EP 108: New Changes from the SBA Affecting Buyers and Sellers of Businesses with Ray Drew

Ed Mysogland  0:19  
Welcome to another episode of the defenders of business value podcast. I'm your host, Ed Mysogland. This this week, we're talking to Ray Drew. And, and for those of you in the Twitter space, he is known as SBA Ray and he is all things SBA. So Ray, he's a five time top producing SBA lender, and the host of the number one podcast in the SBA industry. The title of the podcast, and you should subscribe as I do is the art of SBA lending. And you're saying, Well, why would I? Why would I do that? Well, there's lots lots that goes on behind the scenes and having a clear understanding of, if you're a buyer or seller or an advisor, for that matter. It's a good, it's a good podcast to understand the things that are going on behind behind the scenes, as well as the future of of this type of lending. So He's dedicated his entire professional career to helping small business owners navigate the intricacies of SBA borrowing. And I can tell you after the podcast, he he delivers, he absolutely is an authority on on all things SBA. He's currently the managing business development partner at Fundex. Solutions Group, which is a national leading non bank, SBA lender for business acquisitions. So I, I am certain that you will learn something, it was a great conversation and, and I always love talking about SBA lending, because it is, as a Deal Guy, it really helps to be able to align yourself with, with people that are versed, and people that can get deals done. So I hope you enjoy my conversation with rager a funding solution? Well, Ray, welcome to the show.

Ray Drew  2:23  
Thank you for having me.

Ed Mysogland  2:24  
You know what I've been looking forward to visiting with you. I'm, uh, I lurk on on Twitter, I should, I should probably get more more active in common and things like that. But but, you know, I do follow a lot of what you a lot of what you're preaching what you're saying, and I'm just grateful that that you hopped on for this morning to visit with us about what's going on with the SBA. So always happy to do that. Well, I wanted to start, you know, I always my introductions you have before you come on, you know that they're thorough, okay, but I guess it always sounds better coming from the person I'm interviewing. So can you talk a little bit about your practice? Before we get started? Sure.

Ray Drew  3:14  
I got into SBA lending in 2011. Right out of college, I just, you know, fell into it by accident, like many people in the SBA space, and I'm a Business Development Officer. So I go out, I find people who need financing, and then I work with them through the process to get to the finish line so that they can start grow, wire, their business. And so I've been doing that over the last 12 years. And it's, quite frankly, my only skill in life. And luckily, I love it very much. But I'm now managing business development officer at fund x, we're a non bank lender focused in the business acquisition transactions, I run a small team and I do my own loans for folks looking to buy businesses. Nice. Well,

Ed Mysogland  4:01  
that brings us to I wanted to visit with you So November brought us some some new guidance from the SBA. Can you can you talk a little bit about, you know, some of the some of the changes that, you know, are applicable to to buyers and sellers.

Ray Drew  4:18  
Yeah, and to put it into context, like, you know, people when they're ready to go get an SBA loan, they may not understand that the rules change every few years. And sometimes they change more often than others. And so this time, which really was in August, and even though we got a taste of it in May, but essentially 2023 was the biggest changes to the SBA 70 program in beyond the 1213 years I've been doing this and the SBA has really been pushing access to capital, especially on smaller dollar loans. And they're just trying to find ways to streamline the process now. One of the big changes they did this year was To introduce partial change of ownership transactions, they also loosened up their equity injection requirements. And they made this big pivot to allowing lenders to underwrite and close the SBA loans the way they want to, which, you know, created quite a stir, they also changed their approval process. So any one of these things could have been like the biggest change ever in the SBA world, but they did it all at once. And so when that came out in August, we were left with more questions than answers in some cases. And so they came back here in November, you know, meanwhile, the last three months, we've kind of been like just winging it. But here in November 2023, they came out to kind of close the loop on a lot of those questions that we had.

Ed Mysogland  5:47  
Well, let's start with partial buyouts. I guess I'm curious to know, why do you think they did that? Why, why partial buyouts?

