It’s no secret that a lot of industries were severely impacted by the pandemic. But how exactly did it affect bank financing for owners and buyers of businesses? Domenic Rinaldi shares some handy information for people who are interested in purchasing and selling their business. He explains the need to understand how banks view these deals and the different issues that come with them. Banks are being cautious and are looking at a good track record, monthly financial plans, and comparison between the current and pre-COVID situation. Not only do businesses need improvement, but they also need to be stabilized before banks accept a deal.

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Understanding Bank Financing For Owners And Buyers Of Businesses Affected By The Pandemic

I’m going to talk about COVID impacted companies and some of the challenges that we’re seeing now with getting those companies financed. What we’re starting to see is that companies are coming out of the pandemic. They’re starting to show some improvement. There’s activity on those companies but getting them financed has been a real challenge. I’m going to bring you through some of the things that you need to think about. I have a couple of live examples that I can share with you so that you can understand what’s happening.

In this episode, whether you’re a buyer or an owner of a business and contemplating selling, you need to understand how the banks are viewing these deals and what’s happening. It’s honestly a shifting landscape. Both deals that we’re looking at right now that I’m going to mention have different issues. The banks are being very cautious. They want to see that the businesses are returning to the pre-pandemic levels, even going as far as saying that they liked the deal but they’re not willing to finance and close on it until they see that the business has a good track record of recovery month over month improvements. We’re going to get into a bit of that, what you need to be looking for and how to be better prepared.

Before we do, I’ve been talking to a bunch of buyers who were stuck. They’re stuck understanding how to do diligence, especially on companies that have been impacted by COVID, whether the impact was a positive one or negative. We all know that there are some companies that did well through COVID. Others have struggled and doing diligence on either of those types of companies has proven to be a real challenge. You need to understand what the steady-state is going to be or they have reached a new threshold. People that are stuck, doing diligence, understanding how to get banking, how to even make an offer, it’s a real challenge to figure out how you can get to an offer that owners are going to engage with. That’s been a real challenge.

If you’re stuck in any phase of the deal process, please reach out to us at [email protected]. We’ll look at your situation, analyze what’s going on and see if we can help you get unstuck and get to the next level. It’s a real challenge with all the things that are going on out there. The companies that have been impacted positively or negatively. We’re seeing a lot of it and certainly have the expertise to help you, hopefully, get through that and get to a good deal. Thanks for being here. I hope you enjoy this episode.

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Banks Are Cautious

As I had mentioned in the intro to the show, we are starting to see deal flow come to us for companies that were significantly impacted negatively or positively, but mostly negatively during the pandemic. The owners were able to stabilize the businesses. They’re starting to show some signs of coming out of the pandemic. The owners are at a point where maybe they’d like to sell the business. There are some challenges with that. As we’ve worked with some of those owners and the banks to see if there is financing that would be available to prospective buyers, clearly the banks are being very cautious. They need to see that there’s a track record a month over month improvements.

Bank Financing: Banks are being cautious and if they’re not seeing that the business is not going to have an appetite to finance the deals, they have to see that the business is improving steadily.

If they’re not seeing that, they are not going to have an appetite to finance those deals. They’ve got to see that the business is improving steadily and it’s going back to pre-pandemic levels. The historical view of that is probably 2019. Banks are comparing what the business is doing now to what it did in 2019. It doesn’t always mean that it has to be 2019. Sometimes, the performance of a business might have been better in 2018. They’re comparing period over period. They want to see that the businesses are gaining ground and getting healthy again and have clearly stabilized so they can understand what the goal forward is.

If you’re a buyer, potentially these are good businesses and I wouldn’t pass on looking at some of these businesses. It’s going to take a little bit more time and effort. You’re going to need to understand what’s happened. You’re going to have to dig in. There could be some very good businesses out there that were hit hard by the pandemic but have tremendous upside into the future. As far as timing for buying a business, it’s a great time to buy a business when you think about the fact that the capital markets are wide open. Banks are there and want to lend. They’re being more cautious, but they do want to lend. Interest rates are at incredibly low levels. You can get a lot of business for the money at nowadays’ interest rates and there are incentives. If it’s a deal that’s going to have a loan value of under $5 million, and it qualifies for an SBA loan, the SBA has offered up some incredible incentives, which we’ve covered in previous episodes if you can close the deal by September, including waiving SBA fees, paying for some of the principal and interest payments for the first couple of months of a transaction. When you add that up, it can have a significant impact on the overall cost of the deal. It’s definitely a good time.

These deals should not be passed over if it’s a business that’s been impacted. It’s going to take some serious diligence and review on your part as a buyer. If you’re an owner of a business, you need to understand that there’s going to be a greater level of scrutiny put on your business. The buyers are going to be suspects. They want to understand what their risk is. Banks want to dig in and make sure that the business has recovered. If you’re an owner, understand that most buyers want to get and secure bank financing. Nobody wants to write a check for the entire price of a business.

