Lending myths and misperceptions

There are numerous lenders offering conventional and SBA (or both) acquisition loans in the wealth management industry. Conventional and SBA programs are different, and so is each lender’s requirements and abilities from each other. 

While there are certainly some absolutes and many dependable rule-of-thumbs, lending is very much handled on a case-by-case basis. There seems to be a lot of lending white noise, myths, and misperceptions regarding wealth management M&A lending for loans under $5 million. 

Here is a list of the 20 most common ones we encounter.

Myth: A cash down payment is usually required from the borrower

Most every loan AdvisorLoans has facilitated funding for over the last few years did not involve a cash down payment from the borrower. It’s rare for us to see a conventional lender require a down payment on any of our loans. 

For SBA loans, there is a 10% equity injection requirement, but most advisor borrowers are able to satisfy this requirement with the business value of the clients they already own and do not come out of pocket with cash. Back-of-the-napkin, an advisor with $100K in revenue that receives a $200K valuation (at just a 2 times multiple) would be able to purchase a $2 million acquisition without a cash down payment. If a buyer’s practice values over $500K, then a $5 million (minus SBA fees) acquisition loan could qualify without a cash down payment.

Myth: Lenders require a portion of the purchase to be seller financed

While every lender of course would “prefer” a portion or the purchase be held in a seller note, this isn’t required for most of our loans over the last few years. Most conventional lenders will have a general rule in requiring a portion such as 10-25% be seller financed. Depending on the deal and the borrower, some lenders will make exceptions. Most of the conventional loans we have closed over the last three years did not have seller financing involved.

With SBA loans, the SBA does not have a rule (since 2018) that requires seller financing for any portion of an acquisition loan. Of the SBA acquisition loans we have closed over the last year for 1099 producing advisors, 90% were 100% bank financed (no down payment and no seller financing).  

Sellers of course “can” seller finance any amount of the purchase with a promissory note but the note will have to be subordinated to the bank.

The most common circumstance we encounter that results in a bank requiring a portion of the acquisition payment to be on a seller promissory note is when the deal doesn’t cash flow strong enough.  

Myth: The seller always needs to guarantee an employee advisor’s loan

For SBA loans, the seller is not even allowed to guaranty the acquisition loan that is being used to purchase their practice. We frequently do SBA acquisition loans for W-2 service advisors who are ready to buy their clients, or the entire book of a senior advisor or practice principle. These loans are done without a guaranty from the seller.

For conventional loans, a strong guarantor would be required if the bank is willing to do this. In this situation, the conventional lender is essentially underwriting the seller more than the buyer.

Myth: Business valuations are only required on the seller’s practice

When using the SBA equity injection “assets other than cash” option to avoid a cash down payment, the lender needs to justify the value of the buyer’s practice to meet the equity injection requirement. In most acquisition scenarios with SBA 100% financing loans, third party valuations on both the buyer’s and seller’s practice will be required. The conventional lenders we work with seldom require a valuation on the buyer but we know there are conventional lenders who are now requiring it.

Myth: All SBA lenders are essentially the same

Perhaps the biggest myth about SBA lending is that all SBA lenders are essentially the same since they are all offering SBA backed loans.  While the SBA rules are the same for all, the SBA lenders providing the loans, can widely vary from each other. 

Each SBA lender has their own set of additional qualifying criteria, policies, and requirements that is stacked on top of the SBA rules and requirements. The SBA also defers many of their requirements to the lender’s standard policies, which also widely differ lender to lender. 

The differences in SBA lenders are so significant, that it is not uncommon for an advisor to be rejected by one SBA lender but get approved with a different SBA lender.

Myth: Advisors with previous bankruptcies can’t qualify

There are many cases in which an advisor with a previous bankruptcy can qualify for both a conventional or SBA loan (typically SBA). It will depend on the scenario. If the BK was ten years or more ago, with a good story, is usually not insurmountable to get around. However, there are some conventional and SBA lenders whose internal policy is to not approve any borrower with a previous BK regardless of how many years has past. We’ve closed more than a handful of loans when the advisor had a previous bankruptcy.

