A 100% bank financed acquisition loan is when all of the purchase price is secured through a bank loan. The borrower doesn’t make a cash down payment and the seller doesn’t finance any portion of the purchase.
100% bank financing started to become a mainstream option in wealth management MA in 2018, when the SBA modified their rules for acquisition loan requirements. The significant rule change replaced the 25% seller financing policy with a 10% equity injection requirement. The SBA provides 3 ways the 10% equity injection requirement can be satisfied: cash, assets other than cash, and allows (not requires) up to 5% to be satisfied with standby seller financing (standby means no payments can be made during the term of the SBA loan).
For independent advisors in the wealth management industry, the “assets other than cash” can be based on the value of the advisor’s business or book. If the borrower’s business value is high enough compared to the business being purchased, then the borrower is able to satisfy the equity injection requirement with assets other than cash.
This provision is ideally suited for wealth management MA. As a general rule, most advisors with $350,000 in recurring revenue would have a business value high enough to satisfy the equity injection rule for the maximum $5 million SBA 7a acquisition loan amount. An advisor with $150,000 recurring revenue can typically get a 100% bank financed deal for up to $2 million.
Since this SBA rule change, we saw a steady decline in the portion of acquisition loans with a seller financing component in 2018. Most 2019 acquisitions loans we facilitated were 100% bank financed. In 2020, the vast majority of all wealth management MA SBA loans AdvisorLoans have closed are 100% bank financed.
There are many ways to structure an acquisition deal. For context, AdvisorLoans only works with acquisition deals that need external financing. Of the loans we have processed and closed over the last year, most acquisition deals that require less than $5 million in financing generally look like:
After 12-18 months, retention of revenue is measured and the clawback formula stimulated in the escrow agreement is applied. A minority of deals will have longer retention periods or multiple clawback periods.
How Escrow Replaces a Seller Note for Clawback Provisions
Escrow agreements are typically utilized in 100% financed loans for the clawback provision. The seller will typically receive most of the purchase price at closing wired from the lender.
The portion set aside (usually from 20% to 50%) for the clawback provision, is wired into the escrow account. Some lenders will handle the escrow internally and others will require the borrower to find their own escrow firm. In either case, there is an escrow agreement between the buyer, seller and escrow agent.
The agreement spells out when the money will be distributed and the formula that will be used to calculate the distribution(s). If the retention provisions are met, then all of the proceeds will be delivered to the seller. However, if after the look back period the agreed upon attrition delta is triggered, then the seller receives the adjusted amount and the balance is “clawed back” and usually applied to the buyer’s loan balance.
The Key Reasons Why Seller Financing Has Diminished in Wealth Management MA
In 2018, the SBA changed their acquisition equity injection rules. Before the change, the SBA used to require the seller to finance 25% of the purchase price on a two-year standby note. The new equity injection rule no longer requires (but allows) seller financing. However, if the seller does assist the buyer with seller financing 5% of the equity injection requirement with a seller note, the note now has to be on standby for the life of the loan.