The flagship of The Small Business Administration's programs to support small businesses is the SBA 7(a) loan guaranty program. The program was designed to encourage lenders to provide loans to borrowers that might not otherwise obtain financing on reasonable terms and conditions. Under this program, the SBA will guarantee 75% for loans greater than $150,000 with a maximum loan amount of $5 million with reasonable interest rates. This is a viable option for the average person looking to acquire their first business or an existing business looking to grow through acquisition. This loan is so popular that in 2021, the SBA approved 51,856 7(a) loans totaling $36.5 billion.
A large part of the success of this program was the relatively low-interest rates for the past 10+ years. This time last year, the average SBA 7(a) fixed rate was between 9.25% and 11.25%. Currently, the average fixed rate is between 9.75% and 12.75% and is expected to increase shortly. The wiggle room in the rate is typically negotiated between the borrower and lender and is subject to the borrower's creditworthiness, potential acquisition target, and term, amongst other factors. You'll notice that the rate increase is not too significant, and you may ask why this matters in an M&A transaction. And the answer is since the cost of capital is going up, the price of the business must come down, right? The target acquisition must generate enough monthly cash for the borrower in order to service the debt (bank loan). Sellers will point out: why should I suffer a price decrease because the borrower must pay more in interest than they did a year ago? Buyers will point out that they would love to give more to the business. However, they are subservient to the guidelines of the lender and SBA. This issue will only magnify in the coming year as the federal government seeks to ease inflation by raising the prime interest rate, which the SBA 7(a) program is aligned with.
So what is happening in real-time? Currently, we have a few buyers that are going through the SBA 7(a) program to acquire businesses that we are representing. Historically, many of our sellers liked when a buyer was utilizing the SBA program because of the terms. The program provides the borrower with 90% of the deal value in cash to purchase the business at closing. Since the majority of sellers want to walk away from a transaction with the most amount of cash in their pocket, this was very appealing. Currently, there seems to be a rush to acquire businesses that qualify under the SBA 7(a) guidelines, and one could make the assumption that it is due to the increase in interest rates. Buyers want to lock in the lowest rate possible since they could be paying the loan off with interest for the next ten years. We are not seeing sellers reduce their price expectations just yet. However, as I pointed out previously, as the cost of capital continues to increase, when will sellers have to accommodate? Will they even have to accommodate the SBA buyer or just hold firm and wait for a buyer that is not utilizing the program? Will these rates increase prejudice against potential buyers? Increasing interest rates could ultimately have an inverse effect on what the SBA 7(a) program was founded upon: “to provide loans to borrowers that might not otherwise obtain financing on reasonable terms and conditions.” I guess reasonable terms and conditions are open to interpretation in these current market conditions.
We are also noticing that the current deals that are going through the SBA 7(a) qualification seem to be dragging on, with countless additional questions that are being asked prior to approval. I asked Rod Rodriguez with Live Oak Bank, the nation's largest SBA-approved lender, about the current temperature with the SBA 7(a) program. Rod said that they are seeing the same volume of borrowers as they did last year, which is no surprise since last year was a historic year for M&A for a multitude of reasons (pent-up demand from Covid and low-interest rates). He is also seeing sellers standing firm with their price expectations; however, the average size of the deals is smaller than the previous year. Buyers may have to bite the bullet for a while and pay more in interest as a “cost of doing business” in the current M&A environment.
No matter if rates go up, down, or sideways, there will also be a market for transactions. Compromise ultimately gets deals done, and it looks like this year will be no different.
Americas: Sam Smoot at +1 (813) 898 2350 / Smoot@BenchmarkIntI.com
Europe: Michael Lawrie at +44 (0) 161 359 4400 / Lawrie@BenchmarkIntl.com
Africa: Anthony McCardle at +27 21 300 2055 / McCardle@BenchmarkIntl.com
ABOUT BENCHMARK INTERNATIONAL:
Benchmark International is a global M&A firm that provides business owners with creative, value-maximizing solutions for growing and exiting their businesses. Benchmark International has handled over $8.25 billion in transaction value across various industries from offices across the world. With decades of M&A experience, Benchmark International’s transaction teams have assisted business owners with achieving their objectives and ensuring the continued growth of their businesses. The firm has also been named the Investment Banking Firm of the Year by The M&A Advisor and the #1 Sell-side, Privately Owned M&A Advisor in the World by Pitchbook’s Global League Tables.