Myth: I can have multiple acquisition loans with multiple lenders at the same time

While this may be true in rare cases it is certainly not the norm. Lenders will file a UCC-1 blanket lien against your advisory business for all current and future business assets, including receivables. Virtually every lender, in most every loan scenario, will require that they are in first lien position for a term loan. It is unusual to have two different acquisition loans simultaneously active with two separate lenders.

When an advisor has an acquisition loan in place with one lender, it is very unlikely a different lender will provide a different loan and be in second lien position behind the first lender. By far, the easiest scenario for an advisor on a multi-year acquisition spree, is to utilize the same lender. If a different lender is needed (or wanted) for your second (or third) acquisition loan, the new lender will almost always refinance your existing loan and roll it into the new loan. This is a common practice that we frequently facilitate for advisors.

Myth: I can always refinance my SBA loan with a different SBA lender later

This is technically possible under certain conditions but not very common. The SBA makes it difficult for SBA lenders to poach existing SBA loans from each other. There are also additional considerations if the SBA lender sold the guaranteed portion of the loan in the secondary market (which most do in this space). However, if your current SBA lender is declining a new loan that is needed, and another SBA lender would be willing to do it, then that lender can submit to the SBA to see if the SBA will allow it. In all cases, it is the SBA that has to approve this.

However, conventional lenders generally love to refinance SBA loans into conventional loans. As long as the loan is over 12 months old (ideally two years) and the deal cash flows at the minimum ratios the conventional lender has, these are typically the easiest conventional loans to get done.

Myth: A conventional loan is always better than an SBA loan

There are scenarios when conventional loans would overall be better than an SBA loan, but the opposite is also true. Often times, the combination of the borrower and acquisition deal structure will dictate qualifying for only one program or the other. But for the borrowers who qualify for both, it depends on the specific scenario. 

Conventional loans are typically the better loan option when it is paramount that personal property collateral is avoided (sometimes required with a SBA loan), if the loan purpose is a partial equity acquisition (prohibited for a SBA loan), if an earn-out structure is needed (also prohibited for a SBA loan), and if the loan is north of $5 million. 

SBA loans are typically better when the borrower needs to maximize the loan dollars they can qualify for, when the borrower is acquiring a much larger practice than theirs, and when the borrower is W-2 and/or doesn’t own any (or enough) client AUM already.  

These are high level generalities and with each borrower/loan situation there can be other reasons where one program is “better” than the other. When we consult with our clients we walk through why one option may be better than the other based on the advisor’s specific scenario.

Myth: I can’t get a acquisition loan if I can’t qualify for life insurance

Both conventional and SBA lenders require life insurance (typically 10 year term) for the amount of the loan. For SBA loans to wealth management advisors, life insurance is needed for any amount of the loan that isn’t fully collateralized by property. Generally, for conventional lenders, life insurance for the amount of the loan is mandatory. We have a conventional lender that will allow for personal collateral to be substituted for life insurance, but most conventional lenders won’t do this.

We can typically get around a borrower who is ineligible for life insurance by utilizing a SBA loan. In this case, an insurance rejection letter and continuity/succession plan is required. 

Myth: It’s always preferable for the seller to finance a portion of the purchase

If 100% bank financing is available to the buyer/borrower, this is usually preferable to the buyer (and seller) than having part of the purchase seller financed. It comes down to how the seller financing would be structured. 

Most seller notes are structured from 2 to 5 year terms compared to the 10 year bank loan term. Depending on the  percentage of the purchase being seller financed, the seller loan payments can have too much of a negative impact on cash flow.  If the seller note is only for a few years, borrowers will often prefer the additional cash flow generated from lower payments from the longer amortization of the bank loan. 

If the seller is willing to provide a 7-10 year term note at a much lower rate than the bank, and doesn’t mind subordinating the note to the lender, then seller financing can be ideal for the borrower.

