Business Lending

Applying for a business acquisition loan can be challenging for someone who has not been through that process before. If you have a home mortgage or finance a car purchase, you know that the value of the property pledged has to equal the amount of the loan at least. But when it comes to buying a coin laundry, restaurant, or any other small business, it’s almost impossible to come up with an accurate value. Lenders are just as interested in understanding the amount of the cash flow of the company. The money that will be used to pay off the debt and help them know if the enterprise might be worth financing. For the smart buyer, this means demonstrating clearly that the business is generating enough funds that the new owner will be able to make the payments on time. Making that point with the lender involves more than just showing the firm’s past profit and loss records. It’s likely the books don’t reveal the total, actual cash flow soon to be available to the new owner.

Lenders understand business owners will take advantage of tax breaks to lower reported earnings and reduce the size of payments made to the IRS and the state tax collector. They are informed about add-backs for personal items and non-cash expenses such as depreciation and amortization. Bank Underwriters will not analyze every expense item on a profit and loss statement. Buyers need to be actively involved in the process and explain each expense item that might belong on the bottom line in as much detail as the lender requires. This amount will be the money available for debt service. Recasting the P&L’s should be done when preparing the loan application by including a document that points out items such as amortization, and also does the math. The person evaluating the request should be able to see the amount each add-back contributes to cash flow quickly.

Validating information when requesting a business acquisition loan isn’t a task for someone new to the experience. Get help from a small business loan specialist who understands what add-backs to earnings are legitimate, and which will provoke doubt in the mind of the person reviewing the application. Adding back the expense item called “depreciation,” and calling it a non-cash expense, is a sensible argument provided there is no need to replace fixtures, tools, or machinery in the near future. A loan officer will review and question the condition and useful life of every item on the depreciation list. The borrower should have the right answer. Another way prospective borrowers get in trouble with add back claims on loan applications is identifying as personal expenses, the costs that are needed to operate the business. A loan officer won’t be persuaded that vehicle expenses are all personal. The amount spent can be added back to earnings for use in loan payments when a vehicle is used to make deliveries.

The discussion of cash flow and the requirement that it is sufficient to support loan payments doesn’t mean to discount the need to pledge assets to secure the debt. The degree to which lenders rely on cash flow figures when reviewing a loan application depends on the type of lender. Private investors and non-institutional money sources, mostly concerned that there is more than enough collateral, including assets of the business and other borrower property to secure the loan. If the borrower defaults, they’ll seize and sell whatever assets are needed for them to recoup their loss. This contrasts with SBA-backed lenders who are particularly interested in the viability of the business to be purchased. They don’t want to take ownership of the collateral used to secure the loan. So they look particularly closely at the past performance of the business and try to make a conservative prediction about whether it will produce enough funds for the owner to take care of debt service. Whoever the lender, the entrepreneur seeking a business acquisition loan, needs to make sure the company’s provable earnings will be sufficient to pay off the loan. And then explain it adequately to the lender.

David Dawud
DRE # 01987818
Remax One
Commercial & Business Services
11141 Tampa Ave
Northridge, CA 91326
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