Acquisitions Anonymous - #1 for business buying, selling and operating - What's going on in the debt markets? - Acquisitions Anonymous 210

Episode Date: July 14, 2023

Mills Snell (@thegeneralmills),  Heather Endresen (@EndresenHeather), and Michael Girdley (@girdley) switch it up from the typical deals reviews and have a discussion about debt markets.______________Thanks to our sponsors!This episode is sponsored Rejigg.Rejigg is a platform where buyers can meet SMB owners looking for exits. Rejigg's in-house team does proprietary outreach to find owners considering exits, then lets buyers message them directly to set up calls. The sweet spot is $500k-$10m in revenue, but they have other opportunities as well.Sign up as a buyer today, and start meeting owners looking to sell.Check them out at rejigg.com/aa. Subscribe to weekly our Newsletter and get curated deals in your inboxAdvertise with us by clicking here Do you love Acquanon and want to see our smiling faces? Subscribe to our Youtube channel. Do you enjoy our content? Rate our show! Follow us on Twitter @acquanon Learnings about small business acquisitions and operations. For inquiries or suggestions, email us at [e-mail]

Welcome to Acquisitions Anonymous. Internet's number one podcast about buying, selling, and operating small businesses. Co-hosts Michael Gridley here, we did something really unique today, which is I've been getting a ton of questions from people about what's going on in the debt markets for small businesses, you know, borrowing for banks, borrowing for private lenders. And we spend about a half an hour talking about what we're seeing and what's happening in the market. And then what you, as a borrower, who is using that to fund your business, can do to do better

and navigate the situation. So a big experiment for us. Let us know what you thought. And here is the episode. Our sponsor for today is Rejig, a platform that facilitates direct introductions between SMB owners looking for exits and SMB buyers. They have an in-house team doing proprietary outreach to find owners considering exits, and then they let buyers on their platform message them directly to set up introductory calls. Learn more about their model at Rejig slash AA, and that's R-EG. E-J-I-G-G-G-com, rejig, and tell them that we sent you. Thanks. By the way, for our listeners, I showed up late to the recording today.

I showed up and interrupted the conversation between Mills and Heather, and then redirected boomerang to start an episode that's totally unconventional for us. So you just got grid-lead. Well, cool. So actually, what we were talking about before, we started recording was the debt markets for business buying and business funding right now are like super interesting. And I think it's something I just did my whole co-office hours. I had a bunch of people asking like, what are you hearing from banks? What are you hearing

from lenders? And we started talking about it. And I was like, we should click record. So this is the moment. So maybe what are you guys seeing? Like what's happening with debt options at this point? And Heather, I've heard you're an expert. Yeah, I am. So and it's really fascinating now that I have Vizzo Business Capital, I'm able to really shop bank to bank and, you know, see how they each look at deals differently. The main thing that I am seeing is that it's super difficult to get non-SBA debt on a cash flow basis. If you're going for SBA, it's a little tighter. They're wanting to be a little more thorough, you know, better deal structures, you know, not as much leverage, more seller note, that kind of thing, but not, it's not drastically different on the SBA side,

at least from what I'm seeing. What is drastically different is non-SBA. Number one, banks want you to be bigger than they used to. So they used to maybe say one and a half million, two million EBITDA was okay for a conventional loan, not anymore. Three, three and a half million minimum. And they would still like it to be even larger than that. So they want a bigger company.

They are super picky. I've seen some very good deals that definitely would have been easy to get done maybe a year ago where banks would just find or the lenders would just find one little thing to be kind of picky about and say, oh, no, now we can't do it because of that little thing. Even in one case, the bank otherwise liked the deal but said that a company wouldn't have enough deposits relative to the amount they would be borrowing. So they didn't like that ratio that what it would do to their liquidity. And remember, like banks are now looking at their deposit totally different than they used to. They used to be able to predict their deposit inflows and outflows pretty well.

