SBA-backed lenders, asked for business acquisition financing, are particularly interested in the adjusted net earnings or cash flow produced by the company to be purchased. The loan officer wants to make sure there will be enough income for the new owner to make those loan payments. But the ability of a business to generate sufficient funds to support the debt may not be obvious. The financial reports are likely to reflect the seller’s interest in lowering taxable income, rather than show all of the money actually received by the seller.
To get his loan application approved, the borrower needs to know how to interpret the financials so a loan officer can understand the actual cash figure that will be available for debt service. And that means knowing where to find all the company’s earnings in its operating figures. Some of the clues include:
Treatment Of Discretionary Expenses With Business Acquisition Financing
Interpreting a profit and loss statement to show all of the cash that can be available to a new owner requires understanding how discretionary funds--those listed on the seller’s statements--might be allocated. The discretionary category includes money set aside for replacement of hard assets (depreciation) and for “writing off” the cost of intangible assets (amortization). Payments for interest and taxes also belong in this category. These expenses are discretionary because the choice of how to allocate them is specific to the needs of the individual owner.
For example, the seller might deduct sums from earnings to allow for depreciation and amortization, but the buyer may want to use that money for payment of principal and interest on obligations incurred to purchase the business.
Add Back Personal Expenses
Some expenses shown on a business profit and loss statement might more accurately be described as personal expenses. The company paying the seller’s life and health insurance premiums could, instead, help retire purchase debt owed by the buyer rather than covering her insurance needs. Other dollar costs paid by the business, providing benefit to the owner and not necessary to the operation of the business, can include magazine subscriptions, membership fees for social organizations, and automobile expenses.
While it should seem obvious to most people that spending for personal items doesn’t really add to the costs of doing business, this is a fact that may be overlooked by a loan officer; one who is inexperienced or in a hurry because of a large workload. That’s why the buyer--or perhaps a knowledgeable loan specialist representing the buyer--needs to make sure to explain every relevant entry in the business books when they are being scanned as part of the loan application review.
One-Time Costs Can Be Addbacks
And there are business expenses incurred by the seller of a business that reduce the stated income, but won’t have to be paid by the new owner. That’s the situation, for example, when purchasing new equipment or leasehold improvements that are not placed on the depreciation schedule. Settling a lawsuit with a cash payment or expanding into adjoining space are other examples of non-recurring costs that won’t impact the earnings of the company under its new ownership the way they reduced the income generated by the business when the seller was owner.
But It’s Risky To Get This Wrong In A Business Acquisition Financing Request
If the buyer is not entirely knowledgeable about how to restate earnings, it’s best to engage the services of an experienced business purchase financing advisor, so the information provided for a lender’s review for business acquisition financing is entirely accurate. That write-off of auto expenses, for instance, may be an expense that can be added back to earnings, but only if the owner’s car is not used in operating the business. Trying to convince a loan officer that a listed business expense will not be incurred by the purchaser can be counter productive if it isn’t true.
And it would be a mistake to add back the cost of the bookkeeper with the argument that payments to the seller’s family member for that service is not an expense that will be incurred by the new owner. In fact, the bookkeeper may be replaced under the new ownership, but the company still might need that service and it will represent a legitimate expense. It’s not an addback of a personal item.
SBA-backed lenders, when asked for business acquisition financing, are particularly interested in the company’s provable adjusted net income and cash flow. They want to make sure the money will be there for the new owner to meet the loan repayment obligation. That’s why it’s important for a prospective borrower to make sure all actual cash generated by the business for its owner is identified when the company’s records are being examined by lenders or financial institutions.
About The Author: For over 25 years Peter Siegel, MBA has provided niche business purchase financial advisory and loan placement/brokerage services with SBA Loans, Retirement Plan Conversions, Hard Money, Note Restructures, etc. He assists with financing for: Business Purchases, Business With Real Estate Purchases, Franchise Resale Purchases, New Franchise Purchases, Pay Off Existing Seller Notes, Partner Buyouts, Employee Buyout. Peter Siegel can be reached direct toll free at 888-983-1632 regarding getting professionally pre-qualified, advisory & loan placement services.