Stephen has closed over $200M in SBA loans for e-commerce business acquisitions. Find out why SBA Loans are so popular and also why buyers and sellers should have an SBA lender on their deal team even before buying or selling a business.
- How Stephen started in e-commerce lending
- What’s changed in this time?
- Will SBA loans change with different economic cycle
- What the SBA program IS and ISN’T
- Buyer/Seller Pre-approval
- When to sell?
- When to start getting Pre-approval
Phone: (813) 766-4524
We are live today on Truth About Exits, we have Steven Sphere from e-Commerce Lending. Steven and his team have closed over $200 million worth of SBA loans to help investors acquire online businesses. I wanted to get Steven on the show to talk about transactions from the lender's perspective including a little bit about a deal that we're currently working on that's had some bumps along the way.
Stephen, thanks for joining us here on Truth About Exits.
Coran, thanks for having me.
Stephen, let's start right at the beginning. What got you into lending specifically for e-commerce businesses?
Well about five years ago I had somebody approached me saying listen I was looking at brick and mortar opportunities on the acquisition side and I came across a business that's online. I said, oh, that's interesting. I asked, what kind of business? Well how you go on Amazon and purchase items on Amazon? I said, yes and he said well that's the kind of business I want to buy that I want to sell products on Amazon and acquire a company that sells products on Amazon. That's kind of how I got started.
Oh wow that’s excellent. That's a kind of similar to my stuff. That's awesome and five year sounds like a short amount of time but in this space specifically in e-commerce, a lot has changed in five years. What have you seen change from a lenders perspective over that time, specifically around funding acquisitions?
Well, I think just people are more cognizant of online businesses as it continues to be a larger portion of all retail sales. Five years ago there were a lot of online retail sales going on but not nearly as much as now. As people are more cognizant of that. Our banks, our lenders and everybody's realizing now that not only the here and now but it's in the future and all of the things point towards a larger and larger portion as time goes on of retail sales happening in the online space.
Well, you've got ahead of that really. I know he's speaking to a number of SBA lenders, a lot of them aren't really aware of this space I guess. you've positioned yourself really well there. Is that open market basically for anything that's e-commerce or are you finding that lenders are specific in what they're looking to fund?
I think there are a lot of lending opportunities within the space. It's very specialized. There are a lot of nuances kind of behind the scenes from a lender standpoint. Also a lender really has to understand the space to be able to lend in it. For me things are pretty obvious from a buyer's or seller's perspective, but some other things they're not really aware of that lenders have to look at in financing online businesses. from that perspective it does take pretty sizable expertise and that's what I have.
Okay, excellent. I keep getting asked this a lot from both buyers and sellers in the e-commerce space and also outside as well, that people are expecting the economic cycle to change at some point here in the US and potentially worldwide as well. Do you foresee it to be become harder to do SBA loans if there is a different economic cycle? How do you think about that?
Well, all things are cyclical and you have to be blind to think that a downturn is not going to affect lending because it always does. I feel that lending has tightened up in the last 12 to 18 months, a little bit, especially this year. But there's new business out there, many new opportunities for buyers to acquire companies online. They're vastly more companies online to acquire now than there were two, three, four years ago as and as you put out there earlier this week. But lenders are tightening up a little bit. I think they're being a little bit more choosy in on the buyer's side, especially primarily because ultimately lenders don't want defaults don't want loans to go bad and they're being a little bit choosier as we had probably towards the end of a pretty cyclical boom and had more towards less robust economy.
Sure. A couple of weeks ago we were working on a deal together and we had a couple of bumps at that time. We had a number of phone calls. One of the things you were mentioning was the amount of loans that have been approved year over the year is up but some of the lenders you're working with will pulling back from lending in this space. Could you tell us a little bit more about that? What you would be happy to share publicly off course
Yeah. I think that has more or less to do with this space in the sense that they're scared of the space has more to do with what lenders look at in terms of their portfolio. We do a lot of loans here at e-commerce lending and from time to time we do have one of our lending partners max out on the amount of e-commerce business they're willing to do. I mean that's happened to us a few times in the last year but it's prompted us to also to form new lending partners. Moving forward we're going to be less affected by lenders taking a pause in the e-commerce space because we have increased our table of lenders that we're able to go to for financing.
Excellent. How does that outreach go when you're reaching out to a new bank? Do you have to kind of explain what the e-commerce world looks like for them to be already on board and maybe even lending in the space already?