And after the Silicon Valley Bank collapse, that changed. And they all know that that's not as predictable as it used to be. So that's factoring in as well. It's not just economic conditions, but it's banking conditions. It's tough. So you have all that as the backdrop. And then you also have rising interest rate environment. Happy Thursday to you too. I'm so cheerful. Yeah. But then you have a rising interest rate environment, you know, with a lot of uncertainty that's being priced in. I think it's helpful just to say on the range of sources of capital and they're kind of thinking about lowest cost of capital all the way up to highest. When SBA and depository based lenders, which are the lowest costs of capital providers, when all of a sudden their cost of capital goes up and they're pricing in risk,

the entire spectrum behind them also does the same thing. And probably even on an exponential scale, not just on a linear fashion. And so if SBA debt is kind of the cheapest on a relative cost of capital basis, and then depository lenders who are going to hold the loans on their own balance sheet, but non-SBA, slightly more expensive, they have different underwriting criteria, but it's still fundamentally, you know, very similar. then in my mind, and Heather, you tell me if you see it differently, he moved to kind of debt funds or more cash flow-based lenders who maybe don't even have a depository. They're on a bank,

right? They may not have a bank charter, but they could just be a fund who is loaning money on a spread. And then you move even further up and say, okay, here's somebody who's in that same category, but it's kind of more mez-dent. It's bridge financing, and their cost of capital to you as a buyer is significantly more, like used to be maybe mid-teens, and now it's like high teens, low-20s. And then the only thing to me passed that on the spectrum is maybe the category of kind of working capital financing, you know, factoring your receivables, you know, things that are very, very expensive, and then pass that, it's equity, giving up equity, you know, in exchange for capital.

Yeah, you got it. That's exactly right. And the cost of capital went up for every single one of those players in that spectrum all the way down to what is the cheapest still SBA. But now SBA is 10 and a half, 11 percent, just where we stand now. If the Fed raises again, you know, we're above 11 percent for the safest, cheapest debt. So yes, it definitely changes the entire spectrum and makes it more challenging for everybody. So a phenomenon that I'm seeing that I think is really interesting is, you know, we talk about this idea of my price your terms a lot. And there is a trend now that sellers still want to get old valuations for stuff.

But the, you know, the idea of structured earnouts and seller financing at reasonable rates has become much more palatable to them. So they're bridging the gap here to make some of these deals get done. And there are things like, you know, fixed earn out sizes, but they shift up and down based on performance of the company each year. You're seeing just straight up seller notes. And then my absolute favorite, the holdback, which basically turns out to just be a seller note that is zero percent interest. But people don't really think about it that way.

But that is a phenomenon. Like if you're a buyer right now, sellers want to bridge that, but they still mentally have themselves anchored in the price that they had in 2022. too, and they're willing to take some of the role that the banks are abdicating a little bit. Yeah, and speaking of those different levers you can pull with the seller to try to bring the deal together, SBA doesn't allow earnouts, not real earnouts. So they take one of those away from you when you're trying to do an SBA deal. And so now what you really have left is, you know, seller notes, what we call forgivable seller notes that are not tied to new growth,

but they're tied to maintaining some historic level of performance. And we have now roll over over equity in SBA, which we never had before. That's a new one. That's going to play out really interestingly. It's not always a good idea. Sometimes it could be. But those are the different levers we can pull. And for sure, the sellers are carrying bigger notes and better terms lately. Yeah. It's super fun. Well, just one question on those different lever. I feel like creativity sometimes works to my advantage, but then sometimes people are also like, no, that's incredibly stupid. that will never work. But are there scenarios where people say, you know, hey, okay, I won't do an earn out, but I want to pay the seller, you know, a ridiculously high salary for six months?

Because doesn't the SBA cap it at it like no more than six or 12 months? Well, here's the new rule. When there's no rollover equity, yes, they have to leave in 12 months. When there is roll over equity, they can stay indefinitely. So you could have the seller still be in a role of some kind in the business. So it kind of depends on what that will be, what role. Because I'm thinking you could skew their salary, you know, way above market and kind of like wink, wink, you know, hey, this is not an earn out, but it's a way to say it's performance based or something like that. Well, that's been tried. And most lenders that are SBA lenders anyway will say, no, we'll get, we, the bank,

will get criticized by SBA for going around the earnout rule by doing that. Where there's no written rule per se against it, most banks wouldn't go for it. In practice, it won't happen. What about rent on real estate lease back from the sellers? because I know like it's sometimes hard to pin down what is market rate rent. And usually there's kind of an EBITDA adjustment to say maybe the seller's been undercharging or overcharging or not charging rent. Is there maybe a little bit more wiggle room there or do you get slapped on the risk for that too?