Ray Drew  5:58  
So when it first came out, I thought that maybe it was a way for folks to buy into their company. But you know, what we're seeing more is just people buying, you know, anyone that 90 99% of the company, right? Sellers are essentially exiting their business, but retaining a small percentage, usually, it's under 20. So that they don't have to personally guarantee the loan, right, because anyone who has 5% or more, as personally guarantee the loan. So we're seeing it there a little bit more. But you know, I think there's other things like one thing I thought of was, if you are the owner, and you gave your manager 5% of the company, and you wanted to sell the company, well, if you already are required to retire, but your manager wasn't, you would have to sell the entire company to a buyer and the manager would lose their 5% ownership. So I think ultimately, it was just a way to add more flexibility to the program. Interesting.

Ed Mysogland  6:57  
You know, the I was thinking maybe it had to do with, you know, how everybody wants to do an ESOP. You know, everybody on, you know, that shows up here thinks that they might be a candidate for an ESOP. And, and the majority of the time, you know, we're talking them out that they don't have, you know, what's going on, you know, what they need in order to successfully operate, own and operate, you know, in an employee owned organization. And I think, you know, as far as the partial buyout, I think that that stemmed a little bit, you know, to why, why it was put into place, you know, not only not only from, I think there was an increase and partner buyouts or, you know, the fractional interest buyout with, like, professional practices, but more so that, I think that this gave the SBA a vehicle that accomplishes the same thing as an ESOP. And that grant, we're only talking to an employee as opposed to multiple employees. But again, it's only theory, I have no idea whether or not that's your that your thoughts on it? Or am I way off

Ray Drew  8:15  
base? Well, one of the one of the kind of interesting parts right now is that I don't understand the why behind a lot of what the SBA did in this last round, you know, what we do is we keep our head down and try to understand the rules, trying to educate the marketplace on the guidelines so that they can move forward in their businesses accordingly. And oftentimes, you do understand the why if you really work closely with the SBA, and our trade organization, but this was one of those times where they implemented some things that were just like, you know, what is this? Why are we doing this? No one's asking for this. So like, it would be nice to understand it a little bit more. But the way the marketplace is reacting is essentially, they're using it in a couple of different ways. One is a risk mitigation tool. And there's, you know, a school of thought that if the seller remains in the business, there's less transitional risk, you know, it mitigates the transitional risk and give the seller, a potential second bite at the apple and incentivizes them to help set the buyer up for success. And there's, you know, there's other flip sides to that as well. But that's what we're seeing, in addition to, it's a vehicle that allows the seller to stay on past 12 months. So like with a complete change of ownership transaction, which is what we've been doing. The SBA has a very strict 12 month limit on how long the seller can stay on. And with the partial change of ownership, even if they own 1%, they can stay on indefinitely. And so we're seeing that being used for solutions to different problems, such as licensing, for example.

Ed Mysogland  9:57  
So yeah, I'll tell you the one of the things that that struck me is, yeah, there's similarities, similarities to the, to the vehicles. Like, for example, your you just referred to the second bite of the apple, you know, that is that has been a private equity play for forever in a day where we recap the business and the end the owner, you know, participates going forward. And like I said on the partial buyouts, it almost it almost, it has a lot of the bells and whistles that you would find in an ESOP minus the compliance issues. So maybe they were taking playbooks out of, you know, some of the other vehicles?

Ray Drew  10:41  
Yeah, I'm not sure. It's interesting, but we'll see how it unfolds, you know, yeah,

Ed Mysogland  10:46  
no, no. It I mean, from a, from a deal guy. And from, from your standpoint, keep rocking on SBA. You know, that's, uh, all right, on. So on, standby notes. You know, every seller, you know, it's amazing. The new sellers don't understand, just, you know, you're getting 90 or 95% cash, and you're still pissed about, about a standby note, can you talk a little bit about the standby note what it's for, and, and how, how, mechanically how it works. And then And then lastly, how most sellers will get that numb will will get their money eventually. But it's, there's a purpose behind it. So can you talk a little bit about that?

