Inside the SBA’s new rules – Nokturnal

Small Business Administration loan expert Shannon Hay talks about the changes to the SBA’s new SOP around lending, and what they mean for accounting firms and their clients.

Transcription:

Dan Hood (00:03):

Welcome to On the Air With Accounting Today, I’m editor-in-chief Dan Hood. With all the talk about private equity money flooding into the accounting space to help with firms’ burgeoning capital needs. It can be easy to forget that there are other sources of capital for your firm and your clients. One of the most tried and tested to those is the small business administration, which recently changed the rules around its loans in some very important ways. Here to talk about all that is Shannon Hay. He’s an expert in SBA lending and loan programs, particularly in the accounting space. Shannon, thanks for joining us. 

Shannon Hay (00:29):

Thanks for having me, Dan. It’s a pleasure. 

Dan Hood (00:31):

It’s great to have you because as I say, the SBA has been around for a gazillion years, and I won’t say that it gets overlooked, but there’s a lot of talk about the money coming in and then this remains a big source and worth talking about. So maybe we can start with the basics. For those who aren’t familiar with SBA programs, can you give us some background on those? 

Shannon Hay (00:47):

Yeah, yeah. Well, the small business administration has been in place for a number of years, actually over 50, and it is a government guaranteed lending program. It gives the opportunity for small businesses to obtain capital in places where they normally wouldn’t have, and it’s meant as a supplemental program. In the days, lenders have always really been collateral focused. What the SBA administration does, it gives a government guarantee to the banks if they underwrite appropriately so that now they’re able to lend to small businesses in cashflow scenarios or in goodwill scenarios. So collateral is not as necessarily critical of an element. It’s more about the historical cashflow of the business. The programs are vast and they actually have a lot of what I call runway. The 70 program is a program designed for acquisitions. Primarily. The acquisitions go all the way up to 5 million in limit, and then it’s a 10 year term rates, of course, rates nowadays, and those are always complicated to talk about, but still very, very friendly rates to really make cashflow work in a business acquisition. 

(01:55)

Seven A can also be used for equipment and as well for real estate. And the real estate term is very attractive. It’s a 25 year term, which exceeds most commercial lending, which is generally a 20 year term. And then you have other programs like the 5 0 4, which is designed for real estate as well. And then the USDA, which is a rural program designed for rural cooperatives. Both of those programs not as readily used. And then SBA should also be well known for the PPP program. And then the EIDL program, the Economic Insurance Disaster Relief Programs, both of those are very small business oriented programs and utilized by a lot of accountants. So 

Dan Hood (02:36):

I think it’s clear from your description of those programs why accountants should be interested in it, why accountants and their clients should be interested in the S B A. But I want to turn and get a little more specific and talk about the S B A S O P, which is one of the things where you’re talking a lot of today, there’s a lot of changes to it that were recently announced, but maybe we can start with what exactly is that? 

Shannon Hay (02:55):

Well, sop, it should make it hopefully a little obvious. It’s standard operating procedure for the SBA programs. These are directives and policies that are set forth by the SBA administration. Right. And they’re basically the rules. I like to compare it in the accounting world to kind of like i r s tax code. They put out the rules and then we’re allowed as professionals, lenders to interpret those rules and then apply them accordingly. Obviously that’s a regulated thing and banks are held to those standards, but there’s a difference in SBA types types of lenders. Those that do it often are frequently or have some qualifications with the S O P are called preferred lending providers, and they are basically allowed to underwrite and do SBA A loans without s b a approval or general, what we call general practice, meaning these loans do not have to be sent directly to the SBA for approval. These banks have been approved to do these preferred lending programs without actually any clearance from the sba. 

Dan Hood (03:55):

Gotcha. That’s a very handy thing. Now, recently, the SBA has amended or changed, actually made a fairly long list of changes. I was looking at it recently at an article that you all had written, and it’s a fairly long list of changes, but maybe you can give us some of the highlights of that, because some of them are fairly important and we’ll be particularly of interest to accountants, I think. 