It will get slapped on the risk if you do something way out of market. We do always make though that market rent adjustment. And it does, you know, there's a lot of small deals where the seller owns the real estate and the stated EBITDA in the SIM is way off because of that market rent. adjustment. Once you get to that, you go, oh, wait a minute. You know, here's, here's a problem. Some of the brokers don't, don't pick up on that or don't do it on purpose, I guess. But yeah, it can't really get around the earn-out rule. It'll get lagged somewhere by a bank. So bankers know what they're doing. They're actually smart. I think so.

Well, okay. So I think that's another phenomenon of what's going on right now is I'm seeing tons of banker turnover. Like, like, I'm just seeing people that like, just what, day, like, you get a phone call, and the guy's like, hi, my name's Jim. I'm your new loan officer. And I'm like, what happened to Jill? We just worked with her 15 years. Where'd you go? And the way their comp and non-compete agreements are written, like, they're not even allowed to talk to you for some period of time, right? That's how the banks protect themselves. And it's like, you get this like, and then there's ones who had like weird competitive things where they're like allowed to talk to you, but not about business. So like,

start sending you gift cards and stuff. It's like, what just happened? So, I mean, for me, and, you know, getting to know you, Heather was like huge to really crystallize this. It's like, people think they're doing business with a bank and you're not. Like, you're doing business with a loan officer, a credit officer, and then their investment committee, and then the bank CEOs and processes that they're putting in.

And, like, that's something to watch for. Like, especially if your bank is one that I would call like a tourist bank, that just came into this type of lending during the boom time because they were trying to deploy money and then your loan officer leaves, like you sure as heck better be getting in there worrying about your debt structure and making sure it's stable for the long term because stuff's about to change.

You're getting a new loan officer? That's a new bank as far as I'm returning. It is. And a lot of times the good loan officers, when they're leaving, it's because the bank is no longer going to be entertaining something. And that lender will say, you know, then that kills my book of business. I'm going to go to another bank that does.

So you can usually kind of read the tea leaves, even if the bank doesn't, the bank never announces, hey, we're not going to do this anymore, but they just stopped doing it and they start making different decisions. And the lenders leave. So it is very, very interesting.

And you're right, they're not allowed to solicit their past clients. Yeah. And they'll send you, they won't actively ever get out of a light of business. They send you a term sheet that's basically the, you have to read between the lines. It's the,

we wish, we hope you will leave as a customer. but not really, which is what actually, as a side for you, what soured me on private schools as a concept was when my son had a disability, a learning disability. They discovered it in the middle of the first grade. And basically, the head of the school called us in and was like, well, we're not going to ask you to leave. But there are a lot of public schools that would be better for your son. And I was like, you MF her, you piece of crap. But yeah, you will get that, you got to listen for that term sheet with your bank. Do they send you that one?

And yeah, by the way, one of my companies just got one. I was like, oh, this is something. Yeah, like, that's not really a term sheet. It's like, we gave you something, but it really means something else. You know, there's a couple things that people might find interesting. The lender part, where you said, you know, you're really doing business with the lender. The same bank will sometimes get the same deal from two different lenders in their bank. And one can get it approved and the other one can't.

the exact same. So the interface, the person that's bringing it in to committee can actually sweeten the deal. You know, the bank might trust one or feel more comfortable with one than the other. So it truly is, even in the same organization, depends on who you work with within that organization. They are not the same. And they won't even be able to get the same things done. So I find that pretty interesting. And the other part about like terms sheets that have terms you don't really like and you're thinking, wow, why did they give me this? A lot of times what happens, is, and this was one of my pet peeves, is the lender will take the deal to committee and to the credit folks, and they'll explain why the customer wants what they want, why they're structuring

it the way, why it's important to them. That's their job. They do that. And then the credit person who has the decision-making power will decide that the deal will just be better their way. And they will just restructure it and say, yeah, I'll give you the approval, but it has to be like this. And even though they know that that's not what, that's not really going to work, That's not what everybody wants. They kind of throw that out and just change the terms. It happens in every bank. It's really frustrating.