Ray Drew  11:38  
Yeah, well, you know, that's why business brokers have a tough job, you know, these intermediaries have to educate sellers on what the market is doing, and what's realistic, and why things are required. You know, that's I don't, I don't really speak to the sellers on most transactions. So I don't have those conversations. All I know is that a seller note in general is pretty market, you know, to have in a transaction and buyers like them, because, you know, after you close and you're so reliant on the seller, just a good way to keep them engaged and make sure that the transition is successful, and that the buyer and the business continues to see success. Now, when you get into standby, you're talking about equity injection. So this is one where just give you a little more history. Prior to 2000, I want to say 16. The maximum I could finance on a large business acquisition, so anything with over half a million dollars goodwill, which is like all of them. The maximum I could finance and again, this is pre 2016 was 75%. So unless a buyer had 25% Cash, right, that was a long standing thing. And so you had seller financing in there on all those deals that you saw 15%, seller financing, 10%, cash, 75%, SBA, that was standard. Then in 2016, the SBA said, Hey, let's, let's loosen these guidelines up. And let's allow for 90% financing for business acquisitions. We, I was shocked. I said, no banks ever gonna go to 90 on a business acquisition, that's super high leverage. And yet, we got there. And we got even beyond there with the, you know, the SBA allowing 5% of that to be of that 10% equity injection to be a seller note, but then they introduced the thing called full standby for the life of the loan, we had never seen that before. It was, that's a pretty tough pill to swallow. Because it's essentially like, you're not that 5% You're gonna get paid back and maybe 10 years, right, you can't collect any of that 5% Until the SBA loans paid in full which either 10 year loan. So that was new. And that's a tough one as well. Now, the good news for sellers, if you put that into context of hey, the SBA just made it so that you only have to put this on standby for two years now, instead of 10 years, it's two years and now you can now sell your business to buyers. And the pool of buyers who can afford 5% instead of 10% is going to be much bigger. So you should be able to get more money for your business, you should be able to sell it quicker, and you'll be able to earn interest on on the seller note so I kind of liked that structure now. And I liked the flexibility the SBA has given us to get deals done. Yeah, I

Ed Mysogland  14:30  
think it's gonna I think it will do it will do the, the buying a business community. A lot of good because back in the day, you know, it was like look, you got a 10 year standby. You know, if you never see this that mean our council was if you never see this, are you okay with the deal? Right. So if you're good, then let's proceed. But yeah, I Yeah, the thought was funny and I I'll just address the question. Now you know, back in A day, and this is before your time, I mean, getting all cash or 90 or 95% Cash would mean that you would have to take a substantial discount on price, you know, because all of the risk or the bulk of the risk was being put onto the buyer. And so, so there was, like I said, just the, the price was discounted, but now, I mean, you're still talking 95% cash. And so I guess I, the question behind that is, what do you mean? What's your thoughts on that? Is that a good thing or a bad thing? Because I, the phenomenon would be, you would think that it would lower the price, but it hasn't at all, as a valuation guy. I'm looking at like, oh, I mean, I've got biz comps of, of deals. And there's a book called transaction patterns where they did a study of the, the amount of discount for all cash over a course of a 10 year period. And I mean, it's like 30, or 40%. So it's, it's interesting where we are today. So you got any thoughts on that?

Ray Drew  16:12  
Well, we're talking about pretty mainstream, and maybe some lower middle market deals here in the SP arena, I mean, I could go up to $5 million on a loan. And that those multiples have remained pretty constant for as long as I've been doing this, you know, we've been talking about 3x 4x, whatever Ste. And, you know, if the SBA loan program were to go away, think about what that would mean, for sellers, they're holding north of 50%. And I'm sure taking a discount on on on these transactions, it's only because of the SBA 70 programs for me, that all these sellers can retire with this huge cash windfall

Ed Mysogland  16:52  
at closing. Yeah, and, and that's what's so funny about it, it's like, I don't think you understand just how big of a deal it is, of what the SBA is, is enabling you, and your exit, and enter, right, I don't think they ever will.

