What Lenders View As Red Flags About A Seller’s Business
Banks will vary in how they analyze the seller’s practice or client list, what they view as “red flags”, and in how they deal with a red flag when discovered. When a bank analyst is reviewing and underwriting an acquisition loan there are common red flags most all lenders will have regarding the practice or clients their borrower is wanting a loan to purchase.
Common red flags include:
Cash Flow
Cash flow is king when it comes to advisor acquisition loan approvals. Different lenders have different minimum free cash flow levels they require. Most lenders will have a minimum DSCR (Debt Service Coverage Ratio) from 1:1.25 to 1:1.75. If the deal doesn’t cash flow, the deal doesn’t get financed by a bank.
State of Financials
If the financials are handwritten out or is so basic it appears only seconds were spent creating it, it will give the lender pause. If there are back tax issues that have resulted in previous year tax returns not being filed, the process can be further delayed until straightened out.
Too Fast of an Exit
It makes a bank nervous if the seller wants to close ASAP and doesn’t want to stick around to assist in the client transfer process. Except for scenarios such as death and disability, banks would prefer to see at least 6 months of seller’s commitment in client transfer.
Too Many Add-Backs
Some add-backs are always going to be included but banks don’t like a ton of add-backs. Getting the financials cleaned up before a sale is helpful in maximizing what the bank will recognize as free cash flow.
Premium Pricing
SBA lenders will only lend up to the business valuation price. Any amount over this would have to be paid by the borrower or put into a seller note that is subordinated to the bank. Some conventional lenders can lend for an acquisition amount that is higher than the valuation if the LTV (Loan To Value) is still within their parameters (usually 70% to 80%).
Client Concentration
If more than 50% of the seller’s assets and/or revenue comes from the top 10 clients then the bank may have concern about client concentration risk and want to see that the buyer has accounted for this risk specifically in a retention/claw-back provision.
Transactional /Commission Revenue
Many lenders will discount some or even all of the commission revenue and only focus on recurring revenue for their cash flow analysis.