It’s pretty rare to see that. Especially the nowadays’ interest rates, most buyers want to be able to finance a deal. Having your business in a position where it’s bank financeable is critical. We’re working diligently with a lot of businesses to understand what the recovery has looked like and if they wanted to go to market, is that deal going to get bank financing or not. In some cases, businesses are having to hold on and wait it out a bit longer, even if the owner wants to sell right now. It’s just not the right timing if you can’t get a bank behind it. A lot of that work is taking place.

What Banks Are Looking For

Let me talk about the banks and how they’re viewing this. Every bank is different. They all have slightly different criteria in things you’re going to look for and types of deals that they’ll do, industries that they’ll look at. That hasn’t changed during post-pandemic. That was always the case. Some of the commonalities related to pandemic impacted businesses are, I talked about businesses showing recovery, the benchmark appears to be six months of recovery. What do I mean by that? Banks want to see that the business has a solid six months of top line and bottom line recovery back to the best periods pre-pandemic. If your best periods were 2019, banks are going to compare March 2021 to a March 2019 to see whether or not the business has come out of the pandemic or not. They’re going to watch this month over month.

Do you need to be 100% back? Probably not. You need to be showing that the trend is incredibly positive and it can’t just be top line. It has to be top and bottom line. You need to make sure that even though revenues might be back at the bottom line is healthy and what it was in prior periods, pre-pandemic. The magic around six months seems to be the banks are not going to close on the transaction. They won’t fund the transaction until they see that there’s a solid six months. It doesn’t mean you have to wait for six months to take the business to market and try to get something done.

If you feel like you have a lot of confidence and some visibility to what’s happening with your client base, you see the clients coming back, you know the revenue is going to be there and you are confident to that, you don’t have to wait to go to market. Buyers, you don’t have to wait to look at those deals and try to strike a deal with an owner. However, you may be in a situation where you enter into a letter of intent, the diligence process takes place, the bank looks at the deal. You might be in a holding pattern for 1, 2, 3 months or whatever it is until the bank says, “We are comfortable. We see that the business has recovered. We’re ready to fund the deal now.” Obviously, it’s not a perfect scenario but it’s a great way for an owner and a buyer to lock up a deal in a transaction that everybody’s happy with. You’re just waiting and watching for the recovery to take place so that they can get funded and the closing can occur.

Six months, solid recovery, top and bottom line, an absolute must forecast, banks want to see with some detail what the forecast of the business looks like. This is going to be a challenging part of the process. I’ve been doing this a long time for about two decades and very few smaller businesses do formalized forecasts. Owners are not accustomed to doing forecasts. That’s a real skillset. If you don’t understand how to do that, it’s a real challenge. Buyers understand while that might sound crazy to you and might be frustrating, there aren’t a lot of companies that do formal forecasts. This is where a good M&A advisor, a good banker, can come into play. They can help you understand how to look at forecasting. They’re not going to do it for you, but they’ll be able to coach you through how to look at forecasting, what are the proper elements that go into it so that you can sit down and look at the next 6 to 9, 12 months and figure out what you believe is going to happen and what the trends are going to look like.

Banks are going to want that. They’re going to want to see what the go-forward looks like. That could come in a lot of ways. Signed contracts, maybe you’ve implemented a new sales process, you get your leads from the internet and you can demonstrate how many leads you’re getting and what your close percentage on those leads are, what does that mean in the way of revenue and profitability? There are lots of ways to approach forecasting but it’s going to be imperative that the parties put together a solid forecast that the bank can review. That will give them a lot more comfort, combined with the improving trend over six months.

The other thing that banks are looking for is they want to see monthly financials. A lot of companies have been used to producing quarterly, semi-annual or annual financial numbers. I have a situation like that. I’ve got a client who doesn’t do monthly financials. They didn’t want to pay their accountant to do that. It was a little extra money. They’ve only done by annual financial statements. That’s not going to work. The banks need to see monthly financials. They’re going to need to see them going back to 2019, probably because they need to be able to compare months. They need to see that there’s been a recovery. If you’re comparing March 2021 to March 2019, you need to be able to show the monthly lease. They need to be accurate. Both profit-loss statements and balance sheets. In some cases, that means accountants may have to go back and do some cleaning up of the financials so they can produce monthly numbers. Buyers and banks are going to want to see this in order to get financing. My eyes will get ahead of that now.

The other thing, I can’t say that this has been a tremendous change but there’s more emphasis on this now than there was before. The banks are looking to see that the buyer has relevant transferable experience. That’s not a new statement. You probably heard that before. In this case, they are going to put extra emphasis on this. They need to know that buyer understands this industry. They understand what the impacts were for COVID, the ins and outs, because in case there’s a double-dip on the pandemic, they need to know they have somebody in the operating seat that understands how to handle that and potentially pivot quickly, somebody that comes from outside of the industry may not have that. Transferable experience is going to be key and banks are going to go the extra mile now on making sure that there’s comfort around who the actual buyer is.