Shannon Hay (04:14):

Yeah, so there’s some changes that went into effect on May 11th that are already impacting loans and how they’re processed today. And some of those are really big for the small business world, but I also think that they’re really big for the accounting world as well. One of the big ones being partial change of ownership. That’s really the high level exciting one for me being an accounting specific lender that I see being just highly beneficial to the accounting world from a transitional perspective, but also to the small business world from a transitional perspective. Previously under the S B A program, a seller, when they sold their business and used SBA A financing had to do a hundred percent transition of that business. They could not retain any ownership, they could not stay on greater than one year in a key man role, and were actually kind of forced to leave the business. 

(05:02)

Obviously, this could impact transitions in goodwill and as well, a lot of things related to regulatory things. If you’re a CPA a or a lawyer or doctor or dentist, there’s naming factors and notifications and you know, think of it from a notification on the I C P A side, or maybe it’s a HIPAA notification on the medical side. If a seller is able to retain some ownership, make it 1% even, I imagine that they’re able to now have a longer transition period. The one year rule kind of goes to the wayside. There’s still key man concerns, obviously with financing and key man operators, that is, that’s still kind of a gray area where banks can make a dissemination as to whether or not they think someone should be a guarantor or not based on their key man operation. But we really think that that’s just a huge benefit, like I said, to not only the accounting world, but to most small business with a lot of goodwill and have a large transitional opportunity. 

Dan Hood (06:01):

I mean, there’s no question that for a lot of deals we hear about mergers and acquisitions. You hear more and more people are expecting owners, previous partners and so on to stay on for 2, 3, 4, in some cases, even five years to manage their transition and make sure the clients come over and all that sort of stuff. So yeah, that would be a huge change, I think, or is a huge change, I should say. It’s already happened. 

Shannon Hay (06:20):

Some other big changes are the way that equity injections or down payments for a simpler layman term, the way that down payments are defined under the program have changed as well. There’s probably a little more gray there and there’s a little more banking discretion, and certain banks can have certain requirements where other banks may not, but it’s really gives more opportunities to sellers to participate with their partners or their buyers in qu equity format. So a, sorry, a buyer might not necessarily have to come up with 10% like they used to in a large deal. So say you’re doing a 4 million or a 3 million acquisition, used to be, you’d have to come up with 400 or $300,000 to do that deal. Now there’s ways that sellers can participate with that. You utilizing a seller node on a partial standby two years is what we’ve defined as the standby roles. If that retained ownership in ways can also be captured that way, it really, it really feels like the sba a administration is really trying to broaden the scope of the program and making it much more available for small businesses. 

Dan Hood (07:30):

I mean, all of these things sound like, I don’t want to say loosening in the sense of diminishing it, but opening it up and making it better, more flexible, more in tune with what everybody needs on the ground situation 

Shannon Hay (07:42):

That very much so. Very much so. Even in the way of supplemental guarantor. So if you had a partial guarantee, someone that wanted to come along to strengthen the deal, they’re not being as stringent with those supplemental guarantors anymore. So they might not necessarily require them to provide a personal financial statement or pledge assets as long as you have a primary guarantor, that supplemental can just come along in a much, I would say, looser way. I mean, I hate to use that terminology. Yeah, 

Dan Hood (08:09):

It sounds like we’re saying, ah, it’s just loose. Who cares? It’s not a free for all people. 

Shannon Hay (08:14):

Well, and that’s the thing that we should asterisk everything here is, it still comes down to banking, underwriting is banks are still going to have to review information, make decisions on risk, and they’ll still use their risk modeling. It just allows for more freedom and for buyers and sellers to make more decisions about what’s in the best interest of the business and what’s the most successful way to transition that business. 

