Introduction

Tanya: Welcome to SBA Today, with all the latest news stories and advice, for the week of July 21. I’m Tanya.

Paul: And I’m Paul.

Tanya: And today, look at this. Who’s that sitting beside you, Paul?

Paul: That’s my buddy Greg.

Tanya: Yes, we have Greg today, and he’s with IBA. Greg, would you like to tell us a little about yourself, or Paul, would you like to introduce him?

Paul: I think Greg would do even better talking about himself.

Tanya: Tell us about yourself, Greg.

Greg: Good morning, and thank you for the opportunity to be on SBA Today. It’s a wonderful podcast and a great source of information. I’ve been a business broker for 31 years, and I’ve been president and CEO of IBA, the Pacific Northwest’s oldest and largest business brokerage firm, since 2000. So I’m in my 25th year at the helm.

I’ve been a resource for the SBA and SBA lenders for many years. Many in your audience may know this name: I was honored to represent Joann Bruno in the sale of her company, J.R. Bruno & Associates, which set up SBA departments at banks. I call her the godmother of the SBA. She was with The Money Store at the very beginning. When she decided she wanted to retire, since we had met at SBA training conferences, she asked if I could facilitate her sale because I understood the SBA. In SBA lending, I don’t think there’s a stronger brand in consulting.

Paul: That’s awesome. As a partner of yours, Greg, I can say you and your team do great work in the community. You have great brokers, and you’re so knowledgeable. A lot of brokers know SBA lending, but Greg is really good at getting into the weeds on it. That’s why I love partnering with him and his team. So glad to have you here.

Greg: Well, Paul, a lot of brokers don’t know the SBA as well, and we’ve both seen them.

Tanya: That’s true. I’m not saying IBA, y’all. But I’ve had a few come across my desk, and I’ll tell you right now, it’s so much easier to work with someone who knows the SOP. They’ve done more deals. They’re not depending on someone else to explain what they can and can’t do. They already know it. So everything looks different when we get a package from you or work with your team. Thank you, Greg.

Greg: My pleasure. And tying into your last episode, I’ve always believed in following the banker, not the bank. Bankers make an incredible difference, and they bring their followings and their relationships with brokers and others to their new banks and organizations. There’s no replacement for knowledge and experience.

Tanya: Agreed. That’s what they always say, and it’s no different whether it’s the business broker or the lender. You can train people on a product, and different companies have different products, but you can’t train who someone is.

Why Holdbacks Are Misunderstood

Paul: In today’s episode, we’re going to talk about holdbacks. Before we do, I want to explain why I wanted Greg on this show. Sometimes I don’t know everything.

Tanya: Paul, that’s shocking. My jaw just dropped.

Paul: Even with my team, I always say, “You can tell me my baby’s ugly. If you don’t believe something I’m saying, go double-check it.”

Tanya: Wait, I’m going to stop you right there, Paul. That may be true about everything else, but not about our children. We can say whatever we want about them. Nobody else had better say it.

Paul: So Greg and I have been talking about holdbacks for a while. I thought one way, and Greg thought another. Greg was right.

Tanya: The broker was right. That’s impressive.

Paul: That’s why we want to talk about holdbacks, because there are misconceptions out there.

What the SBA SOP Says About Escrow

Paul: Let’s start with what the SBA says about holdbacks and what it’s not okay with. The SOP states that you can’t use an escrow account for more than five business days to facilitate a loan closing. That’s clear. For example, say we do a loan and send the SBA loan funds to escrow, and for whatever reason they sit there for seven days. That’s a violation of the SOP, because the loan funds sat in escrow for more than five days. Maybe that money was going to pay off a debt, or you wanted to hold some back for a future purpose in a business acquisition, and let’s use business acquisitions as the main example here. In that case, you can use a multi-disbursement term loan instead.

The whole point is that the SBA wants to make sure its funds are being used, not sitting in an account waiting to be used while the borrower is charged interest. Hopefully that part of what the SOP says makes sense. Greg, can you think of any other specific examples related to what the SBA won’t allow?

Greg: I’m very aware of the five-day period. What I often find trails the process is transferring vehicle titles and determining whether the bank will be on the title. In Washington, for example, there’s a narrow window to match a value, or the Department of Licensing will reject the title transfer.

Tanya: Exactly. Especially with multiple titles.