Bank Financing: There could be some businesses out there that were hit hard by the pandemic but have tremendous upside into the future.

Case Studies

That’s a lot about what we’re seeing in the market, what the banks are looking for, what buyers are going to look for. I have a couple of examples. You can put live examples to work here. The first one I’m going to mention is we have a food manufacturing business. This food manufacturing business was significantly impacted to the negative based on the sector they serve. 2019 was an incredible year for them and was a record year, then the pandemic hit around March 2020 and you saw an immediate decline. Everything was hit. The business was impacted the entire year, even going into the beginning of 2021. We’ve started to see that the business was showing signs of recovery in February 2021, both revenue-wise and the clients that had disappeared were starting to come back. They were calling for quotes. They were starting to place orders.

The orders weren’t immediate orders. The orders were, we want to start back up in 2, 3 or 4 months but the orders and call were starting to come back in. They service the primary market but different clients within those markets. They were starting to see some real returns from some of those client targets. If you look at March 2021 to March 2020, it started to look very promising. April was even more promising. We’re starting to see the return back to normalcy. They’re not back by any means to full numbers compared to 2019 but they are clearly back in well over the performance in March and April of 2020.

I’m doing this in the middle of May 2021. We’re seeing some significant improvement for May 2021. I’m hearing that the orders are flooding and the forecast is looking very promising. We’ve got a situation here where the business is looking like a strong recovery. The owner has a desire to be able to retire and leave the business. We have engaged with a couple of banks and having preliminary discussions. Sure enough, everything that I covered earlier is happening. The banks have said, “This looks great. We like the numbers and the climb back up. We think that this makes a lot of sense. If we continue to see the numbers increase, we could get behind financing this deal. We’ve even talked about valuation expectations.” The bank is comfortable with the valuation expectations. They have made it very clear. They’re going to be looking for a buyer that comes from this industry or has significant transferable experience. All things that I covered before are holding true here.

What we’re finding is that the owner has a strong desire to be able to exit the business before the end of 2021. There happens to be a buyer that we think is a good fit. We’re going to go down the path, engage the buyer, explain the situation, see if we can get an offer on the table, hopefully, get an offer that’s accepted, get into diligence and then we’ll be in a holding pattern. My best guess is a deal like this could close in about September or October 2021. If we’re lucky and the forecasts were right, the improvement continues. It was a great business before the pandemic. It will be a great business again. It was impacted by COVID. It’s very promising, hopefully for both parties but banks are not going to write the check until they see the full recovery.

The second example that I wanted to cat was with a distributor. Unlike the food manufacturer, this distributor had an unbelievable 2019. They were doing incredibly well. The pandemic rolled along and the business was hit significantly. However, unlike the food manufacturer, we started to see a recovery at the end of 2020. The good news here is with a recovery at the end of 2020, improving trends, improving forecast and some improvements that the owners made during the pandemic to the business, they’ve made some infrastructure changes to the business that has a good impact on margins on a go-forward basis. When you model all of that in, we’re in a situation where we could start taking that business to market, start talking to buyers. There’s a good chance that we’re two months away from showing that six months of recovery.

By the time a buyer comes along, makes an offer, we’ll be in a situation where we can accept the offer, get in the diligence and the bank will be willing to lend and close on the transaction right away, assuming that we continue to see the improvement and the steady progress, which seems to be the case. You can see in this business that it was pandemic impacted when you see that as a buyer, it’s okay to go down the path with those businesses. You’re going to have to do more diligence but it’s okay. Not to state the obvious but we’re in uncharted waters. All of us have never experienced anything like this. We don’t know what lies ahead of us for sure. It appears that the recoveries are happening and businesses are getting back to some level of normalcy in pre-pandemic levels. As a buyer, the same adage holds true.

Surround yourself with good advisors, educate yourself, pay attention to details, do the work that’s required and diligence all over. Don’t cut corners. Surround yourself with smart people that understand deals. There’s plenty of a good deal flow out there if you’re looking in all the right places. Sometimes that’s a challenge you get. You need to understand what the right places are. There are good deals to be had. I think more and more are going to be there. My sense is, there are plenty of owners who lived through the 2008 recession and now the pandemic. If they’re Boomers, they’re probably a bit tired.

These are two unbelievably, in most cases, negatively impacted situations that have occurred. People are going to be tired and probably want to look at a good exit. I think there’s going to be a lot of opportunities for buyers over the next couple of years. Good deals flow. Just surround yourself with smart people. I hope you enjoyed this episode. If you enjoyed our content, please remember to subscribe and review our podcast. I look forward to seeing you again on the next episode. Until then, please remember that scaling, acquiring or selling a business takes time, preparation and proper knowledge.

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