At Madison One, we are not attorneys who close loans, but we have seen enough from over several hundred million in Commercial Loan Closings to keep an eye out on certain key components of a purchase and sale agreement necessary to ensure a seamless commercial loan closing. For more information and details, we recommend you consult with your advisors and/or attorneys:
1. Know who’s who in the deal
The biggest risk in commercial lending is in change of ownership transactions, such as business acquisition, commercial real estate purchases or partner buy outs; is the seller juicing up the numbers to maximize the asset values of the underlying business? Why is the Seller selling and does it make sense that they are selling at the price they are selling at? These are questions you always must ask.
Here are a few key pointers:
- Make sure the buyer’s name matches up with the Borrowing entity docs; any change in ownership of the Buyer must always be disclosed to the Lender and the Borrower/Buyer needs to understand that from Day One.
- If the assignment of the purchase agreement is needed, make sure the purchase agreement allows for it by both the Seller and the Buyer.
- Make sure you know the Seller and do your due diligence – it’s advisable to have your attorney run legal searches on the entity that is selling assets as well as the individuals who are authorized to sign on behalf of the corporation that is selling the assets in order to ensure no pending legal action, injunction, etc. which could affect the Buyer after money changes hands.
2. Break down the Purchase Price Allocation
Buyers always do their due diligence before they make an offer to acquire the assets of the Seller, but Buyers are limited by what their Lender can extend in the way of loan proceeds based on the Purchase Price Allocation of the business assets being acquired.
- What is the Seller’s estimate of the market value of Real Estate?
- Each Lender’s risk appetite is different, but the SBA SOP states that Lenders may advance up to 85% of the market value of Commercial Real Estate.
- What is the Seller’s estimate of the Orderly Liquidated Value of Equipment?
- Similarly, the SBA SOP allows Lenders to advance up to 80% of Orderly Liquated Value of Equipment (remember there is a difference here between Auction (or Fire Sale Value), Orderly Liquidated Value and Fair Market Value.
- What is the Seller’s Estimate of the Goodwill or Intangible value of the business you are purchasing?
- Review EBITDA of the Selling Business with the proper adjustments, such the Seller’s personal expenses, overstated payroll costs, etc.
3. Non-Competition Agreements and Restrictive Covenants
Non-competes are EXTREMELY important, especially in sale of business transactions whereby the Seller obtains a significant cash payment in consideration for the sale of assets. Even more important is ensuring that the non-competition clause is enforceable in the state where the Buyer is acquiring the assets. Each state has different standards, but the key components are the duration of the non-compete clause, the function industry in which the business is involved, and the geographic restrictions associated with the non-compete.
Changes of ownership do carry a big risk and while we have only outlined three key observations above, due diligence and proper consultations with your attorneys is a paramount.