Navigating Excess Cashflow Distribution in Self-Funded SBA Deals

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When embarking on a small business acquisition using a self-funded SBA deal, understanding how to manage and allocate excess cash flow is critical. This not only ensures compliance with loan conditions but also balances investor returns with business sustainability. Below, we’ll explore a detailed framework for how cash flow can be managed post-acquisition, using a hypothetical deal to illustrate the financial movements and decisions involved. This comprehensive article draws from industry experts’ insights shared in a recent Searchfunder forum discussion.


Hypothetical Scenario


  • Purchase Price: $3 million
  • EBITDA: $1 million
  • Sources of Funding:
    • SBA Loan: 80% ($2.4 million)
    • Seller Note: 10% ($300,000)
    • Equity: 10% ($300,000), of which $100,000 is from the searcher and $200,000 from an investor

 Debt Servicing Breakdown:

  • SBA Loan Payments: $415,000 annually (12% interest over 10 years)
  • Seller Note Payments: $30,000 annually (interest only at a 10% rate)

After deducting debt payments and estimated taxes of approximately $170,000, the remaining operational cash flow is about $385,000.


Allocation Strategy for Excess Cashflow


 Priority to Debt Payments:


  • SBA Loan Compliance: The first charge on any cash flow should be the SBA loan payments, as non-compliance can lead to severe penalties and jeopardize the business’s financial health. As Brad Hettich from Commercial Lending X explains, “When you do SBA financing, of course, your priority has to be able to service the SBA loan from cash flow.

  • Seller Note Considerations: If the seller note agreement includes a subordination clause, payment might be deferred, prioritizing the SBA loan. Hettich further notes, “If the seller note is on standby, then technically you are not supposed to make payments on that loan, and the seller is not supposed to accept payments.”  However, this could vary based on specific terms agreed upon with the seller and any bank involved.

Distribution to Equity Holders:

  • Equity Distributions: Distributions to equity holders are typically permissible once all senior debt obligations are met and are generally made in proportion to ownership stakes. However, these distributions must be made carefully to not violate any covenants of the SBA loan or terms with other debt holders. Mike Adhikari from Illinois Corporate Investments mentions, “You can make distributions to equity holders from excess cash flow,” clarifying that this should only occur if it doesn’t violate any loan covenants.

  • Waterfall Distribution Model: In some setups, a structured approach like the waterfall model might be employed, where cash flows are distributed in a hierarchical manner, starting with senior debt, then mezzanine, and finally equity according to predefined return thresholds.  As Wade Bruffey from Mainshares outlines, “Basically any excess cashflow after debt service gets waterfall’ed down according to ownership percentages… until the full value of preferred participating, and finally common [equity], is paid.”

Retention for Business Growth:


  • Building Reserves:  Retaining part of the excess cash within the business is a prudent strategy, particularly early in the loan’s life. This retained cash can serve as a buffer for future financial obligations or be reinvested into the business for growth, which can ultimately enhance the value of the enterprise to the benefit of all stakeholders. Drew Osika from Wintrust Bank highlights, “It’s worth reiterating the importance of retaining earnings… particularly early in the life of the acquisition loan.


Legal and Strategic Considerations:


  • Understanding Legal Restrictions: Familiarity with the terms set by both the SBA and any other lenders involved is crucial. For instance, SBA loans often have specific stipulations about early payments and distributions.

  • Investor Expectations: Clear communication with investors about how and when distributions will be made is vital. Setting these expectations upfront can prevent misunderstandings and conflicts.

  • Financial Prudence: Maintaining a balance between making distributions and retaining earnings to ensure the company’s long-term viability should always be a priority. A good rule of thumb is to hold back enough reserves to cover at least one year of debt service.


Expert Advice

Several experts from the industry weigh in on the importance of adhering to these strategies. For example, Brad Hettich highlights that while SBA rules allow distributions, they should not negatively impact the financial condition of the business. Similarly, Mike Adhikari points out the potential risks involved with premature distributions if the business encounters financial difficulties later.


In summary, effectively managing excess cash flow in an SBA-funded acquisition involves a delicate balance between meeting debt obligations, making investor distributions, and retaining sufficient funds for business stability and growth. Each decision should be guided by the specific terms of the debt agreements, the strategic goals of the business, and the expectations set with the investors from the outset. This approach not only ensures compliance but also positions the business for sustained success post-acquisition.


Frequently Asked Questions

The primary priority is to service the SBA loan. After fulfilling this obligation, other allocations, such as payments to seller notes and distributions to equity holders, can be considered.

No, if the seller note is on standby, you should not make payments on it, and the seller should not accept payments. This is to comply with the subordination agreement with the bank.

Yes, distributions to equity holders are allowed as long as they do not negatively impact the financial condition of the business and comply with any loan covenants.

A waterfall distribution model allocates cash flow in a hierarchical manner, prioritizing senior debt, then mezzanine debt, and finally equity. It ensures that each level of stakeholders receives payments in a specific order.

Yes, it is advisable to retain a portion of the excess cash flow to build reserves and ensure business stability. This practice helps safeguard against future uncertainties and financial obligations.

You must adhere to the terms set by the SBA and any other lenders. This includes respecting subordination agreements and ensuring distributions do not violate loan covenants.

Clear and transparent communication is crucial. Setting the right expectations with investors about how and when distributions will be made can prevent misunderstandings and conflicts.

If distributions negatively impact the financial health of the business, it can lead to serious issues, including potential default. It’s recommended to retain earnings to ensure liquidity and cover future obligations, ensuring the business remains financially stable.

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Picture of Written by Roman Beylin

Written by Roman Beylin

Roman Beylin is the founder of DueDilio, a leading online marketplace to assemble an M&A deal team. Our large and growing network of highly vetted independent professionals and boutique firms specialize in M&A advisory, due diligence, and post-acquisition value creation.

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