Ray Drew  17:09  
That's, it's just like anything, you got to put yourself, put yourself in the buyers shoes, like, if I was going to go out buy a business, I'm going to require that the seller hold some papers, especially if I don't know the industry, because I'm going to be reliant on them. And I don't want there to be like, if the business if it turns south after closing, and you don't have a seller note, you're kind of like screwed. So like, if you if you do have a seller note, at least you have that additional lifeline now, most deals, you know, aren't going to move in. It's not like these deals are going bad left and right. The SBA has a pretty low default rate. Although I think there's a little bit, you know, of I think that it's artificially low to a certain extent. But still, you don't want to put yourself in that situation where you just are, you know, up SS creek without a paddle. Right? Well, you know,

Ed Mysogland  18:15  
and again, I mean, you're right, I mean, the seller, a note is an attention getter. And I as a, you know, now the with the SBA that has has, has enabled this only to go to yours. I mean, it from a seller standpoint, and a buyer for that matter, you know, it accomplishes what it's supposed to within two years, you should have a pretty good idea about the business. And if there's any kind of right of offset, you will have already addressed it in that note. So to me, you know, good on the SBA on the, on the reduction of the of the term, because if that's what they were trying to do, they accomplish both things, you know, meaning the, you know, they got the lower equity injection, from the buyer, and they and they're enabling it to serve as the vehicle to mitigate the risk in the event of, you know, misrepresentation or whatever the issue may be. Right. So how much due diligence do your underwriters do when when they're getting financed? Yep. Because I think sellers. Yeah, it. Now here's the here's, here's all this information that that's provided you, not as much as provided to the buyer, but there's a pretty good chunk that goes to you. So what do you guys do with all that?

Ray Drew  19:41  
I would say the due diligence we do is probably about a 10th of what a buyer could do. I mean, we are in there's one thing that's pretty common in all of the deals that come across my desk, and they all want to move very quickly. Because everyone understands time kills deals. And sometimes people are searching for six months, a year, two years to find the right business. So when you find it, you don't have time to go work with a lender who's going to just start lollygagging around, you know, you want to be able to work with someone who can pick it up and run. So we've designed our program around speed and execution. And so when I submit my file to underwriting, they, most often will, what they'll do is they'll take the package. So this is everything that we get mostly tax returns and business plan projections, were mostly focused on cash flow, the amount of cash flow, terms of debt service coverage, and the quality of cash flow, do you do ask some qualitative questions as well and dig into customer concentration and things like that fire risk, but they have that file for about five days. And that's not enough to do due diligence on a deal as a buyer should, right so like they're going to have maybe two conversations with the buyer, the underwriter is, they're going to look at the package we've assembled. And they're going to create an SBA credit memo that's going to be used to submit the loan for approval. We are focused very much on debt service coverage. So most deals that have a good business with good debt service coverage, and someone who we think can be a good operator for that business. 99% of those deals are going to work. And so we're just trying to make sure we are not missing anything, and that there's no red flags. And so that is a a one week process. So how much can an underwriter possibly do in a week, it's enough for us to get comfortable, but it's not enough to do diligence.

Ed Mysogland  21:49  
So from start to finish, how many days?

Ray Drew  21:54  
So we see, I'll tell you my fastest was six and a half weeks, we've done a couple of those in the past year or so. And those are the ones that's like, a my lender told me this, we've got a full file, we got to go. And you know, the other lender dropped the ball, or they changed the terms at the 11th hour or whatever. And, you know, so if you if you were, if you're late in the process, and you come to me, yeah, we can turn it around in six, seven weeks. But most of the people coming to me are coming to me much earlier. Right, right before loi and most of those deals are taking a solid 60 to 90 days, I would say for them to actually go through the process. Like Like I said, My process is only a week to underwrite a deal. So it's really them going through due diligence going through the APA, or stock purchase agreement negotiations, assembling all of the different closing documents. And then once they have all that stuff put together, you know, we we go ahead and close the loan, I got a

Ed Mysogland  22:55  
lot of sellers want to know about the business valuation and two things one, you know, why is it required? That's the first thing because if it pencils out from underwriting, why do I need a business valuation? So that's my first question.

Ray Drew  23:14  
Can it can my answer be because the SBA says so?

Ed Mysogland  23:18  
Know? Yeah, I mean, absolutely. I mean, I know a lot of people that do business valuation work for, you know, for compliance per SBA compliance purposes. And, and I always heckle him, I'm like, does any of your does anything ever come back? I mean, you know, anything that you ever say, Yeah, you know what, this is a bad deal. You know, it wouldn't have gotten to you. If it were if it was a bad deal. You know, that's just me. But I may be wrong.

