If you’re a self-funded searcher that gets a business under LOI, congratulations are in order. It’s easy for folks in the ETA ecosystem, whether it’s prospective investors, existing owners, or other advisors, to downplay this with a “now the real work begins!” 

Fair enough. But in today’s market it’s harder than ever to get a strong deal under LOI. So I’ll be the one to say congratulations – because it’s worth taking a moment to celebrate. And after that celebratory moment, and a deep breath, you should then ask: “How do I position this deal most favorably to lenders and investors?”  

That’s where we can help. At SMB Loan Support, we’ve witnessed hundreds of acquisition entrepreneurs start a search, secure a deal, and then figure out how to position that deal in the most favorable light. This article focuses on lenders, who think very differently than investors. Below are two of five ways to make lenders fall in love with your deal.

The remaining three ways, plus the full article, will be published next Wednesday, November 5.

The best buyers can not only describe what happened in a company’s financials, but why it happened. In other words, they understand the story behind the numbers. 

As a buyer, it’s easy to get caught up in the multiple of earnings you are paying. You might frame a deal as “TTM EBITDA is $X, and I have the deal under LOI for 3.9x.” Sounds great.

But too often we see buyers who haven’t really examined the last three years’ results and can’t thoughtfully explain what’s driving revenue growth, gross margin expansion (or compression), and, ultimately, cash flow. 

Consider a hypothetical: A buyer finds a business right in the sweet spot for a self-funded searcher: $750K EBITDA at a 4.0x multiple ($3.0M purchase price). Further assume a popular 80/10/10 structure – 80% SBA debt, 10% Seller Note, and 10% equity. The final sources and uses of funds might look something like this:

We made some assumptions on the Seller Note terms, but assume for our illustration that annual debt service is $465,000. The debt service coverage ratio (DSCR) appears healthy. $750K divided by $465K = 1.6. But now consider the last three years’ results. 

This should raise some questions for our buyer. Should you expect gross margin to be 50%? Or closer to 60%? Why did margins weaken in 2023 and 2024, only to rebound in the TTM period? What’s “normal” for the industry? How does what’s normal compare to our target? How did EBITDA margin improve in 2024 despite gross margin falling to 49%? 

The best buyers aren’t afraid to be the “dumbest” person in the room with the Seller and ask what’s driving the results. Sometimes there are good answers. Other times, the Seller doesn’t quite know. In either case, the numbers must back up the Seller’s story. Why are you confident the same issues won’t happen to you when you take over?

One of the most common mistakes I see first-time buyers make is failing to look at the last three years’ results – especially DSCR by year. That’s a sure-fire way to put your deal in jeopardy. 

Finally, you must tie your analysis to the tax returns. Build from Net Income to adjusted EBITDA (the numerator that lenders will use in calculating DSCR): 

The headline multiple isn’t what determines whether your deal works. A three-year, tax-return based view of EBITDA and DSCR tells you what valuation and structure actually work.

If you want help with pre-LOI structuring (including levers like Seller Note terms or two-note structure) to improve DSCR, we offer complimentary pre-LOI consultations at SMB Loan Support. Feel free to schedule a consult with us here.

If you’ve looked at brokered deals, you’ve undoubtedly seen a wide range of claimed “addbacks.” What makes SBA financing difficult is deciding whether a lender will accept those addbacks. 

Here’s a question we get all the time at SMB Loan Support: can you tell me exactly what addbacks lenders will accept? Rather than give you a list that categorically declares which addbacks are a “yes” and a “no,” it’s far more helpful for you to have a framework for evaluating addbacks. Here’s the framework we find most useful:  

So, let’s test our framework with the most common addback: the Seller’s salary. Say there is a husband-and-wife team, where husband runs the day-to-day and pays himself $150K while wife does bookkeeping at $75K. Both are retiring. What is an acceptable addback to cash flow?

Let’s run through our three questions. 

   Husband’s Salary: $150,000

+ Wife’s Salary: $75,000

- Buyer’s Salary $125,000

- Bookkeeping Firm $25,000

Total addback $75,000, subject to test #3.

Can you prove it? Two common ways to validate owners’ comp in SBA deals is via (1) a line-item in the tax returns for “Compensation of Officers,” or (2) a W-2 / 1099. If neither of those work, be ready with a strong explanation and documentation. 

Other common addbacks (health insurance, personal vehicle expenses, retirement contributions, one-time broker prep fees) still need the framework. For example, if you add back the Seller’s health insurance, you should only add back the difference between the Seller’s cost and your post-close cost.

Harder claims include generalized “personal” travel/meals, one-time failed marketing campaigns, or costs tied to a fired employee “no longer needed.” Once you run them through the framework, you see why they’re problematic. Are they really non-recurring? You’re never going to attempt to grow the business and perhaps strike out on some marketing expenses? And can you really verify that you don’t need an employee’s role anymore to generate the historical earnings? How do you prove these things?

A few other practical tips:  

Want to make sure your deal stands out to lenders? Book a free consultation with Drew to discuss your specific scenario.

This is Part 1 of a two-part series. Stay tuned for next week’s email featuring the final three tips and a link to Drew’s full article.