In most cases people have invested a good portion of their life savings into the business now going under. Losing your business is a terrible thing. And, being faced with the prospect of repaying your SBA Business Loan with little or no savings and the loss of your business is daunting.
In a majority of cases, business owners opt to work with their Lender to put the business on the market and sell it to a third-party or simply liquidate the assets piecemeal. Here are a couple of common questions and the answers will probably surprise you.
Can I really do a better job than the bank in selling my business?
In almost all cases you can. Lenders are not in business of selling businesses, they make loans. They can repossess the collateral and, in rare cases, they could appoint a receiver to operate a business and then sell it, but in our experience, the business owner is in the best position to maximize recovery here.
If you can arrange for the sale of your business, you are likely going to avoid a brokerage fee of between 6-12% (or more). Or, if the bank repossesses the assets and auctions them the cost of doing so will get charged to the loan (increasing your balance). In many cases, auctioneers charge between 25% – 35% to auction off miscellaneous assets; those buying them are looking for bargains. If your business is a franchise, then the franchisor may want to place someone else in your location and this may also result in that party assuming (taking over) the ground lease as well.
If you are thinking about selling your business assets, talk to your Lender and your attorney and determine the best course of action.
Will the proceeds from the sale count against what I owe the Lender?
Yes. The purchase price will be applied to what the Borrower owes the Lender on the loan. But, be careful here. The assets belong to Borrower and the Borrower’s legal liability has been reduced, but if the proceeds from the loan don’t fully payoff the loan then a deficiency will result. In other words, the remaining balance must be paid — by the guarantors!
Won’t the proceeds from the sale of the Borrower’s assets count against my Offer in Compromise?
No, the balance you are compromising has now been reduced from X to Y because of the sale. As a guarantor you must now settle that liability yourself. For example:
1. The original loan balance is $100,000
2. The sales proceeds are $30,000
3. The Deficiency balance (whats left) is now $70,000
4. The credit you receive as a guarantor against your offer is $0; that’s right – zero.
As a guarantor, you must now make an offer to compromise your individual liability to the Lender under your guaranty agreement. This means that you, as a guarantor, must offer something more to settle the $70,000; this money must come out of your own pocket or be borrowed. It cannot come from any remaining cash in the business bank account or from the sales proceeds.
Before your discuss your offer in compromise with the Lender, talk to your attorney first. Ask how the proceeds from an asset purchase will be applied. This answer can come as a shock to a business owner who is losing their business and must now settle the remaining loan balance. Therefore, be sure you have a plan to fund your offer in compromise because selling the business only solves part of the problem, but will still leave you on the hook in almost all cases.
We are frequently asked by business owners whether they can sell their business assets after an SBA loan default. The short answer is – yes, but the longer answer involves working with the your Lender to get permission to do so. Under your security agreement the lender has what is known as a security interest.
What is a security interest?
In the context of an SBA Loan, a security interest is a legal right granted by the Borrower to the Lender over the Borrower’s property (usually referred to as the collateral). The security agreement provides the Lender Bank with recourse to the property pledged as collateral, if the debtor defaults in making payment or otherwise performing the secured obligations.
How do I know if my business assets are pledged?
Any Borrower closing an SBA loan should expect the Lender to place a blanket lien against the assets of the business. Lenders will file a UCC-1 financing statement. This form is filed in order to “perfect” a creditor’s security interest by giving public notice that there is a right to take possession of and sell certain assets for repayment of a specific debt with a certain priority. You cannot sell assets subject to such a security interest without first paying off the loan giving rise to the security interest in full or getting permission from the Lender to to do so.
I have a buyer for the business assets. What can I do?
If you want to sell the assets of the business to help pay down the loan, you should discuss this option with your attorney before making a commitment to any party to do so. Your attorney may suggest drafting a non-binding letter of intent (LOI) and forwarding this to the Lender for review. Lenders liquidating collateral must take care to act in a prudent manner or risk losing their SBA guaranty rights. Therefore, a Lender will want to compare the offer in the LOI to their appraisal numbers before approving a sale.