Paul: Fleets are a lot of fun, aren’t they?

Tanya: Oh, they’re so much fun.

Borrower Funds vs. Seller Funds

Paul: Now keep in mind, that’s pretty much all the SOP says you can’t do when it comes to escrow. Everything else is, as with most things in the SOP, open to interpretation.

Tanya: Paul, when you sent me this topic for today’s discussion, I thought you were right, because of the way we read the SOP. It states the rule, but it isn’t clear, depending on how you read it. It’s only talking about borrower funds. But that’s often not clear, because we’re all thinking about escrow in general: “You can’t have escrow. You can’t do that.” It isn’t necessarily talking about the funds going to the seller. It’s talking about loan funds from the borrower.

Paul: Correct.

Tanya: That’s where the big confusion comes from.

Paul: Exactly. There’s another section of the SOP that talks about escrow holdbacks the SBA is okay with. But interestingly, it has nothing to do with business acquisitions. It covers 504 escrow holdbacks for environmental reasons, which is a whole other rabbit hole.

Tanya: You mean you sometimes have to dig around in the SOP and go to other sections?

Paul: I know, it’s weird. There’s a 504 section. I don’t play in it much, but it’s there. It covers environmental reasons, and that’s about it.

Why Holdbacks Exist: Trailing Liabilities

Paul: So now let’s talk about holdbacks, and this is where I want Greg to come in, because holdbacks are very common in business acquisitions. Greg, tell us about seller funds and what sellers can do with holdbacks.

Greg: Certainly. The legal purpose of an escrow holdback is to protect the buyer against trailing liabilities. The basic principle is that the seller should take responsibility for what happened while they were at the helm of the ship, and the buyer should take responsibility for what happens after they’re given the keys to the vessel and take it forward.

As you’re both aware, transferring a business is a lot like jumping on and off a moving train.

Tanya: Or a float, in my case.

Greg: It’s virtually impossible to tie off all the loose ends. So what smart attorneys do is create a mechanism for addressing trailing liabilities.

From your standpoint, and Paul and I discussed this over lunch, the money essentially goes to the seller from the sale. The loan is completely funded. But part of the proceeds sits in limbo in case a trailing liability comes up.

One example of a trailing liability is unpaid taxes. In Washington, sales tax is paid the month after the period ends, and there’s successor liability if the business stays in operation under the same name at the same location. If that tax isn’t paid at closing, the buyer will be responsible for making good on it, even though the seller made those sales and received the money in the prior period. So trailing taxes are a common one.

Another common one is warranty or repair work. Say we sold an HVAC company, which, as we’re all aware, is a very hot space right now. A week before closing, a furnace was installed with a loose wire, and it stops working. The property owner asks them to come back and fix it. The buyer of the business wants to go back. They don’t want a negative Google review saying the furnace was installed a week ago and the house was cold at Christmas dinner. So they go out and fix it. The seller in that transaction should pay for the labor to make it right. The buyer shouldn’t be damaged. So in the purchase and sale agreement, there may be an agreed labor rate per hour. Or with a manufactured product, where everything has a failure rate, the agreement addresses how returns are handled.

Another example: say you close the sale based on the inventory value in the point-of-sale system, and a later true-up determines the count was wrong. Money should go back to the buyer, because they overpaid.

All of those items get addressed through an escrow holdback, which lasts anywhere from a few months to a couple of years, depending on the company. From your standpoint, the transaction is done. But from a legal standpoint, the buyer wants the seller to close up shop on their end and not pass along any problems for the buyer to deal with.

Disclosing Holdbacks to the Lender

Tanya: I want to make sure people understand what Greg is describing. This has to be disclosed to the SBA. When you’re doing the transaction, any agreements or holdback terms have to be disclosed in advance in the purchase and sale agreement. Often it’s treated as something outside the transaction, and it can be, as long as it’s disclosed, because there are certain things the SBA will say no to. So make sure you’re disclosing all of this up front.

Paul: I do think it’s really important. Of course it needs to be in the agreement, describing in detail what it is and how much is held back. Be as detailed as possible. The SBA would want to know in case of a default, but even more, we as the lender need to understand what you’re preparing for. It’s really more of a lender concern than anything. And we need clear instructions on how the funds will be disbursed, whether it’s an escrow company or the institution holding the funds that will release them. There need to be clear expectations.