I think a little bit of both. The biggest thing is generally I look for and I have a lot of connections within the business, I look for somebody who is aware of e-commerce and aware of the lending within e-commerce. It's very rare for us here at e-Commerce Lending to just pick a lender who we really don't know and who really doesn't have any expertise or knowledge within this space. Now there is a lot of expertise I bring to the table but still ultimately the underwriter approving or not approving a loan needs to somewhat have the skill set to be able to know lending within the space.
That makes sense. Okay. You spoke about going out to different lenders and what you do with e-Commerce Lending. Now I know that you primarily do SBA backed loans. Are you looking to increase outside of SBA backed loans in the near future for this space as well?
Coran, that's an excellent question. I always look for new opportunities in lending. The biggest limitation within the space is that when a lender lends in the space, there's really no collateral. There's no, as I like to say, there's no brick and mortar. It's just goodwill lending. It does limit the amount of lending opportunities outside the SBA area or arena. But one thing that we're trying to obtain here at e-Commerce Lending is being able to fund the much larger deals in the deals, what I call the no man's land of $7 to $10 million where they're generally too big for SBA and too small for private equity. We're making strides in that arena to be able to bring that to the marketplace by the end of the year.
Oh wow. That'd be great. We have been talking about this SBA acronym for awhile. For someone that doesn't understand what SBA loans, could you just briefly explain what the SBA program is?
I'll explain what it is and what it is not. SBA lending is the Small Business Administration. They ultimately insure loans that banks do. They do not underwrite the loans. They do not fund the loans. They simply put out guidelines. Pretend they're an insurance company basically a lender will lend based on the SBA guidelines and if the loan was to go bad, the SBA would ensure 75% of that loan. It allows lenders to have a lot higher risk tolerance than maybe a local bank would perhaps doing other types of loans. It's a win-win for everybody. One thing I do need to mention that the default rate within e-commerce lending, meaning within the space of e-commerce is extremely low. It does allow lenders to be even more aggressive within their lending tolerance within the space.
That's awesome. Why are these loans popular? I get that backs the bank, but why is it popular with investors looking to acquire businesses?
Well, if you think about it, let's pretend it's $1MM acquisition and you're an investor who could maybe even pay cash or come close to paying cash or a portion thereof. But imagine only having to inject or only put a down payment of $100K for a $1MM acquisition. The business you're trying to acquire is growing at let's just say 20% per year. Well, that's a 200% return on your investment. I don't know where you or any of your listeners invest but a 200% return on investment is pretty colossal.
Absolutely. Yeah, that's a good way to frame this. Let's dig into it a little bit more. You mentioned down payment or equity injection. In that example of being 10% what does that typically look like as far as what the buyer needs to put down?
Generally and this is depending on the cash flow of the business and the strength of the buyer. Generally it's 10% SBA requires a bare minimum of 10% from zero to $5 million, which is a loan maximum. But lenders have their own, what I call overlays. Most lenders are not going to only require a 10% injection on a $5 million acquisition. That's just not going to happen. Generally the rule of thumb is 10% up to $1MM, in north of $1MM, anywhere from 15 to 20% from the buyer. If you get kind of in the $2MM and up range, not only is there a 20% requirement, but also generally lenders like to see some seller note and honestly buyers like to see some seller note because it keeps the seller interested in a smooth transition and they have a vested interest in the future success of the business or selling.
Hmm. Absolutely it can work as a win-win. Just to circle back to what you were saying there, if you're looking at acquiring a $5 million business and especially if it's an inventory-based business chances of getting approved if you only have half a million dollars in cash is pretty low, right?
It is, yes. Yeah.
Cause you need working capital and you also need more assets to back that purchase. Excellent. Okay.
That's a good point, especially if it's an FBA business where it's maybe a very capital intensive business and we definitely look for post-closing liquidity and also we're able to shore up working capital, the loan to make sure that the buyer has enough runway to be able to scale a business in a pretty quick fashion.
Huh. Excellent. Do you typically look for buyers? I was actually going to go sell-side, but we're talking buy-side. Let's keep going on this line.
When you're looking at the buy-side, we often refer buyers directly to you to get prequalified before coming to talk to us about deals. What do you typically go through with a buyer and does that change the larger the deal gets from the buyer standpoint, the profile like to see is a buyer with obvious liquidity meaning enough money for the injection or down payment in most cases a good a fair amount of post-closing liquidity.
Again, back to making sure that they have enough liquidity for inventory purchases post-closing. We look at that and yes further up the food chain. We go in terms of acquisition price, definitely we look for stronger buyers. We work up that amount at $5MM the profile of a buyer's vastly different than $500K I would say anything above $2MM lenders are looking for direct industry experience. Even if it's not running their own business. It could be that they worked for an e-commerce company, but definitely more on the direct side, above $2MM, whereas south of $2MM indirect experience is fine. We just have to bridge that gap and be able to give the narrative to the underwriter that indeed yes a client does not have direct experience, but he or she has enough indirect experience to continue with the success and the growth of the business that they're acquiring.