You should avoid signing any contract for the sale of your business assets unless your attorney has reviewed it first. In many cases a “condition precedent” to closing the sale should require a written consent by the Lender approving the terms of the sale – in particular, the sale price and the list of assets being sold.
What if my offer is not accepted by the Lender?
If your offer is not accepted by the Lender you should discuss this fact with your attorney. Without the Lender’s consent to the sale, they will not release the lien placed on the business assets and you will not be able to grant the buyer good clean title to the assets; this is something the buyer expects. In most cases, the buyer’s attorney will have required a representation and warranty from you that you do indeed have the ability to give the buyer title to the assets free and clear of all liens.
Asset Sales are Common, but Use Caution.
If you sell your business assets to a buyer without first obtaining bank approval, you may be subject to suit from the buyer, the Lender, and the SBA (in some cases, your actions may trigger prosecution for a criminal offense). Therefore, it is critical that you act carefully and seek qualified legal counsel to help you review offers from any prospective buyer.
What is a CDC/504 Loan?
The Small Business Administration (SBA) has a loan program know as the “504 program”. The 504 program helps small business owners purchase commercial real estate (e.g., a hotel/franchise or a small office building). Unlike the 7(a) program that incentivizes private lenders to help small business by partially guaranteeing their loans, the 504 program is a hybrid.
Under the 504 program, the the borrower has two loans: one to a private lender and another to a Certified Development Company (CDC). In such scenarios, the real estate is financed by a conventional loan that is not guaranteed by the SBA; this lender covers 50% of the project. The second player is the CDC, a nonprofit company acting as a conduit for SBA funds, and it funds 40% of the project; this loan is 100% guaranteed by the SBA. The remaining 10% of the project is funded by the borrower.
In a CDC/504 Loan, the private lender takes a first position lien on the real estate while the CDC takes the second position lien. In the event of a default, a short-sale or foreclosure will usually result in proceeds sufficient to pay off all or nearly all the private lender. I say “usually” because as some of my colleagues have pointed out, real estate in some markets has taken a nose dive.
I am current with the bank, but months behind with the CDC, why aren’t they foreclosing?
The short answer to the question is that your first lender is not in monetary default, so they are unlikely to foreclose on the basis that you have defaulted another obligation, although in some cases breaching loan covenants and representations and warranties will stir a bank to action.If the second lien holder files a foreclosure action, the sales proceeds must still be applied in order of lien priority. Therefore, if the CDC sees that it will not reap enough to make foreclosure worth it, then why foreclose at all. In many cities market conditions for certain types of commercial real estate are so bad that the CDC simply cannot foreclosure. This posture is then assumed by the SBA once the guarantee to the CDC is paid and the SBA assumes actual ownership of the Note and Security Agreement plus the attendant personal guarantees.
If the SBA won’t foreclose, why do I need to worry?
Although foreclosure may not be in the cards for you, that is not to say the CDC won’t sue the borrower and/or pursue the guarantors. And, if they choose not to do so, the SBA still can once the guarantee payment to the CDC has been made. An SBA Offer in Compromise (OIC) may be an available option. If initiated early an OIC can sometimes provide hapless guarantors an opportunity to walk away from a mountain of debt for a relatively modest percentage of what was owed. But, a settlement is not foregone conclusion. The SBA will expect you to dig deep and make a serious offer, otherwise a quick rejection often follows.
Remember, if the SBA cannot collect, then they will send the bad debt to the Treasury Department for collection where a 28% one-time collection fee will be added to the debt. In addition the Treasury Offset Program (TOP) will begin to review the file and take action, including tax refund intercept and offset of social security benefits if you are already receiving them. And, if that is not enough, and you are gainfully employed, you will likely be the recipient of a federal wage garnishment order that can remain in effect continuously until the debt is paid in full.