Dan Hood (08:36):

Gotcha. I want to talk a lot more about how this is going to impact accounting firms and what you see at accounting firms is you’re out there working with them on loans. But before we do that, I want to talk just a little bit, just more about the general impact on small businesses. I, I think a lot of, you’ve described how a lot of things, how it’s going to matter, but this, for instance, is this answering a lot of the problems that small businesses were having with these loans? Not problems, but Yeah. Well, 

Shannon Hay (09:04):

It’s barrier of entry, right, Dan? So if you make the barrier entries easier for small businesses or you know, make the on-ramp easier for small businesses, you just get more availability in the program. Even things like life insurance requirements have changed a little bit. Leases aren’t necessarily as stringent as they used to be. There be a real cost, strong cost for landlord waivers, landlord lien waivers, those, there’s just a lot of more flexibility that a bank has. Now, I still, again, think a bank might drive down to some of those things as requirements as part of what they see as the risk profile, but it does allow the business owners to make more decisions and have more flexibility in those decisions. Just wider in scope and more available uses is what I see. 

Dan Hood (10:00):

That’s what we want from our loans. Excellent. Up to a certain point, again, no, of course for us, for a certain value of loose, not too loose, not too, 

Shannon Hay (10:07):

Yeah, mom, there is a worry. Those things that expand too quickly then tend to contract too quickly too. So 

Dan Hood (10:15):

Let’s be clear, this is not the mortgage industry in 2007, this, that’s not what we’re talking about. No, 

Shannon Hay (10:20):

Excellent. No, I know this is really small businesses, the backbone of American economy and giving them capital in ways that’s easier for them is just a good thing for us all around. 

Dan Hood (10:32):

Yep, absolutely. Excellent. Alright, as I said, we’ve talked a lot about how this is beneficial for small businesses. I want to dive a lot more deeply into what it means for accountants and what they’re going to do with it and all that sort of stuff. But first we got to take a quick break. Alright, and we’re back with SBA lending expert, Shannon. Hey. And we’re talking about how the small business administration and how it’s easily recently changed some of its rules. As we said, not to make loans easy to get, that’s not the point, but to make them more broadly available to the small business of America. It’s the backbone of the economy and we’re maintaining high standards obviously in lending, but we’re also lowering the barriers to entry for qualified businesses. We’ve talked a lot about the impact that this will have on small businesses, and you pointed out some things that will make it obvious why this would be attractive to accountants. I mean, obviously they want to know about these changes to the rules so they can advise their clients about these loans as a source of funding, but there are also some pretty obvious implications for accounting firms themselves in terms of how they’re going to use these loans and maybe we can dive a little bit into that. 

Shannon Hay (11:30):

So again, it, I’ll drive back to the partial change of ownership point. Now, a seller can retain or make decisions about what portions of their business that or an accountant can make decisions about what portions of their business they may want to disseminate in some way or change their equity position. So it’s like, for example, maybe a portion of your business is no longer you, you’re wanting to scale back a little bit. You’re wanting to get rid of maybe your test work or maybe it’s your personal tax returns that you just don’t want to deal with those anymore and you want to sell those. It used to be under the S B A program, if the buyer was using S B A financing, there had to be a hundred percent change of ownership. There was no partial dissemination. Now you have this capacity where sellers can retain ownership within their own firm sell, have a partial change of ownership. 

(12:23)

And so it also opens up now, and a whole nother subject is ES ESOPs, employee stock ownership programs. There’s ways to create greater succession planning within a business using S B A financing. I talk a lot about when I’m educating accountants on succession plans within their firms, there’s a lot of creative ways that you can, I wouldn’t say gift equity, but reward equity to your partners or to who you see as your successors, which then can create an on-road to S b A financing to capitalize your buyout in the end. So the partial owner that has five, 10% ownership, that counts as equity towards their acquisition of the remaining portion of the firm. But here’s the good news. The remaining portion of the firm doesn’t have to be the other 90%. Now the remaining portion of the firm can be 80% or 70%. I would always encourage sellers if they’re trying to push away from personal guarantees or being responsible for those loans that they would want to keep that, push that ownership below 20%, because speed does still require that any owner greater than 20% will have to personally guarantee the SBA loan. But that is still allow, that’s allowable now too, where if you were receiving proceeds from the sba, you weren’t allowed to participate you in any way, shape, or form going forward. Now that’s completely change with this partial ownership rule. So I really think it just opens the doors for accounting transitions. 