Well, and one of those people as a salesperson, right? And they're trying to get you on the hook because they want to bring something to committee. And that's important for their livelihood. But then the compliance person has no outward facing sales. Like they don't care. Their job is to protect, you know, the bank and the bank shareholders' deposits and also to mitigate risk because they're regulated. and they only have certain, you know, bounds to operate in.

But it's amazing the things that, you know, the variance that happens between, you know, you talk to the sales guy. You're like, okay, he's got it. He knows what I want. And, you know, maybe I have like an email, but not a full term sheet. And then all of a sudden you get the term sheet. And it just feels like the rug got pulled out from under you because a different guy makes the decision. That's right.

And the different guy doesn't really, not that they don't care, but, you know, they need to look good internally. That's really what matters. The sales guy needs to look good to you externally. The credit guy needs to, or gal, needs to look good internally and giving, you know, tighter terms makes them look better. Even if it's not, doesn't really make the deal better sometimes, you know, statistically some of this stuff doesn't really matter in terms of risk. But, you know, that's the whole way kind of the sausage gets made internally in a bank. Yeah. Any other trends from, from you guys? And then I'd love to talk a bit about, like, how should listeners be navigating this environment and advice for them there? But any other kind of trends you guys are? I just, I spouted all the stuff I'm seeing. I talked about tourist banks, loan officers trading, you know, trading banks, tightening credit market, like just whimsical nose. Any other stuff kind of as trends were seen?

Mostly what you said, you know, prices remaining stable, but bigger and more interesting seller notes. Instead of lowering the prices, they're doing that. dead. I'm seeing a lot of banks that are focused on their deposits, but they are not just saying that, right? They're waving really high money market rates in your face. I got an email today, and somebody's like, hey, you know, I know that you're not looking to switch banks, but basically, do you want to move some of your deposits? Because they now all of a sudden have a lot bigger spread to play with. Banks had gotten used to making money in a low interest rate environment. As interest rates go up, there's a lot more wiggle room for them. to be able to play that spread.

And so all of a sudden, you know, your money markets might have been like, you know, 10, 15, 20 basis points. And now you're talking about, you know, we get money market rates that are over, you know, 3%. And it's just cash on cash. You know, I mean, it's very, very compelling to, you know, to wave that carrot in some people's face. And then all of a sudden, you know, there's a million dollar or $2 million outflow

and inflow into a different bank just because they have a little bit more money market. Well, and there's more to that, I think, just to add on there, it's that Silicon Valley bank effect, right? There was this huge flight to quality. So businesses that had a lot of deposits, now usually, now they have two banks. If they might have had one bank before, they may have two banks now. And one of them might be a big money center bank like Chase and then they're regular banks. So those smaller banks that do all the lending in this space, the big banks don't do the lending in this space. The small ones do. Those are kind of deposit starved a little bit. They're having. to spend a lot more on their deposit programs, on the interest rates that they offer, to be competitive with that outflow that they saw and that they'll probably continue to

see permanently. They will not have the same deposit base because everyone wants to move the uninsured money to a bigger bank. And that's, I think that's a huge change and it's probably a long-term one too. It's fascinating. Okay. So next topic, I'd love to dig in on this. If you're a borrower, what are some things that you should be doing differently to CYA? Cover your butt-sox. Well, I give my clients, so I run Vizzo Business Capital, and I give my clients the advice that sometimes they don't want to hear.

We need to wait sometimes before we submit the deal to the bank. We don't need to just get an LOI and run straight to the bank and before we have a Q of E, before we have some of our diligence items in, because what's happening very often now is retrades. right? So we're getting, we can kind of spot them coming. You know, you can look at certain deals and say, ah, this is on cash and it's going to be converted to accrual after the Q of E. That's going to change some things. There's some weird adbacks that have to be verified. Let's wait sometimes, not always, but let's wait sometimes and get the Q of E and gets the answers to certain really important questions. Then we go to the bank. The reason for that is the less time we spend in the credit process,

the better. The more times we have to go back and change things and ask for a different amount or whatever, it gives the credit committee a chance to change their mind from the decision they made in the first place. Some of the things they said they were fine with, they might say, well, now I'm not fine with it. So my advice is get organized before you go to the bank and have all those, at least 80% of the questions answered before you go. And sometimes that may even mean getting the Q of E first. it's a little scary for some people to do it, but it does yield better results. You get through credit faster and cleaner.

