Showing Add Backs To Get Large SBA Loan Business Acquisition Financing
Requests for large SBA loan financing are invariably met by a key question posed by lenders. They want to know if the business to be acquired will produce enough income for the new owner - the borrower - to be able to repay the SBA loan over a ten to twenty-five year period (depending if there is real estate attached with the business purchase).
And, as many buyers and all loan underwriters know, the tax returns and profit loss statements on the business that the seller provides, may not represent all of the actual earnings the seller has collected throughout the year and an accurate picture of add backs that will be counted toward useable annual cash flow to satisfy the buyers loan debt service and living requirements. That's when it's necessary for the lender to understand the actual earnings expected by the proposed borrower, and it's up to the borrower to explain where the money will come from to support the loan's monthly principal and interest payments.
Depreciation Might Not Be A Legitimate Add Back
The practice of treating depreciation as a non-cash expense is based on the assumption that the depreciable, or economic life of a capital asset is considerably shorter than its useful life. In other words, it's usually assumed that the $50,000 value of a manufacturing machine, for example, can be written off in three to five years, while it actually will be used on the production line for ten years or longer. And typically, the money theoretically set aside specifically for the purpose of replacing that machine will not be needed for several years. That’s why the depreciation figures assigned to that piece of equipment are considered non-cash costs that might appropriately be addbacks - funds available for other purposes, including the payments needed to get out of debt. This sum might not be a legitimate addback, however, if the equipment is nearly ready to be "retired," and the depreciation fund will actually be needed to replace it. In that case, the depreciation entry is not a "phantom" expense that can be added to the owner's actual earnings, but a real cost that will need to be paid.
When Personal Expenses Can't Be Used to Pay for Business Acquisition Loans
Also problematic is the attempt of a prospective borrower to convince a loan underwriter that certain expenses shown on the business P&L are actually for the seller's personal benefit and those amounts can be added back to earnings. That may be the case in some situations, but a loan applicant needs to be sure that the claim is accurate. SBA lenders are not going to audit the business being reviewed, so distant line items may not be accounted for in an analysis.
One common example is the cost of leasing, servicing, fueling and insuring the seller’s vehicle. If the vehicle is not needed for the business, it may be correct to argue that expenses associated with it can be added back to earnings. But the vehicle costs cannot and should not be added back if, for example, the new owner will need a car or truck to make deliveries.
Another personal expense that shouldn't be added back could be country club dues. Yes this looks like a non-business expense, unless the lender digs deeper and learns that the new owner will rely on the relationships cultivated at the club to sell the company’s products and services. Especially if that has been an important marketing strategy for the seller.
Help Available To Buyer/borrower In Recasting Earnings Statements
By correctly identifying seller expense entries on business tax returns and business P&Ls, that can be added back to earnings and used for debt service, buyers often can strengthen their application for large SBA loan financing. But they can run into trouble if the addbacks (for identifying annual cash flow) aren't chosen correctly, or explained effectively.
About The Author: Peter Siegel, MBA is the Founder of SBALoanAdvisors.com and is a specialist assisting clients with obtaining large SBA loans ($500K to $5M) for "large" small business (with or without real estate) purchases, debt refinancing, partner buyouts, working capital, expansion purposes, etc. You can reach Peter direct regarding getting professionally pre-qualified, pre-flighting a deal, or submitting a package for underwriting at 888-231-2182 or 925-785-3118.