Yeah, absolutely. We go through less detailed but similar questioning. When we first start talking with buyers about an opportunity we often see, not often. Occasionally you'll see people come through that definitely have the capital and the way with older by the business but they don't really understand that it's an operating business and they need to manage the business. They kind of look at this and think, oh, it's running without me. That's great. Or that the owner is claiming to work a few hours a week. This'll be super easy. But that's a good point that we dig into as well as who's going to run the business post-acquisition because typically the seller themselves want to get out of the deal. And especially with an SBA backed deal, they need to get out of the deal. They cant be involved for the longer time. Is that correct?
That's correct. Anything beyond 12 months. Right. yeah, that's pretty important to be able to take over the deal. Awesome. Okay, let's talk a little bit about the seller side of the equation. When we're prepping a business for sale, that is US-based to the small business administration as a US government program. They back US-based businesses and they don't unfortunately back acquisitions of foreign entities, entities that are outside the US which was a shame. I wish I did, but they don't. When we're working with a buyer that meets the criteria and we send them over to you for pre-approval, how does that process look like? Also maybe let's step back a step at what is the actual criteria on the seller side?
Well one thing I request on the seller side, let me first start off with a quick comment here. From a seller side, it's incredibly advantageous to have financing available to a potential buyer. It is just massively increasing your buyer pool by being able to when you sell a business that is financed through the SBA. That’s something I help with. I'm able to vet the financials of the business, be able to get detailed information from you or any broker regarding the type of business that the sellers involved with and what the financials look like and be able to really vet that business and then give that business the go-ahead on the prequalification that first and foremost needs to be set and then once you go to market with that business, be able to vet potential buyers as an enquirer regarding that business. That's really imperative because especially from a seller standpoint, the last thing a seller wants to do is have their business taken off-market and then 90 days later it has to be put back on the market because the buyer doesn't qualify.
Yeah, exactly. I was actually on the podcast it, he'll be coming up shortly here in the next few weeks. He used another broker and they weren't going through any commerce professionals like yourself. They were actually going through a local bank and it turned out that it was the first e-commerce transaction that this local bank had ever done. That extended the process quite a bit. Instead of taking those standard time, which we'll get into, it took almost six months to get that deal done. Yeah, having partners involved early on that have experience in this space is a great idea.
Yes, we wholeheartedly support that getting pre-approved is definitely where it's at. It's not only the entity being US-based but they need to be paying taxes in the US for more than a year. Is that correct?
Usually one to two, Yes. That's a very good point. By the way audience, I've looked at e-commerce businesses where they hadn't been paying taxes and they've been around more than one or two or three years and it just baffles me. But regardless, I'd like to see at least two filed tax years generally, depending on the price point, but at least that. Then obviously a year to date P&L would also be if available. I like to look at those things and I also like to see a business summary and that really lays out the type of business they are, number of skews, product mix, inventory demands, etc. I kind of look at everything regarding the business. Great.
That's a good point actually. I have people come to me in Q4 saying I want to sell that business now and or is it better to wait? Typically, as we've discussed a number of times the tax returns play into that equation, but you also mentioned an up to date trailing 12 months profit and loss statement. How do you weigh those two things, especially if a business is in hyper-growth mode. Some of these deals we're looking at right now, growing 100-200-300 percent year over year. How do you balance that in the pre-qualification pre-approval side? On the sell-side?
Definitely the tax returns hold much more weight than a year to date P&L or even trailing 12 months. Especially with a high growth business, most of the time it depends on the time of year but most of the time especially Q4 it's very advantageous with a high growth company for to wait till January to be able to file the tax return and be able to go to market. Then I've seen it where they're getting a lot more for their businesses and having that approach. The business has been around a long time and there's not hypergrowth then it's not as affected by that. But definitely if you're in a business that's growing 20-30% a year and it's Q4 and could wait half a month or a month, it's definitely advantageous to do that.
Absolutely. The deal we are actually working on at the moment, if I remember correctly, the pre-approval was actually lower than the buyer got approved for in the end. As far as the multiple goes that pre-qualification is a good guide and we always typically go above that with a number of ways that we market the business. It's not like the pre-qualification as the last word, but it definitely gives you some power when you're going out to market that it's been looked over by lender and as approved to x amount already. It's a great tool to use. I always if possible, ask clients to wait until the new year, especially as we go into Q4 and there are high growth business that's excellent.