Dan Hood (13:46):

Yeah, well, and just greater flexibility in this sort of thing that seems to be, we’re seeing this in a lot of different areas. This obviously one example of just greater flexibility in the kinds and shapes of deals that you can arrange. If you can get lending with this amount of variety and this amount of flexibility, it just opens up your options in a lot of ways that just weren’t available. Well, as just said before May, whatever, whenever in May they came out. Yeah. May 11th. Yeah, May 11th. May 11. There you go. Yeah. So on May 10th, you had far fewer options and May 11th suddenly got a lot. I think, well, as one of the reasons I’m mentioning all that is because at least my next question, which is there is more funding and more varieties of funding now than there have been, I think for accountants for a long time. Particularly, as you said, the entry of private equity and now we’re seeing family office firms and wealth management firms buying accounting firms. So there’s money coming in from a couple of different angles. Maybe can you give us a sense of how this compares with some of that, or how you see, are they serving different needs? Are there different reasons why one is better than the other? And obviously I think we know which you might think is better, but 

Shannon Hay (14:50):

Well, of course I’m a little biased to the SBA program. Right? 

Dan Hood (14:54):

A little 

Shannon Hay (14:55):

I to say a little bit about what I do on a daily basis, Dan, I only finance the acquisition of accounting firms, so I only work with accountants. So I get the opportunity to see the market trading, and I’ve kind of been waving the banner for a decade now that there’s goodwill value in an accounting firm and that a seller deserves cash or equity for that value at the closing table. As far as other programs, conventional lending is also an opportunity out there. I would say that there are some conventional lending programs in the accounting world, but also obviously there’s conventional lending in the broad based small business world. Generally what you see, the difference in that is that those terms are shorter, right? So the terms are generally going to be seven years rather than 10 years, which then just causes cashflow strain, which can make some deals more difficult to do. It’s the same on the commercial real estate side, as we talked about a little earlier, is that there’s that 25 year and 20 year difference between SBA and commercial lending that those five years can really make a difference when it comes to your monthly mortgage payment on that real estate. 

Dan Hood (15:59):

Sure, absolutely. This is great. This is, as I say this, there’s so many more options for accounting firms and for their clients in these areas and more need for I think capital than there has been for a long time. So it’s great to know that all these options are out there, Shannon. Hey, any final thoughts on anything people should you think people should definitely be bearing in mind as they think about their capital needs or the S B A loan loan programs or anything like that? 

Shannon Hay (16:22):

I mean, again, just reminding advisors right to that. The SBA program is not, not your grandma and grandpa’s s b A program. It doesn’t have nearly the difficulties I would say that maybe has been branded with the red tape is somewhat been taken away. And I would say that working with a preferred lending provider that does a lot of SBA loans is usually your best bet and ask those questions. It’s always important to know who you’re working with, what their area of expertise is, and what their experiences is in these types of loans. It’s important element. 

Dan Hood (16:56):

Excellent. That’s great advice, Shannon Hay, thank you so much for joining us, 

Shannon Hay (17:00):

Dan Hood. Thank you so much. It’s been a pleasure, 

Dan Hood (17:02):

And thank you all for listening. This episode of On the Air was produced by Accounting Today with audio production by Kevin Parise. Rate or review us on your favorite podcast platform and see the rest of our content on nokturnal.com. Thanks again to our guest, and thank you for listening.