A seller note isn’t required to satisfy client transition attrition concerns. An escrow agreement/account can accommodate clawback provisions.

Myth: The lender will always be willing to do my next acquisition loan

This is not always true and it completely depends on the lender. Lenders familiar and just as importantly committed to the wealth management M&A space are more comfortable with lending to advisors who are strategically focused on inorganic growth through acquisitions. Of course, the subsequent acquisitions have to cash flow and make financial sense. 

Some lenders who are dipping their toe into wealth management M&A are not comfortable with doing multiple acquisition loans in the same year, regardless of how good of a deal it is. Some won’t approve a second loan until at least a year (sometimes longer) after the first loan was closed. If the lender only offers 7 year term loans then this could be a sign that they aren’t committed fully to advisor lending and may not be comfortable with multiple, sizable loans to the same advisor.     

If your intent is to complete multiple acquisitions that will need bank financing, over the next few years,  it is imperative that you speak to the bank directly about those goals. If the borrower and lender aren’t on the same page, the advisor can get “trapped” with a bank that limits the frequency of ongoing acquisition funding.

Myth: Rate is always the most important factor of my loan

Considering that both conventional and SBA lenders are generally going to be within 25 to 75 basis points of each other for the same loan and program being equal, there isn’t a “drastic” difference in rate between lenders that are focusing on the wealth management industry. Of course, the lower the rate the better but the cost of the loan isn’t usually a nigh and day difference between most of the lenders focused in the wealth management industry niche.

For example, this is the difference a 25 basis point increase makes to the monthly payment for a $1 million loan on a 10 year term:

6.00% = $11,102 mth payment

6.25% = $11,228 mth payment

6.50% = $11,354 mth payment

6.75% = $11,482 mth payment

7.00% = $11,610 mth payment 

The more important factors than rate for most borrowers will be the lender’s qualifying criteria, their expertise and experience in wealth management M&A, how dialed in the lender is with process and support, if there will be collateral requirements, what the lender’s long term commitment is to the advisor lending space, the willingness to approve and fund multiple acquisitions, the cash down payment and seller financing requirements and flexibility, and the lender’s ongoing required covenants imposed on the borrower. 

Myth: SBA loans have a lot more ongoing covenants than conventional loans

The opposite is typically true. While there is a bit more paperwork in getting an SBA loan, there are fewer ongoing covenant requirements after the loan closes than with most conventional loans. With an SBA loan, the primary ongoing covenants consist of the borrower providing an annual tax return and updated personal financial statement. 

All conventional lenders we are aware of will also require annual tax return and financial statement. Some will require more than this including semi-annual or annual AUM and revenue reports. Some may have ongoing minimum cash flow requirements that are monitored. The borrower may have to provide P&Ls on a quarterly, semi-annual or annual basis and then have to explain to the lender if cash flow dips below the required bank’s ratio. If a borrower goes below the ongoing free cash flow (or debt service coverage ratio) minimum in a conventional loan covenant, and stays below, they would be technically in default.

Myth: Seller financing would be required if there is going to be a claw-back provision

Using a seller promissory note to claw back against higher than anticipated attrition is still happening, but not required, for most acquisition loans today. Instead of a seller note, an escrow agreement is typically utilized in 100% financed loans for the clawback provision. 

Increasingly over the last few years, the escrow agreement has been replacing the seller note to deal with clawbacks. The escrow structure allows for an amount to be set aside in escrow and disbursed according to the time tables and clawback formulas laid out in the agreement. The seller often prefers this since they know the money is in an account waiting for them.

The escrow agreement spells out when the funds will be distributed and the clawback formula that will be used to calculate the distributions. If the retention provisions are met, then all of the proceeds will be delivered to the seller. If the clawback provision is triggered, then the seller receives the adjusted amount and the balance is usually applied to the buyer’s loan balance.

