Preparing for Success in the M&A Arena : Pre-Qualifying for Bank Financing

Posted by Kem Taylor on Jun 10, 2020 1:59:16 PM

Preparing for Success in the M&A Arena

Acquiring a wealth management practice brings immediate growth and is an alternative to spending money and time on marketing to find new clients. That’s why there is currently an average 75-to-1 buyer-to-seller ratio. If you’re going to succeed in this arena, you need to stand out from that crowd. If you don’t have the cash on hand, one of the best steps you can take is to become prequalified for a conventional or Small Business Association (SBA) loan.

Twenty years ago, most acquisition deals consisted of a down payment of around 30% with the balance seller-financed through an earn-out arrangement. As fee-based practices became more prevalent, buyer demand increased. The combination of recurring revenue and increased demand pushed values higher and, in time, strengthened the underlying deal terms as well. Gradually we witnessed a shift to the use of performance-based promissory notes in place of earn-out arrangements. And, in the last seven years or so, the landscape changed yet again when the availability of bank financing entered the picture. This has afforded younger, smaller buying firms the opportunity to compete financially with larger, more established firms.

A place to start accessing this financing is to prequalify for a loan. A bank will review your finances and give you an estimate of how much they will lend to you. A bank’s prequalification tilts the acquisition playing field in your direction; you can knock out 90% of the competition. Sellers like the security prequalification brings to the transaction. In addition, you’ll be ready to move quickly if there’s a new opportunity or if a seller has a short time horizon.

Reasons to PreQualify

You’ll learn how much you can borrow

The biggest reason to get prequalified is to learn how much you’ll be able to borrow for your acquisition. You may have a seller in mind and can share details of their business with the bank, or you may be getting ready before you enter the market. Getting prequalified will let you know if you’ll have access to the funds you need. The bank will review your personal credit score, tax returns, financial statements, business revenue, profitability, and historic and anticipated growth. It is better to find out sooner rather than later if you’ll be approved for a loan in the first place, rather than putting in the time and work to secure a deal and finding you don’t qualify for the cash you need.

Common reasons loans get rejected are: low credit score, insufficient collateral, too much debt on the books, and poor business performance. The prequalification process can give you the opportunity to work on business improvements, change your loan amount, or seek other sources of funding. There is no bad news here—you either get prequalified or you learn what it will take to get prequalified!

You’ll better understand the process

Details count and you need to learn them in advance so you can plan appropriately. A prequalification will not only give you an idea of how much you can borrow, it will prepare you for the process of working with banks down the line as a deal solidifies. For example, the banker will explain what information is needed in the due diligence process and also how many weeks or months it will take. It is important to note that having the requested information and documents prepared in an organized and accurate manner is critical. Many loan applications get held up due to missing or incomplete information.

Other important things to learn are what the interest rate could be (rates fluctuate, of course, but you’ll get a ballpark idea), what the term length could be, and how much you’ll have to pay the bank in fees.

You’ll have more control

When an opportunity presents itself, this preliminary work will allow you to speak intelligently with both the potential seller and the loan officers about deal terms as you enter into discussions. You’ll ask smart questions and save time. You’ll know what lenders are referring to when they mention DSCR, EBITDA, and PG.*

You’ll have time to find a banker you can work with

You may start looking for financing by talking with your local banker only to learn they don’t understand your business model and cannot lend on it. As I mentioned in the introduction, there now are banks that work specifically with wealth management firms. SkyView Partners, Live Oak Bank, PPC Loan, and Oak Street Funding make loans specifically to financial advisors. Banks can provide SBA loans or conventional loans. SBA loans are available when the founder is ready to exit within one year after the sale. These loans are attractive because of their longer term lengths and their backing by the federal government. For cases where the seller will remain in a key role well after a year, advisors can turn to conventional lending (which isn’t guaranteed by a government agency). Broker-dealers and custodians are also offering loans to advisors to finance acquisitions. Lastly, private equity is emerging as another source of capital. It’s worth it to take the time to explore your options to see what is the best fit and where you will get the best deal.

Getting Ahead of the Game

If you anticipate a lending need in the next 12–36 months, start talking to lenders now. They are always willing to have preliminary conversations to educate advisors on the process and answer questions. A prequalification will also focus your acquisition search by guiding you towards the size of deal you can manage. There is usually no charge for these initial conversations.

It is important to note that a prequalification doesn’t 100% guarantee a final loan approval. A change in circumstances, such as a decrease in your income, a significant lowering of your credit score, a significant increase in debt, or a change in your business, could impact your ability to get a loan even if you have been prequalified. You may also consider asking the lender if they anticipate any upcoming changes in lending requirements so you can prepare for any fluctuations on that side of the equation.

The time it will take to have a few conversations with lenders is worth the peace of mind it brings to your acquisition plan. In the end, you’ll be well ahead of all the competing buyers who didn’t take the time!

*Debt Service Coverage Ratio; Earnings Before Interest, Taxes, Depreciation, and Amortization; Personal Guarantee.

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Topics: Acquisition, Bank Financing