Heather, that brings up an interesting point. I've had these instances where, you know, in my distorted thinking, I'm like, I'm just going to talk to one bank, and I'll just focus all my energy on this one person and hope that they bring me the best deal and their pencil as sharp as possible. And then I go out and I get disappointed.

And I'm like, wow, that's not at all what I thought was going to be. and then I start talking to other banks, and you don't want to have to do this. I feel disingenuous sometimes doing it, but all of a sudden, when there's, you know, one of my old clients used to say, hey, if you want to sell, you know, nine puppies, invite 10 people to the puppy party. Introduce some scarcity, right? So go to these lenders and say, hey, I'm actively looking for term sheets. Here's the information.

I have it already. All of a sudden, they're realizing, okay, this isn't, I'm not the only person they've sent this to. And you say, hey, look, I'm expecting to get, you know, term sheets back by, three weeks from now from a bunch of lenders. And it's amazing the quality of term sheet and the way that it improves, especially if even not disclosing somebody's term sheet to another lender, but just saying, hey, here's the deal that I'm getting. All of a sudden, my deals, I've had drastic, drastic improvement.

And not being untruthful, just saying, hey, this is what somebody else is willing to do. All of a sudden they go, well, hang on, we don't want to miss out on that. Maybe we could get more comfortable if I take that back to credit. Yeah, really good points because the banks want to know what their competitors are doing. Sometimes they'll be a little skeptical. Like, you know, internal talk will be, I'm not sure they can get a bank to do this. I've heard that many times. No other bank is going to do this.

And I'm thinking, that's not true. There are other banks that are going to do it. And so there's a little bit of cat and mouse that goes on there. But what I do is I use a data room system. And my banks, first of all, know that I'm going to. that I'm capable of going very easily to another bank. Everything's all in one place, and I can shut off your access with one button.

So I give them read-only access for the initial period, so they know that they don't have anything. They get to look, they get to make a decision, they get to ask questions. If they're not going to issue a term sheet, we can move on very quickly. But I think it is important that you introduce that competitiveness. But a lot of them will internally start thinking

that no other bank is going to do what they're going to do. So it is something you have to overcome. So switching gears a little bit, we're almost out of time. But one I would add, like, this is a great time if you have standing debt for your business, like go look at how far out you have it, right? Like you have a nine-month cliff where your loan is expected to be renewed at that point. Do you have 24 months?

Do you have 18 months? You know, this is a great time to be talking. You want to be talking extension before you need the extension, if that's that makes sense. Like I don't want to, you don't want to be that person that's like three months before renewal and you're like, okay, well, can we start to talk a renewal now? Like it, you want to be talking about it. One of my companies is doing it 11 months before expiration, which lets them know, hey, we want to do the bank know, hey, we want to renew this right now. We want the stability of it. Or we're going to go start shopping it. And that's really powerful to make sure that you're,

I mean, the worst thing can happen is you have a liquidity crunch, right? Like, they, call up and say, hey, we want the money back. And you're like, what money? It's in the dirt or whatever. So, anyway, we lost meals. Maybe he didn't like my talk. He's going to call his bank. He's going to get that process started. That's what he did.

It's South Carolina internet. Not so good. That's right. Cool. Anything else people should be doing now? You know, this, in terms of how they think about banks, do you think? No, I think it's just, I think we covered most of it, but just be ready that. that maybe the first request that you make is not going to be the one that you would have to be flexible.

And be prepared and maybe don't spend a lot of time going back and forth with the bank. Get the deal fully baked before you go in so that there's not a lot of changes. Yeah. I think the good news is, like, I've been around and you were around in 0-8, 01, I guess 93 was the one before that, but I was still in high school. where, you know, and I guess there was also one that happened mid-COVID for three days when everybody thought the world was going to stop spinning. But like, you know, you want to be ready for liquidity crunch, but like right now we don't have one.