What are you looking full with the tax returns specifically in relation to an SBA loan?
Well, I mean there are certain tax strategies that CPAs use that you have a company that's high growth, high top-line number and then when we lenders get down to the bottom number and it's a negative that it gives us a lot of heartburn. I look for businesses that are actually profitable at the end of the day. Now there are multiple added or add-backs that are part and parcel with these types of businesses. But at the end of the day, I look for the bottom line revenue with those add-backs in there and that bottom line number needs to be able to support the proposed debt service of the proposed loan in that really when I look for, so debt coverage ratio and there's their ratio someone should be looking at with a business it depends on the bare minimum from by SBA is 1.15 oftentimes, especially right now you have a business that's maybe below 1.1 or 1.0 debt service for 2017 for 2018 I'd like to see well above the 1.15 it depends on the transaction itself, but the bare minimum is 1.15 and most of the businesses I do vet there'll be just shy of that in 2017 and then in 2018 they're just crushing it. There are 2, 2.3, 2.5 I kind of weigh everything in terms of determining the business qualifies. Okay.
Okay, great. Yeah, that's a really good thing to think about. That's just ticked over to July, 2019 at the time of recording this. If someone's thinking about selling that business in 2020 when would be the right time to other than engaging an advisor, of course, when would be the right time to reach out to a lender like yourself and see if that business can qualify for an SBA loan?
I would say immediately because often times I'm able to review not only the current financials but previous years financial and getting a little color in regard to how those numbers are derived. And in some cases, a seller's gone back and amended their returns based on some observations I've made that I would say start now, especially if there's any sort of commingling involved with the returns, which unfortunately, I won't say it's commonplace but I see it a lot. That really makes the water's murky moving forward. Oftentimes it could take a CPA months to untangle that Web. Especially if you feel like you don't have really clean books, I would definitely get the process started immediately.
Sure. By co-mingling you mean other income from other businesses or other sources, correct?
That's correct, yes. Yeah. For example, they have two e-commerce separate e-commerce businesses and they're running through the same returns, that makes it very challenging for a lender. I'm not saying that it's a deal killer or anything but it definitely takes time for a CPA to untangle the commingling and to provide adequate financials to support the business that's being told.
Hmm. We've just been through that with one client and yeah, it takes some work and then you've got additional add-backs and opens up more questions on the buyer side. That one isn't an SBA deal but yeah, we had to do that regardless because the need to pass diligence even if a traditional loan isn't being used that's on the sell-side. Get started as soon as possible. On the buy-side, is there a time where someone should reach out as far as the process when they're starting to think about acquiring other businesses?
I would say right at the start, once he or she decides to move forward on acquiring a business, feel free to reach out to me. I could start the pre-qualification process now. Unfortunately, people don't and then they put their letter of intent in the first question, any good broker's going to ask is have you been prequalified? If the answer is no, especially with a lot of these listings where it's pretty much a buyer's feeding frenzy, they're going to miss out on a large opportunity. Whereas if they're pre-qualified and I'm pretty well known within the circles, generally their offers are going to be the hold a little bit more weight than somebody who hasn't even spoken to a lender.
Yeah, absolutely. We've been through that on a couple of deals recently and it's more and more important. I think that's how you gain an edge. I had some friends reach out to me recently, a number of them actually talking about acquisitions in the e-commerce space and they're wanting to target that $1MM to $2MM range and that was my advice to them was kept prepared as soon as you can. You want your offer to come in strong and have the best chance of closing because there is much competition on the buy side, which is a good thing for people looking to sell for sure. But on the buy-side you really need to be prepared and ready to move quickly.
Additionally it is absolutely imperative for a buyer to get very well known with a broker like Coran to be able to when the opportunity does, even prior to opportunity coming to market where Coran goes up, gosh, I remember, David he's interested in that exact same type of business. Maybe I'll give him first shot at that business priority. Even if going to the marketplace. Buyer's out there, it's imperative that you get the process going now and get a very strong relationship going with Coran. It'll pay dividends on the back side when you go to acquire a business.
I appreciate that, Stephen. That's nice. Yeah, it is important to work at connections and build up a case before the acquisition. Most people think that having access to capital or just the thought of buying makes you stand out and actually the opposite is true. if you first talk to a buyer and you say look, we could get you to about a million dollars, $2 million in acquisition price, is there anything they can do with, they wanted to acquire a larger business or work with the longer term to improve their position? Have you worked with buyers like that in the past that have gotten to a larger level?
