Financing the Transaction
One critical aspect to transactions in our industry is the ability for an advisor to secure capital in order to consummate a practice acquisition. In most transactions a large portion of the acquisition cost is structured through the combination of an earn-out, promissory note payment, employment agreement, or cash payment. Given the uncertainties inherent in purchasing another practice and the necessity to keep the seller involved in the transition process most transactions involved, at least to a certain extent, contingency payments. These payments are normally based on the future revenues or profitability of the practice and keep the seller motivated to insure a successful transition. However, most sellers will also require a significant up-front cash payment as part of the deal structure. These up-front payments often range from 20-50% of the purchase price. Historically one of the biggest hurdles for buyers is to come up with the up-front cash necessary to facilitate the transaction.
Fortunately advisors have several sources of financing they can utilize to help them with the cash needed to fund the transaction. Some buyers rely on personal loans, collateralized brokerage loans, business lines of credit, or even home equity loans to raise the necessary cash. Others choose turn to the Small Business Administration (SBA) to provide the guarantee needed by the lending institution to finance the cash payment.
For those of you who don’t know, the SBA loan program is a government-sponsored loan program created to encourage, assist, and protect small businesses. SBA loans are available from SBA-approved financial institutions and carry an SBA repayment guarantee to protect the lender against default. Typical guarantees range from 50-90% of the loan amount. Keep in mind, however, this guarantee does not protect you or your business. If you default on the loan, the lender has the right to take your collateral and/or pursue legal action.
The SBA loan has a price. Generally the SBA charges a guarantee fee ranging from 2% to 3.75% of the loan depending on the amount. In addition, an annual service fee of .5% of the outstanding guaranteed portion is charged.
Generally SBA-loans carry an interest rate based on the prime rate plus 2.75%. Given the nature of the loans this rate is often significantly lower than the interest rate on most businesses or personal loans obtained directly through a bank.