Myth: I can use the 10% equity I own in the firm I am acquiring for the SBA’s equity injection requirement

Sometimes this is true. Most advisors will have enough business value for the clients they “own” to satisfy the SBA equity injection requirement. The advisors that don’t are cases when the borrowing advisor is currently a W-2 employee, is a non producing partner, or doesn’t have enough individual client production to value high enough to meet the SBA equity injection. For advisors who have “equity” in their firm of course they will want to utilize it to meet the 10% equity injection rule. However, in many cases the owned equity may not qualify to satisfy the SBA’s 10% equity injection rule.

SBA lending does not allow for a partner to do a partial equity purchase or equity buy-in, but does allow for a partner to buyout all of the equity of another partner. When buying out a partner, the SBA’s 10% equity injection is still required but the rules how the 10% can be satisfied differ. The partner can pay 10% as a cash down payment or use their current equity in the business they are buying out their partner from. 

However, the SBA requires for this equity to be able to qualify, the partner buying out (the borrower) needs to have been actively involved in the business for the last 2 years and needs to have had the same (or higher) level of equity ownership over the last 2 years. The SBA does not mandate how this has to be verified so most SBA lenders will require not only the partnership agreement but also to see it reported on tax returns or Schedule Cs as well. The SBA also requires that the business balance sheets for most recent year and quarter must reflect a debt-to-worth ratio of no greater than 9:1 prior to change of ownership. 

Myth: If I get an SBA loan I will have to use my house as collateral

Not exactly. The SBA does not require borrowers to have equity in a house/property to qualify, but if the borrower does have such equity an SBA lender may have to use it for collateral if certain conditions exist. 

The SBA does not require lenders to collateralize the loan with personal property if the borrower has less than 25% equity of fair market value. The SBA does not have personal property collateral requirements for loans under $350K and defer to the SBA lender’s standard policies for loans this size. Some SBA lenders have internal policies that will cause them to require the property with 25% equity as collateral even if the loan amount is under $350K.

It is an SBA requirement that for loans over $350K, if you have 25% equity in any personal real estate, including residential and investment property, that it be required as collateral, up to the full loan amount. This means in some cases, multiple properties could have a junior lien applied to it by the lender.

For SBA loans considered marginal or borderline, the bank may require the property as collateral even if the SBA isn’t mandating it. For example, if a loan is a 1.15 DSCR, 625 credit score, and had a BK 7 years ago, the lender may require to collateralize available property.

If an advisor is considering an SBA loan for more than $350K and has 25% or more equity in their home then getting a HELOC in place can bring the equity available to under 25% and therefore avoid a junior lien being placed on their home by the SBA lender.

Myth: I won’t be able to get an acquisition loan for under $250K

This is true for conventional lenders (usually) and most SBA lenders lending to wealth management advisors will also have a minimum loan amount requirement, usually at or around $250,000. However, we can get qualified SBA acquisition loans for as low as $100,000 because we essentially press our lenders into doing them. If an advisor is trying to build their business with a series of smaller partial client acquisitions, we can usually help.

Myth: The borrower receives the acquisition funds from the bank and then pays out the seller

For both conventional and SBA lenders, the funds due to the seller are wired directly to the seller at closing. Any amount initially withheld from the seller for a clawback provision is held in escrow by either the lender or wired directly into a third-party escrow. Lenders will not wire these funds to the borrower to for the buyer/borrower to then pay the seller. The only funds that would go directly to the borrower is any working capital that was included in the acquisition loan. 

Myth: The acquisition loan needs to be a different loan than the office building I’m also purchasing

The SBA 7(a) program allows for acquisition loans to be combined with the loan to purchase owner occupied (51%) commercial real estate like an office building/condo. The big advantage here is that the term of the entire loan (including the acquisition portion) can extend beyond the normal 10 year term. 

If the real estate portion is at least 50% of the loan amount then the loan term can go out to 25 years. If the real estate portion is less than 50% the combined loan can extend out from 10 to 17 years. While there are no pre-payment penalties for standard SBA 7(a) ten year term loans, when terms extend to 15 years or more, there is a 5/3/1 prepayment penalty (5% year 1, 3% year 2, 1% year 3).