That's an excellent question. Primarily my recommendation is can you partner up with somebody. I've had a lot of buyers come to me and saying, listen, I'm really looking to go higher up than just the million dollars. What do you recommend? I said anybody that's interested in obtaining a business as well and partner up economy's a scale and go for a higher level.
Absolutely. Yeah, that's a great, great option. I've worked with a number of buyers recently that have done this on multiple acquisitions even and it seems to be a pretty good strategy. You obviously want to work out your partnership agreement very tight but that could be an option to take down a larger deal. Let's switch gears a little bit. Have you ever had a deal that just didn't work out and would you be able to talk us through that a little bit?
I think when deals don't work out, it has primarily, at least in my experience, has to do with two things. When a buyer doesn't exactly tell the truth upfront during the approval process and then it's found out later that certain things were not disclosed. That's from a buyer standpoint, I had a recent situation where the buyer disclosed that he had x amount of liquidity and at the end of the day he didn't have anywhere near that. That kind of killed that deal. Then another instance has been where on the seller side where the numbers look great and then the seller puts out there whatever Q1 year to date numbers and they're dismal they're 50% off of what they were last year or something like that. Lenders get really skittish when numbers are going down. I had an instance in early April just like that where the business had been around three years, numbers look great, increasing sales and then 2019 it was like the business hit a brick wall and numbers were 50 per actually less than 50% of what they were the previous year, year over year. And that's pretty much a deal killer. There's no wiggle room through that. Lenders do not like financing what I call a falling knife and that would really make things tough moving forward on that specific deal. Absolutely. Oftentimes a seller will get to a point where they sign the LOI, the offer looks great, the buyer had been pre-approved were going through the process and the sellers pulled back a little bit and think, well that's the deal done. Let's move on and go do something else. Actually that's the worst time to do that. You want to pay more attention to your business during the sale process to make sure you get through the other side one just to get the deal closed and two if anything doesn't work out, because not every deal closes if something doesn't work out, you still want to have a sellable business and a couple of months from now. It's really important to keep managing the business and also be open in communication during that time. If anything does change with the business, with Amazon businesses specifically, sometimes that suspensions. What we've our clients do in the past is immediately when they see something happen, advise all parties in the process. Have you had, other than a 50% or more year over year decline, which no one's going to buy that but has there been other scenarios that look like the deal was going to fall through and you've managed to save that deal somehow?
Yes. I don't know. If I was able to save it but it had more to do with between buyer and seller. I've had it where certain things are found out during due diligence and the buyer goes back to the seller and ask for a price reduction. I've had it the other way where a week before closing the seller says, Gosh, my Q2 numbers look great. I want more money for the business. I've seen both scenarios happen before. But usually back to your question usually where there's a will there's a way but there needs to be a will on both sides. Usually it's worked out. There are situations where there's a deal where the lender comes back requiring additional injection or down payment or additional seller note or a seller note or whatever. But usually depending on the communication between the buyer and the lender and the seller and the broker usually those things get worked out.
It's very rare, at least with my business, that deal doesn't close. First off, it's extremely rare for us at e-Commerce Lending not to be find financing for a client. That's extremely rare. Secondly, I have a great team here and I have obviously great brokers. I work with as well as exceptionally good attorneys, buyers attorneys involved, sellers, attorneys involved. all of us are very familiar with the space and all of us make it happen where you see a lot of us are used to working with one another. it's very fluid and usually, 97% of the time we bring it to the finish line.
Yeah, absolutely. And that again is just a reason to use a good team that has experience in your niche. in this space, specifically with e-commerce online businesses definitely should consider Stephen as part of the mix. Thanks for walking us through all of those scenarios. I think that was super helpful, especially for people that are new to the space and don't understand what the SBA loans really are thrown around a lot. But that was good to get some clarification. And just before we wrap up here, Stephen, is there anything else that I should have asked you but didn't?
Anything else that you should have asked me, I think you did an excellent job and asking all the right questions but if any of your buyers or sellers need some additional direction, feel free to reach out to me here at my offices at (813) 766-4524. I'll be more than happy to assist you and hopefully in all my comments I've been able to help your listeners in helping them guide either towards a sale of their business or acquisition of a business. I appreciate you having me on.
Yeah, absolutely. Also check out e-Commercelending.com to Stephen main website for his business. Thanks again for coming on the show, Stephen. We'll add all of that to the show notes and definitely recommend people reach out to directly when they're looking to do this all the business or looking to start on the acquisition side. Thanks much for coming on Truth About Exits.
Coran thanks for having me. I truly appreciate it.