Ray Drew  23:46  
Well, you know, you'd be surprised because there are some deals where you'd look at it, and it works. It's tight, but it works. And so the debt service coverage, which the SBA is debt service coverage, minimum was 1.15. Now, the reality is, most deals at these valuations should warrant much higher debt service coverage. So you don't really have if you have a deal that's priced, right. It cash flows, right. Like most of the time, that's why I like these deals, there's always a way to figure out a way to get it done. But if I'm really tight on my debt service coverage, I look and I say, Well, you know what, I'm at a 1.15. And then I look at the multiple I'm like, There's a 5.8 times multiple, it's like, something's off here. And so I'll be like, Hey, let's just to let you know, like this works for me, because I needed debt to hit my debt service coverage requirements, but it's probably you're gonna have a valuation issue on here, because I see this range here, two and a half to four and a half times. Let's say, you're over here. You got to take a look at that. Yeah,

Ed Mysogland  24:51  
I can. I can see that. I've seen more operational disqualification moreso than financial disqualification and because nor Really, some somebody like you will will pump the brakes and say, Yeah, you know, this, this, this is so paper thin that, yeah, if there's a, if there's a miss anywhere in the process, we, you know, you run the risk of default and, and you're only putting five 10% down. So you don't have a lot of a lot of room to, you know, to make that mistake and I have seen a retreat as a result after, you know, after talking with somebody like you and fortunately they did. And you know, there's only so much money it has to pencil out. So again, I will continue to hassle my business valuation brethren that do SBA work and just checkbox work. Just that just dead talking, I'm I'm shoot my mouth

Ray Drew  25:52  
off the SBA, the SBA actually just requires that the business valuation supports the loan, not purchase price. So you can theoretically overpay for a business, you know. And if you have a large seller note, you can overpay by a lot. And I don't you know, not that I wouldn't want to but like some people do. And sometimes it makes sense in a strategic acquisition. So you do have that flexibility, which is nice. But for the everyday person coming off the street, in corporate America looking to buy a business, they probably want to buy something that's at fair market value. And I think the SBA just wants to protect the buyer. And that's what the thought is behind just having that requirement. Yeah,

Ed Mysogland  26:32  
I get you. And like I said, I mean, as a as a valuation guy, I have all kinds of reasons to hassle my my brother. I wanted to ask you about, you know, on these partial buyouts, so you and I, you and I buy a you buy my business, I stay around for 20%. You default? If for whatever reason, I and I have no idea why you did. But I'm here I am. I'm 19% I don't have a personal guarantee I could let this thing burn to the ground. My question is, how can I get the business back? You know, do I do I have to allow the default process to run its course? Or can I quickly come in and assume the loan? You know, what, what are? What are my options? That's

Ray Drew  27:21  
a great question. And the interesting part about this period in time is that situation has never happened. Because the partial change ownerships are so new, that didn't have enough time to have made one I just made my first one two weeks ago. Right. And so hopefully, they're not in that situation. And, you know, it will happen eventually. And you're gonna have to see because like, you get into the default process with SBA, which is not my area of expertise, although I did have someone who specializes in that on my podcast a couple of weeks ago. But that is, that's a bridge, we're gonna have to cross at some point, but we have not yet.

Ed Mysogland  28:02  
That's curious, see, if there was any guidance, alright, we'll move into buyers. So what makes you start to touch upon it on on going to underwriting so what makes financing go easier for a buyer.

Ray Drew  28:18  
So for a buyer, you know, I just got off the phone this morning with someone who's trying to get pre approved. So pre approvals for buyers, something I used to not do, because it's kind of like meaningless, like, you know, it's not like a mortgage where hey, I've pre approval, I'm going to pick, you know, my house and close. It's, but it is a good way to just, let's start some real to make sure you've got the cash in order. Let's make sure you have the right type of experience to operate a small business. And let's make sure you don't have any credit issues or background check background issues, it's going to prohibit you from buying a business with an SBA loan. So you kind of can start there. I created SBA pre approval.com. So folks, go right in there, fill out the questions, and I can work with them on getting them pre approved. And then when they go find a business. Yeah, hopefully, most of the deals I'm doing right now are, there's an intermediary involved. So they are packaging up the sale. And so if you have a buyer who's prepared, you have an SBA lender, who knows, acquisition and SBA, which, you know, that's, that's always my biggest advice to a buyer is, you know, because there's, if you look at the list of SBA lenders, there's 1500. There's over 1500, that made one last year, but the bottom like, get the number, but it's, it's a long, it's like the bottom, like several, like 900 of them are just not x, they just they're community banks that want to service their customers and do one here, one there. And if I'm going through this process, and I need to close in 60 or 90 days, you know, there's no way they're going to be able to so you just want to work with the folks at the top who are doing this every day and And so if you have that, in place, you have the buyer who is prepared, and you have a seller who's working with an engineer mediary, who's telling them, I'm prepping them for the process, hey, you might have to hold a seller note, and hey, you know, your tax returns should be filed on time. And let's make sure you don't have any, you know, tax issues that come up in the middle of the process. And so you just be proactive, and you get the right team together. And these things are not that bad. Honestly.

