SBA loan requires is 10 Typically,

you know, obviously the more you put down the better it is for banks and and you

know goes into more of a strength I'd say typically we look more in the 15 % range

and then You know, maybe even 20 % depending on the deal ever obviously every deals

on its own a little unique, but the

10 % we the only time I typically see that is if there's real estate the collateral

is really solve. You kind of have to check basically all the boxes off of

everything fits really well. If not, I'd say the 15 % range is probably a good

expectation for a lot of the buyers and borrowers to understand.

But again, so if you're a little bit short on that, well, let's look at some

seller financing and see, you know, maybe there's everything's always up for your

negotiation. So maybe there's a way to still get there on that piece of it. Well,

that was really helpful. Anything before we wrap up, Brandon, that you would add

just as far as expectations for options, financing options for business owners? I'd

say maybe just to kind of wrap up, I mean, it's some of the key things that we'll

look for the bank. Obviously, cash flow is paying. That's the way that any

traditional bank will look at deals is, "Okay, what's the cash flow business?" Even

on a projected base. So, if it's a startup or even if it's been losing some money,

okay, well, let's get some projections, see what that looks like. And, you know, if

we can justify what, you know, and kind of measure out what we think they'll

achieve, then that's what we basically underwrite too, is the cash flow today, or

what the future cash flow will look like. Obviously we'll look at the collateral,

that'll dictate a lot of the type of loan that we get you into.

And then, you know, we'll We'll look at really the personal strength from a

guarantor standpoint and then their experience. I think that sometimes goes a little

bit kind of under the radar a little bit is how important that is for banks.

If you've got John Doe coming in and off the street and said, "Hey, I want to buy

into

roofing business." Like, "Well, okay. What's your background? Have you done And if

not, then, you know, tell me how you think you're going to be successful this and

you really have to try to justify it. So, yeah, I think that's one thing that,

you know, obviously, we obviously love for it to be a good fit and same thing for

y 'all that, you know, you're fitting the buyer and seller to work, you know,

if the business isn't successful, then the bank's not successful. So, we need that

to work out. So it sounds like there are three main things that the bank initially

really focuses on, right? And one is the cash, right? Cash king,

right? Cash flow. Number two is the collateral. And then number three is the buyer.

And really the capability of the buyer that the bank believes that this buyer's

going to be successful, right? And so, yeah,

That's great feedback because, you know, it's it's something where I think I I think

I I

Read somewhere recently where it it was It was hey,

it's not it's not The business is worth what a buyer is willing to pay. It's it's

more about The business is worth what a buyer is able to play to pay,

right? And and and And so it's about buyer capability and it's also about the

business. And is it, is it bankable, right? I mean, can you, can a buyer go attain

financing for this? And so, you know, we're, we,

that's super helpful inside. I know I appreciate that for sure. - Absolutely,

absolutely. And not say all this. I mean, there's obviously plenty of banks and all

that. There's two little pieces. So if you are looking through getting an SBA loan,

a big piece of that is making sure the bank is a preferred lender. And really,

that's just a timeliness standpoint. What that does is basically once we get our

internal approval, we go to the SBA and say, hey, you know, we go to their

website, put in some information, and then we basically get a loan number back. If

they're not a uh, Linda, they're what's called a general partner and the bank does

their underwriting and they ship it to the SBA They do their own underwriting and

that could just drag out the process That's my knock on the government. They're not

the most efficient quick process Man gonna praise them and then knock them down in

the same in the same episode. Here we go

Yeah, so I think that's pretty critical piece, but then obviously just talk to talk

to your banker Obviously that every every every deals unique, every situations, you

know, there's plenty of experience in what you guys do and what you've seen. Same

thing with the bank side of things, but certainly don't hesitate to pick up the

phone and just kind of talk through, hey, I've got this situation. Let's kind of

figure out a way, get creative and fit it inside the box. So that's the value we

bring to it. - That's great. Well, Brandon, thanks so much for joining us today.

Andrew, thanks for jumping on again. That's all the time we got for today. And that

wraps up another episode of Integrated Insights with ICCG. Be sure to subscribe and

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