Like there's still liquidity in the system. It's just a little bit harder to get money, which is kind of how it's been all the time. It's little. We're just reverting back to the mean a bit. Right. And, you know, just you want to make sure you're not when the, one of the people that when the tide goes out, you've been swimming naked. That's the important thing.

And I agree. She would ever do that, Heather. No, no, please. You're a classy lady. That's the way this works. Yeah, no, that would never happen to me. But I do think, you know, this is not really that bad. You know, like you said, we've been around a while.

And 2008, that was pretty bad. This is not that bad. This is really minor. And actually, it is kind of funny for me that most of the bankers I work with weren't around in banking in 08. So to them, I think it does seem worse than it is. they had 15 years of easy good times and it seems a little worse to them,

but it really isn't that bad. Businesses are doing pretty well. The default rates really haven't gone up significantly. And I think we're doing pretty good for, you know, a difficult time. It's really minor. 100%. All right.

Well, I think we'll wrap it up there. And yeah, appreciate you guys doing an audible today. I thought this was really cool. Yeah. But, yeah, I mean, I got, I've been getting a lot of questions about debt. I think this was a great thing to do. Hopefully the audience likes it. If you liked this or hated it,

tell us about it on the socials, and we'll try to do better next time if you hated it. Or, I don't know, consider some of the other podcasts out there. I heard Joe Riggins great. Whatever. So my funny story for you, my son, he's been stuck in the house a lot with health problems, and he's 14.

He's a dad, whatever the opposite of homesick is, I'm that. Like, I want to be out of the house. Yeah, he wants to go. That's how I kind of feel about some of these discourses on Twitter or discourses on Joe Rogan. I'm just like, whatever that is, I want to be the opposite of that. That's the podcast I want to do,

is the exact opposite of, like, talking about vaccines or arguing about whether a home is an investment or is a mortgage a good thing. Like, I just, I'm not interested. Why do people want to be angry? I don't get that. I just don't get it. Why is that thrilling for people?

and why is that a form of entertainment now? But it is, sadly. I don't know. I don't know. It's just not stuff I want to talk about. I just want to be constructive and positive and build a better life for me and the people around me. Yeah.

And maybe, maybe this is the wisdom of age we have, Heather. I think so. I think it is. I find a lot of things I think about differently as I get older. And honestly, one of them really is that money doesn't really matter. It just doesn't really matter. And we spend too much time thinking about it. and we should spend more time thinking about the positive things we want to do,

the productive things we want to do. The money comes. But we're too focused on money. I'm taking Spanish lessons. I'm getting, as they say, Mejord, which is better than Spanish. Yeah, there's one Spanish word. It's a bilingual now. But I talk to my Spanish tutor is this lady.

She's very well educated. Her husband's like a celebrity chef. Like she does tours in Spain and France. All the conversations are like America versus Europe or versus the rest of the world and cultures. And invariably, she's like, I don't understand this. Why would Joe Rogan do this?

Or like, why would you guys do this? Or like, why do you buy so many gifts to take home when you're on trips? And like, invariably, my answer is always like, America has a fixation with money. Like, and we equate money to success, to health, to happiness, to wealth, to intelligence. And she's like, that's crazy.

And I'm like, yeah, That kind of is crazy. It is. It is. It is. Yeah. And because somebody made money doesn't make them smart.

And I can say that as a banker. I can see what money people make. And there's a lot of not smart people that made a lot of money and vice versa. There's nothing to do with each other. Intimately. And then I think you double click on that. And you see the way, you're like,

wait, you just made $100 million and you realize they just got super duper lucky. Lucky. Super duper lucky. Right. It's like you just happen to be in the right place at the right time. for somebody to come along and like the lottery ticket paid off and it's like oh maybe I shouldn't I shouldn't assume rich people are smart that you shouldn't you really

should not yeah and and you shouldn't assume what wealth people have by what they show because that is it's usually pretty opposite let's go amazing all right great episode thanks for doing it today see you back tomorrow and thanks everybody for listening we appreciate you all