Reader,

I thought you might find this story interesting. It's relevant on a number of levels.

I recently had a deal in progress for $1.5mm on a building supply business, which included the business' real estate. The buyer - "John Doe" - was savvy and had experience in buying & selling businesses. He had recently sold a prior business which he had owned for only 15 months.

When I asked why he sold it after only 15 months, he replied, "Because I was offered $200,000 more than what I had paid for it." He made $200,000 in 15 months on that business.

He had seller financed a large portion of that deal. He also transferred cash obtained from an EIDL loan he had received on the business.

He essentially sub-leased the EIDL loan at closing. The cash in the account transferred to the buyer. But the loan stayed in John Doe's name. The buyer paid John on the seller note. John took some of that and paid on the outstanding EIDL loan. Creative, though questionable.

Fast forward to our deal. Both parties had agreed on price & terms. The bank liked the deal. The buyer had experience and cash in the bank.

However, as the lender reviewed the buyer's PFS (Personal Financial Statement) they noticed a liability in the form of an EIDL loan.

The bank was utilizing an SBA 7(a) loan to finance this deal. This loan is commonly referred to as an "SBA loan". Ninety-nine percent (99%) of small business deals $5mm or less are financed by an SBA loan.

SBA requires there cannot be an outstanding SBA loan balance post-closing when obtaining an SBA loan to acquire a business. The SBA requires all such loans to be paid off. In fact, small business deals are often structured as an asset purchase.

The buyer acquires the business free & clear of any existing debt. Their only debt at closing is to the lender. In exchange, the seller keeps the cash in the business checking account.

In our deal the buyer had an existing SBA loan, so the lender was not going to issue another SBA loan until the EIDL was paid off. Technically, one is supposed to pay it off at the sale of the business anyway. But in the world of Small Business M&A one never knows.

The lender required the buyer to pay off the EIDL balance. The buyer, however, could not pay off the entire loan. That cash had already been given away. So the deal came to a screeching halt. With no financing the deal evaporated.

This is a new hurdle since COVID. Government money flooded small businesses. Many of these businesses still have existing funds from PPP, EIDL & a host of other programs. Some of these loans were forgiven, some were not.

As a buyer, seller, broker or advisor it is critical to understand the liabilities of a buyer and seller - especially if a bank loan is being pursued. Knowing on the front end potential hurdles can save a deal from collapsing on the back end.

Just ask me, I know from experience!

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Sincerely,

Shep Campbell

Deal Street Digest Editor