One of the more frustrating situations in a business sale happens when everyone agrees the business is good, the buyer wants it, the seller accepts the offer, and then the lender starts raising concerns.
Owners are often caught off guard. The company may have been profitable for years. It has employees, customers, equipment, a solid reputation, and enough income to provide the owner with a comfortable living. From the seller’s chair, there may be no obvious reason financing should be difficult.
Business acquisition financing runs on a different set of questions than the ones an owner has spent years answering successfully. A lender has to determine whether the business can reliably support acquisition debt after the sale, under new ownership, while still covering normal operating expenses and leaving enough room for the unexpected.
That difference between a successful business and a financeable transaction is where plenty of otherwise solid deals start getting complicated.
A Good Business Can Still Be a Difficult Loan
Buyers naturally spend time thinking about opportunity. They may see room to increase prices, improve marketing, add a salesperson, expand into another part of Florida, or introduce services the current owner never pursued.
Those ideas may make the acquisition more attractive to the buyer, but lenders put much greater weight on what the company has already demonstrated.
Historical tax returns and profit and loss statements matter. So do balance sheets, existing debt, owner compensation, the consistency of earnings, and the support behind any adjustments being made to reported income. SBA 7(a) loans can be used for changes of ownership, but the lender still has to be comfortable with the transaction and the borrower’s ability to repay the debt.
A buyer may be convinced that revenue will grow 20 percent after closing. The loan still has to make sense without depending on that growth materializing exactly as planned.
Sometimes the Books Don’t Tell the Same Story as the Owner
This is one of the issues we regularly encounter when evaluating businesses for sale.
Many owners work with their accountants over the years to legitimately reduce taxable income. The company may pay certain owner-related expenses, provide benefits, record depreciation and interest, or carry other expenses that need to be examined when determining what the business actually provides to one working owner.
That’s why financial recasting is such an important part of a business valuation. At Green & Co., we typically look at several years of financial information and identify appropriate adjustments to arrive at owner benefit or seller’s discretionary earnings.
A lender is looking at many of those same numbers from a different perspective. An add-back that makes sense to a buyer or business broker still needs enough support for the lender to accept it when calculating repayment capacity.
That becomes especially important when a large portion of the business’s presented earnings comes from adjustments rather than income clearly visible on the tax returns. The lender may accept some adjustments, question others, or calculate usable cash flow differently than the seller expected.
Clean records make that conversation considerably easier.
SDE and Lender Cash Flow Can Produce Different Answers
Sellers and business brokers frequently talk about seller’s discretionary earnings, or SDE. It’s a useful measure because it helps show the total financial benefit available to one owner-operator before certain discretionary or owner-specific expenses.
SDE is also commonly used when valuing smaller owner-operated businesses.
The number a lender ultimately relies on for underwriting may be different. Lenders have their own requirements for determining which adjustments are supportable and how much cash flow is reasonably available to service the acquisition debt. They’re also considering the terms of the proposed loan rather than looking only at what the current owner has historically earned.
Imagine a business marketed with $300,000 in SDE. If a meaningful portion of that figure comes from adjustments that the lender won’t fully recognize, the cash flow available for underwriting may be lower. Add a substantial annual loan payment and the transaction can become tight fairly quickly.
The seller’s SDE calculation may still be reasonable for valuation purposes. The lender simply has another job to do with the numbers.
Understanding that difference early can prevent a buyer and seller from negotiating a deal around cash flow that the bank later calculates differently.
The Purchase Price Can Create More Debt Than the Business Can Carry
A company may generate plenty of income for its current owner and still struggle to carry the debt required to buy it.
Consider an owner who has operated the company for 20 years and has little debt associated with acquiring the business. The business produces a healthy income, and a buyer agrees to a purchase price based on a reasonable market multiple.
After closing, that same stream of earnings may have to support a significant acquisition loan.
The business hasn’t suddenly become worse. Its financial obligations have changed.
This is where valuation and financing have to be considered together. A company can justify a certain value based on its earnings, industry multiples, comparable transactions, and buyer demand while a particular financing structure still places too much pressure on available cash flow.
There may be ways to restructure the transaction, adjust the buyer’s equity contribution, include seller financing, or address another piece of the deal. Those conversations are much easier before the parties have spent months working toward a closing date.
Lenders Care About the Quality of Earnings
Two businesses can generate the same annual earnings and look very different to a lender.
One may have hundreds of customers, relatively consistent monthly sales, stable margins, and detailed records going back several years. Another produces the same profit but relies on a handful of large projects, with revenue moving significantly from one year to the next and one customer accounting for a substantial percentage of sales.
Both businesses may be attractive acquisitions. Their future cash flow carries a different level of uncertainty.
Customer concentration can get attention during underwriting. So can declining margins, large swings in revenue, a recent strong year following several weaker years, or an unusual expense structure that requires considerable explanation.
Florida businesses can have their own operating pressures depending on the industry. Rising insurance expenses can materially change margins in some companies, while labor availability and wage pressure can affect service businesses that depend on finding and keeping skilled employees. Local demand may be strong because of continued population growth and in-migration, but a lender will still want to understand the expenses required to produce that revenue.
Consistency makes historical earnings easier to rely on. When the numbers have changed significantly, documentation explaining why becomes much more important.
Owner Dependency Creates a Different Kind of Financing Risk
Financial statements can look excellent while another issue is sitting outside the spreadsheet.
