Last week was Glenn Gould’s birthday. The Canadian pianist’s career was launched in 1956 with his controversial interpretation of Bach’s Goldberg Variations: fast-paced, eschewing the signature repetitions, brash. The recording lasted just 39 minutes, easily fitting on an LP. Still, the recording is considered one of the most important milestones in classical music and made Gould an international star. Gould continued to forge his own style and in 1962, Leonard Bernstein, the then music director of the New York Philharmonic made history by prefacing Gould’s First Piano Concerto of Johannes Brahms, essentially saying “it’s not very good, WAY too fast, and I want nothing to do with it.”
Bach is my favorite composer and to celebrate Gould’s birthday I listened to his 1981 recording of The Goldberg Variations. Recorded a year before his untimely death, his approach to the masterpiece is completely different from the 1956 recording: measured, respectful, and introspective. This version lasts 51 minutes.
What does this have to do with SBA lending?
Our approach at Gulf Coast Small Business Lending reflects my taste in music, specifically what I like about the 1981 version. And, as importantly, we probably wouldn’t be a good SBA lender for a business modeled after the 1956 version. Allow me to explain.
Here is why high growth presents challenges to an SBA lender like Gulf Coast Small Business Lending:
- Free cash flow vs. EBITDA: EBITDA (or SDE) is interesting and important to some audiences, but not to lenders like us. Our credit decision is based simply on the business’ ability to repay our loan, and those payments come out of free cash flow (“FCF”), not EBITDA. Items like working capital changes and capex greatly affect the FCF and the amount of excess cash available to service our SBA loan and the gap between FCF and EBITDA grows rapidly when high growth is projected.
- Lender vs. Investor: Investors look for return on investment which is fueled by growth; lenders look for loan servicing ratios, which are sometimes reduced by growth, especially for sub-10% businesses (the majority of businesses out there).
- High-risk growth drivers: High growth situations we encounter, whether in business plans, acquisitions of existing businesses, or refinancings are often driven by unusual circumstances such as a very large new customer or contract; opening an Amazon distribution channel; or successfully exploiting a short-term supply-chain disruption. From a lender’s perspective, these are fleeting positive events that cannot be relied upon for future debt service.
My generic advice to SBA loan applicants, but even more so to high-growth borrowers, is multifaceted:
- Know your audience: Lenders have very specific criteria to decide whether or not to offer financing to potential borrowers; what advance rates to offer (e.g. how much can be advanced against a specific project); and what terms to provide (e.g. length, amortization schedule, and rates). Lenders are completely different from equity investors, and a presentation that works great for the latter might scare away the former. For example, hockey-stick revenue projections might attract equity investors because of the implied returns, but will scare the typical lender who, from experience, knows that working capital needs would severely limit debt-repayment abilities. To make things even more complex, all lenders are not the same. Many look for collateral, others, like us, are far more interested in the cash flow.
- Do your homework: Knowing that the lender is most interested in understanding the business’ ability to repay the loan, provide the financial information that addresses that aspect of the analysis. That requires taking the model beyond Adj. EBITDA, layering changes in working capital, and expected capital expenditures. The more granular the analysis, the more confidence the lender will have in the model, and the greater chance you have to get a credible term-sheet.
- It’s all about liquidity: This item is very specific to our shop and our products (SBA 7a, 504, USDA B&I, and franchise finance). Other lenders may not care/know. By far the most important aspect of our loan underwriting is determining the liquidity of the business at any point in the past, present and future and making sure that our financing provides ample flexibility to address foreseen as well as surprise ups and downs in available cash. In other words: we really don’t want you to run out of money…to accomplish that, we first strive to understand the operating cycle (see item #2 above). We then run sensitivity analysis to show how the cycle changes as major variables are flexed and what happens to the cash position of the business. Finally, to address any shortfalls we examine the size of the loan, the borrower’s post-transaction personal liquidity, and finally the possibility of adding a line of credit as an extra safety measure.
In summary. Growth is good, growth gets the blood pumping, and it is something many of us are after. But it also complicates debt financing. We provide capital to many growth companies using the tools and knowledge we have and would love to discuss your project with you.
Gulf Coast Small Business Lending is a direct SBA Preferred Lender actively financing small businesses nationwide. If you have a question or a comment about anything here, or if you want to run a deal by us, drop me a message or reach out to one of our BDOs (https://gulfcoastsba.com/our-people/).