Ed Mysogland  30:34  
I know, we talked a little bit about you know, the deal having depends a lot, but what we didn't talk about is direct operational experience, or relatable experience to the acquisition. I know a lot of buyers are first time buyers, and and they're trying to get into a particular business, they find it they fall in love with it. But you know, perhaps they're coming from manufacturing, they're going into service. So, you know, how do I, how do I bridge the gap of operational relatable experience?

Ray Drew  31:11  
Well, it's a good question, because there's a lot of banks that require direct industry experience, that is, okay. Essentially, it's a less risky transaction to finance if somebody's buying a business in the industry that they know. Now, that's mostly not the case for the business acquisitions, I finance. Most of the people looking for businesses that work with me are coming from different walks of life, and they're buying a business and many of them are industry agnostic. So what I tell buyers is, you do need some transferable skills, and you definitely need relevant management experience, you can't go buy a business. And now this is going to be the first time you've ever managed person before. Right? There's better ways to learn management, which is a hard skill to learn than buying a business. And I would encourage you to go do that. Understanding a p&l or managing a budget, these are also skills that you can go get in corporate America and other places where it's going to transfer over to any business that you buy, thing that's not is going to be the industry jargon and the industry specific information and the salaries, processes and procedures and you know, there's things within the business, they're going to have to learn. And that goes to the importance of the seller note because that stuff is going to be taught after closing, and there's going to be a transition period of up to a year usually, sometimes it's three months, it varies, but the seller is going to teach Meyer those things. So that's a little bit of the leap of faith you've got to take, ultimately, I think buyers should buy businesses that they are going to be able to add value to and that they can see themselves being in every day, and living that life, if that's what you're really buying. It's not just cash flow on pieces of paper. It's the business with living breathing things and people and employees and customers and vendors and all that.

Ed Mysogland  33:12  
But it's funny, because we talk more people out of business than into business. It's like you have no idea what what what you're thinking about getting into and, you know, if, you know, being CEO and head janitor, you know, frightens you, this is probably not the path you want to go at least at least at this season of your life. Yeah.

Ray Drew  33:34  
And I was just thinking about this this morning about how like if you're if you and your own business, ie, you getting you I think you get paid last to a certain extent. And that's maybe a controversial statement. I think I've heard people on other podcasts that bought a business and it actually ended up I think, doing poorly and they said I'm gonna always pay myself first. And I cringed because I said that's not what this is. You know, and and so it is very difficult and if cash flow is tight that month, you're going to suffer and it's not something to jump into lightly these these businesses. These small businesses are very hard to operate. Yeah,

Ed Mysogland  34:16  
well and the the Profit First mentality I did I had Mike McCalla wits on on on the podcast a year or two ago. And you know that the problem that buyers don't understand is, yeah, you do pay yourself first. But you do have a command of the other operating expenses that facilitate you being able to pay yourself first. And that's the that's the mechanics of it. It's, it's true. You can you can do do that and you make better operational experience decisions, but at the same time, you do have a real big problem. If you don't make those changes before you Institute, paying yourself first. So I'm with you. One of the questions that has crept up is, does a lender or someone like you have an obligation to me as a buyer, I say no, but I may be wrong. I