What happens when the seller leaves?
In some businesses, the owner holds the important customer relationships, does all of the estimating, approves every major purchase, handles difficult technical work, recruits employees, and carries years of operational knowledge largely in their head.
That arrangement may have worked extremely well for the current owner. It creates a transition question for the buyer and the lender.
The greater the seller’s personal role in producing the company’s earnings, the harder it can be to determine how those earnings will transfer to a new owner. A strong transition plan helps, but businesses usually become easier to sell when important knowledge and relationships already exist inside the company rather than depending entirely on the person who’s leaving.
This is one reason owners planning a future sale should think about delegation well in advance. Documented processes, capable employees, shared customer relationships, and clear operating systems can improve the quality of the business a buyer is stepping into.
The Buyer Is Part of the Financing Decision Too
Sometimes sellers spend months improving their business for a sale and assume that finding an interested buyer solves the financing side.
The lender is underwriting the buyer as well.
A profitable company paired with a buyer who has limited liquidity, credit problems, insufficient relevant experience, or very little cash remaining after closing can still be difficult to finance.
Relevant operating or management experience may also affect how comfortable a lender is with the transition. A buyer doesn’t necessarily need to have owned the exact same kind of business, but stepping into a specialized company with no related background can raise reasonable questions about how the operation will perform after the seller leaves.
Liquidity matters for another reason. Buyers need enough money to complete the purchase, but using every available dollar for the acquisition can leave the new owner exposed immediately after closing.
Our business buying guide walks buyers through the broader purchase process, including evaluating a business, structuring the transaction, and preparing for ownership.
Working Capital Matters the Morning After Closing
Purchase price gets most of the attention during negotiations. The business still has to open the next morning.
Depending on how the transaction is structured, the seller may retain cash and accounts receivable generated before closing. The new owner could immediately be responsible for payroll, inventory, insurance, rent, fuel, supplies, marketing, and other expenses before enough new customer payments arrive.
That timing matters.
A business can show healthy annual profits and still require significant working capital during a normal operating cycle. Seasonal companies can be particularly sensitive, as can businesses that complete work well before customers pay their invoices.
A lender evaluating the transaction has to consider what the buyer’s financial position looks like after the purchase funds have been wired. If the acquisition consumes nearly all of the buyer’s available cash, a normal slowdown or unexpected expense during the first few months can become a much bigger problem.
Good deal structure considers the purchase itself and the capital required to run what was purchased.
Seller Financing Can Sometimes Help Make the Structure Work
When conventional or SBA-backed financing doesn’t cover the transaction in a workable way, seller financing may become part of the discussion.
Under a seller-financed structure, the seller agrees to receive a portion of the purchase price over time. The buyer may use a combination of personal funds, third-party financing, and a seller note to complete the acquisition.
There are situations where that flexibility helps bring the numbers together. A seller note can reduce the amount that needs to come from another lender, broaden the pool of buyers able to pursue the business, or help address a gap between the negotiated price and the financing available.
Seller financing also means the seller is taking credit risk after the business changes hands. The buyer, repayment terms, security, priority relative to other lenders, and default provisions all deserve careful consideration with the appropriate legal and financial professionals.
We cover the structure and some of the tradeoffs in our seller financing guide for Florida buyers and sellers.
Sellers Can Improve Financeability Before They Ever Meet a Buyer
Owners who expect to sell within the next few years have an advantage: time.
Start with financial records that are easy for an outside party to follow. Revenue should be traceable, expenses categorized properly, and discretionary or owner-specific costs clearly identifiable. If an unusual event affected one year’s results, keep the documentation that explains what happened rather than relying on memory several years later.
Look at the operation itself too. If customers only know the owner, start introducing other people. If important procedures exist entirely in someone’s head, document them. Review employee responsibilities, contracts, leases, equipment records, licenses, and other information a buyer will eventually need.
Then look at value realistically.
A seller understandably wants the strongest price the market will support. Knowing what the business is likely to be worth, how buyers will view its cash flow, and how an acquisition might reasonably be financed gives the owner a much better starting position than choosing an asking price first and figuring out financeability later.
Preparing this way doesn’t guarantee a lender will approve a future buyer. It does reduce the number of questions that have to be answered in the middle of a transaction, when time is tighter and both sides already have something at stake.
Don’t Wait for a Loan Problem to Discover a Sale Problem
Financing trouble often reveals issues that were already present but hadn’t mattered much to the current owner.
Maybe the financial records require too many explanations. The business depends heavily on the seller. One customer has gradually become too important. The asking price produces a debt load that leaves very little room in the cash flow. Or the buyer simply isn’t financially strong enough for that particular acquisition.
Finding those issues after an offer has been accepted can mean renegotiating terms, changing the financing structure, reducing the purchase price, looking for another buyer, or losing the transaction altogether.
Owners with time before a sale can address many of these areas gradually, without trying to transform the business during due diligence.
Moving Forward with Confidence
A good business deserves a sale process that reflects how buyers and lenders will actually evaluate it.
At Green & Co. Business Brokers, part of preparing a company for market is looking beyond the asking price and considering the quality of the earnings, the documentation behind them, the likely buyer pool, and how a transaction may come together financially.
If you’re considering selling and want a realistic starting point, request a free confidential business valuation. It can help you understand what your business may be worth today and identify issues worth addressing before a buyer and lender are sitting at the table.