Greg: Isn’t it typically held by an escrow company rather than the bank itself? That’s a question. It’s usually a different escrow from the one closing the transaction. And because it’s seller funds, if the seller is innocent and nothing comes out of the woodwork, they can earn interest on that money while it sits.

Paul: Right.

Greg: Because it’s truly their money. They’re innocent until proven guilty.

This is where the purchase and sale agreement is important. I have yet to see an SBA lender close a deal without an executed purchase and sale agreement, so you’ll review all of this. But there also need to be mechanisms to make sure buyers don’t try to get reimbursed for unjustified claims, because that can happen too.

This is where we need good attorneys in transactions. I always say to break the machine: make sure the purchase and sale agreement can handle every scenario. In a perfect world, the agreement goes into each party’s safe and no one ever looks at it again. But if an issue comes up, you pull it out as a reference manual: this is how we deal with this.

For example, say the seller puts their child into a business doing exactly the same thing. Does that violate the non-compete? Hopefully the buyer’s attorney was thorough enough that there isn’t a loophole letting Johnny or Jane hang out a shingle and go into the same business under the family name.

Paul: Right. And that’s why it’s so important to have legal counsel on both sides.

Why You Shouldn’t Go It Alone

Tanya: And that’s why having a good broker who knows the industries, knows how these deals work, and knows SBA loans is so helpful. There are so many moving pieces. I’ll admit it: I once tried to sell a piece of real estate myself, for sale by owner. It was the dumbest thing I’ve ever done, and I told myself I’d never do it again. There are people out there who try to sell or buy a business on their own. I’m sorry, but that’s the same thing as for sale by owner. Good luck. It’ll be a train wreck.

Paul: And you’re going to lose money. Everybody is focused on paying a little up front to get a good business broker working for them, or paying a lawyer, or a business plan writer, or any of the other things that go into making good decisions and putting your best foot forward. That even includes talking to a banker maybe two years before you decide to sell your business, because there are so many things you need to put in place first. Otherwise you’re not prepared, and it will show. Sometimes it’s worth spending a little money up front, because you’ll reap so many more rewards afterward. All three of us have seen people who didn’t do that work up front and paid the price on the back end.

Greg: Agreed. And I’d add that, in my experience, mature, successful business owners delegate. They’re not the ones trying to figure out how to build a website. They hire someone to build it. Selling a business is the same.

I’ve been doing this for 31 years. I’ve done over 300 transactions myself, and the company has done 4,400-plus. There’s knowledge gained along the way. I always say there are issues that four out of five business brokers can solve, and there are issues only one in five, one in 10, one in 20, one in 100, or one in 1,000 can solve. I’d guess the same is true on the banking side. Based on knowledge and experience, you can get a deal to the closing line that another banker, who hasn’t been doing it long, wouldn’t be able to.

Tanya: That’s true. It’s what makes you valuable in the industry when you put in the work to know more, learn more, and do more. It definitely makes you worth more.

Paul: Exactly. That’s why, as Greg said earlier, and as we’ve said in previous episodes, people bank with a banker, not necessarily a bank, because the knowledge follows the banker.

Tanya: It’s like age. The older we get, the more knowledge we have. I keep telling my kids that.

The Key Takeaway

Paul: We went a little over time on this, and this topic probably won’t get us our highest ratings, which is sad. But the information here is critical. The biggest thing I want everyone to take away is this: seller funds can be escrowed. Bank funds cannot. As long as the bank funds are sent out and disbursed, what the seller does with those funds, including putting some of them in escrow, is totally different. And I even got someone from the SBA to confirm all of this, 100%.

Tanya: That was impressive. I just have to say it.

Paul: Go ahead and close us out, Tanya. And thank you, Greg, for being here.

Tanya: Yes, thank you, Greg. As you can all tell, I’m not there with them. What does the weather look like out there?

Paul: Bad.

Tanya: Key West’s doesn’t, baby. No, I’m kidding. All right, everyone, come check us out on Tuesday mornings, typically at 9:00 a.m. Mountain time, on LinkedIn, YouTube, or wherever you get your podcasts. Reach out to Paul or me on LinkedIn, because we’d love to connect with you. Thank you so much, Greg, for coming today. We’ll see you next week. Be safe.