Ray Drew  35:21  
mean, like, obligate my only, not really. I mean, my obligation is that I, and this is, and this is not like an obligation that is absolutely required, it's my own personal obligation, I want to make sure that, for example, when I put out a term sheet that I get that deal done, and that I get it done as I've presented it, and that's my obligation, and what I do on the front end to make sure I can ensure that is going deeper, and making sure that we're able to follow through on our promises. And that is something that is a problem in the SBA space, because a lot of lenders like to put out term sheets to get the deal off the street. I mean, I've literally been coached to do this as a younger BDO. And let's get it in here. Let's take a look, let's, let's get the deal off the street. And it's like, well, they think that you're actually going to follow through on that, and it's gonna you're gonna wait six weeks, you're gonna get the loan committee, which is a whole nother topic. And and somebody from loan committee is going to say, why are we doing this with this equity injection, we should ask for another this or that, and we should get this person we should get their dad to guarantee and and then they got to come in, they say, Okay, now I have to decide, do I risk losing this deal? Because I don't have time to start over with another lender? Or do I bite the bullet and do what this lender is asking, and I get these calls every day? I mean, I lost the deal the other day, and this exact thing happened and went all the way the loan committee and they said, you know, instead of 10% down, we want 20% down because you don't have any industries. Okay, well, tell me that two months ago, you know?

Ed Mysogland  37:08  
Well, I, and again, I'm glad you confirmed it, because I always say, you know, look, a lender does not have any fiduciary responsibility to you at all. And, and as far as what you don't want to happen, and you've already alluded to it, is there's nothing worse than having to regenerate on on lending, you know, and so if, if you're going to put out something that this is this is what has to happen. I mean, the caveat is that deals change over the course of the six to 12 months it takes to sell a company things might change that, yes, that that force the lender, so don't so this little piece of paper that says I'm willing to lend this that all bets may be off based on your six month numbers that are tanking.

Ray Drew  37:50  
Exactly. That's the biggest thing I'm seeing right now is do we get the updated interim financial statements, and business is not going how we thought it was going to be going, that's a material change. Now, all bets are off. We just finished, you know, going past the tax extension, and I'm looking at deals and we had a 12 month p&l, now you get the tax return and you know, oh, wow, it's different. Okay. Is that Is that a problem? Yeah, it's a problem. We underwrite off the tax returns. So that's a big problem. So we're seeing that stuff now.

Ed Mysogland  38:24  
Yeah. And, and again, I think you'll continue to continue to see it I. But it's funny that that people, you know, if you don't like the deal, or the like the banks deal, then be the bank yourself. And you can control all of this and just do it all in seller financing. I don't want to do that. Well, then the person that holds the money really has the opportunity to kind of mitigate their risks to Hey, you can we can you can coach all you want sellers and about it. But boy, it's like banging your head periodically. But such as life. I wanted to ask you, you know, the default rate on SBA loans is only about 2%, which to me is a staggering number that that it's that low, I would have thought it would have been times three, four, I would have I would have thought it'd be seven to 10%. But 2% across the board. I mean, how is that? Do you have it went in the in your travels? Have you found why that is?

Ray Drew  39:35  
Well, yeah, I mean, I think like I said earlier, I think it's artificially low. I think that, first of all, after the Great Recession, the default rates spike to double digits. Then lent lending completely tightened up for many years. I mean, through 2015, I would say lending was very tight. I mean, the types of deals we would remember on business acquisitions, were It was a small portion of the overall seven a portfolio. The ones we were doing were low leverage. And that opened up in 2016, a little bit with the 90% financing. And the economy, though, in 2017 1819 was heating up. So you have this kind of run where you had artificially low interest rates, you had. I mean, even even when the economy was hot, I mean, the interest rates are still historically low. And you had you had this whole run up now, then you had 2020. This is when you would expect, you know, the this all to catch up with you and defaults to spike because of COVID. But the SBA, they put an unprecedented amount of liquidity into the marketplace. And to their credit, they directed it towards small business, instead of the banks. Right. And last time, so I commend them for that. But you had PPP, putting out all that free money into the market, you had eidl loans, which are emergency loans, which everyone got at, you know, payment terms. Yeah, you had the SBA making your payments for you for six months on the existing portfolio. So everyone from April to October, I believe it was yesterday, he was just making your payment for you. So no one was defaulting 2020 2021 There were more incentives. There's BP now. 2022 and 2023. You see it starting to pick up but it's still relatively low. I think next year, you see it Go go You break above two for sure. And it starts getting back to normal because now you have liquidity drying up. You have interest rates at you know, double digit, and you have different in the economy. No,

Ed Mysogland  42:00  
I mean, that was a that was a great synopsis. I hadn't when when you had said it was artificially, you know, I was thinking oh, yeah, so another politician. But now the way you described it, I totally can see how, how it has how they have unintentionally kept it kept it low. So that I appreciate that one. So you and I had a bill by name of Brett canes on our podcast on from Loomis data. What a fascinating business that is. Hmm.

