What Your Business Sells For May Just Be an Amortization Schedule

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Many owners who own their building have already decided what to do with it. They are keeping it, leasing it to the buyer, and treating it as the part of retirement that keeps paying after the business is gone. It is a reasonable plan, and one usually made on tax and estate-planning grounds, which is where it belongs.

What almost nobody realizes is that the same decision affects the price a buyer can finance for the business, and under the SBA rules taking effect October 1, it does so more directly than before.

In an SBA-financed transaction, you are not really being paid a multiple of earnings. You are being paid whatever an amortization schedule allows the buyer to finance, subject to valuation, equity and the rest of the underwriting, and the multiple falls out the back end. That has always been roughly how this end of the market works, but the new SOP writes nearly every input down, which turns much of the answer into arithmetic you can run yourself before a buyer ever sees your financials.

Coverage has to clear 1.25 on an Initial Acquisition, tested against your last fiscal year or the average of the last two. For an Initial Acquisition, once the Business Purchase Price reaches $3 million, excluding owner-occupied commercial real estate acquired with it, an independent Quality of Earnings report becomes mandatory, conducted for the benefit of the lender rather than prepared by or for you or the buyer, and the lender must use the earnings from that report in the coverage test, so your add-backs are a proposal until somebody with no stake in the outcome agrees with them. Projections have to be evaluated but expressly cannot be used to satisfy coverage. And the amortization on a change of ownership cannot exceed 10 years, with one exception, real estate, which is the whole reason your building matters here.

Say your company produces $800,000 of defensible cash flow before occupancy cost, after a market salary for the job you actually do, and pays $120,000 a year of rent to the LLC that holds your building, which would appraise around $1.2 million. The business-only deal gets tested on $680,000, and using an illustrative 9.75% interest rate, a 10-year amortization and 10% buyer equity, that supports roughly $3.8 million of purchase price before working capital, transaction costs and other uses of proceeds. You keep the building and you keep the rent.

Put the building in the deal and two things move at once. The lender can add the rent back into the historical coverage calculation, so the cash flow being tested can return to the full $800,000, and because the real estate portion is the only part allowed to run past 10 years, out to 25, the weighted-average maturity on a blended loan gets longer. At approximately $3.9 million for the business and $1.2 million for the real estate, the weighted-average maturity is about 14 years, and a $5.1 million transaction with 10% buyer equity requires roughly $4.6 million of acquisition debt before working capital, transaction costs and other financed uses, which under these illustrative assumptions clears both the coverage math and the $5 million cap on a Standard 7(a) loan. The business price barely moved, but instead of leaving the closing with roughly $3.8 million and a lease with a stranger, you are potentially converting another $1.2 million of real estate to cash, and in this example the coverage margin improves as well.

The $5 million cap is worth understanding in its own right, because on larger transactions the limiting factor can stop being cash flow and become program structure. A larger combined deal may require more buyer equity or a separate real estate financing structure, potentially including a 504 loan, which the new rules expressly permit.

None of which is me telling you to sell your real estate. That decision runs through your own tax and estate-planning picture and may argue the other way, since a sale can create current tax consequences and change the estate-planning outcome, and plenty of owners want that rent check in retirement and are right to want it. The point is narrower than that. In an SBA-financed deal, the real estate decision is not separable from what a buyer can finance for the business, and if you settled that question years ago without modeling the alternative, you settled it with half the information.

Treat the figures above as illustrative rather than as a quote, since working capital, closing costs, other uses of proceeds and the interest-rate assumption move all of them. The financeable number is also a ceiling rather than a floor. The business valuation has to independently support the business price, and if the agreed price exceeds the valuation, debt cannot simply make up the difference, so the excess has to come in as additional equity or the deal has to shrink.

If it were my company, I would spend an afternoon with my accountant building the number from the bottom. Look hard at what your adjusted cash flow survives in front of somebody with no reason to be generous, apply the coverage requirement and the amortization, see what price falls out, then run it again with the building included, and compare both against the number you have been carrying around in your head.

If the number in your head is the bigger one, better to learn that now than in month four of a process, which is usually when owners find out.