Ray Drew  42:35  
Yeah, that's a really cool one. We're Yeah, we are. So Brett is he's the you I know he was on your podcast a couple episodes ago. And you know, he he has that. He's the former CFO of Live Oak which, right? I mean, why voc is such a big player in the SBA space, like, I think I'm pretty sure they can like split into two and both of them would still be the biggest SBA lenders. And so you know, that what he was able to see there during his time was, you know, I'm sure fascinating, and then he went and leverage that into his own business. And, and its data. Yeah, I mean, this, this, I love it. Because in those committees I told you about at the banks. We don't have old school and committee here at Fundex. By the way, we do it kind of more, it's the more new school approach. But in a lot of the banks, they still do that, where they go into a room and the bank officers and the retired bankers that are on the board make loan decisions based on whatever they want. It's like, Hey, I had a carwash go bad in 1992. So I don't want to do the car washes anymore. So this is a way to actually bring some data to those banks and say, well, actually, the default rates really low on on this particular sector. And, and here's the data.

Ed Mysogland  43:52  
Yeah. Well, I'm just curious to it, I mean, six data points, and they can they can predict the default rate to me. I mean, that's, that's really exciting. And and I'm just curious to know whether or not Yeah, because I do see that the future of lending as well as the future of there'll be some, there'll be some layer that helps buyers, select their businesses, you know, that this is a preliminary due diligence step. And I'm really stoked for those guys. But, but, yeah, you you already alluded to it that it's, you know, it's all it's so much data driven, and and the underwriting process can be augmented using their platform. So I was just curious to see what what you thought of it.

Ray Drew  44:41  
Yeah, it's gonna be a game changer. And I, you know, we're using it. We actually have a call today at the time that we're recording this with them to redesign their contract did last week, and so we're rolling it out and, and I think it's going to really impact the small loans. First, I mean, the small loans in the SBA Seven a program means under half a million dollars, which is there's still deals going on under half a million and and you know Business Brokers particularly need to take note of this because it's no longer do I need to get elbow deep into these small $300,000 deals to figure out if they work, we run a score, we get the Loomis report, we were looking at the buyer more now, we're going to do a high level spreading of the business cash flow, but it's not going to be anything close to what we're doing on the S SP 70 standard loan, which are over half a million to 5 million. So with these small loans that the SBA is trying to drive home is we want to they want to do more of them, they want a more streamline. So they have their own scoring model, which is called SPSS Lumos is scoring models like way, it's I think it's a little bit more nuanced. But between these all these scores, you can make credit decisions now a lot easier and get the money out the door a lot quicker. Yeah,

Ed Mysogland  46:02  
um, and the hope is that they they expand the the SBA express loan up, you know, raise that cap even higher to accommodate this, this type of loan where, where it's based on credit in scoring, more so than then I don't wanna say the merits of the business that because it that does play a part. But I think as far as pushing those deals through, I think I'm hopeful that that's what what ends up happening. So anyway, I'm glad to hear that. Because he's such a good guy. It was. I'm glad to hear you guys are working together. franchises. What do you think?

Ray Drew  46:49  
I mean, is you guys do a lot of franchises or no? Yeah, franchises are franchises. It's again, data, right. So, in fact, Brett's partnered with a company called Bret brand data now, right, and so we get the data from them. And it basically tells us, I mean, we get the default rates, first of all from the SBA, so we can tell the SBA is track record with any given franchise, but you also have the FTD, the franchise disclosure documents, which we love looking at, and it oftentimes, you know, in item 19, they have these financial representations, and some are more transparent than others. But anytime you can just kind of compare the actual set of financials, you know, assuming it's a business acquisition, to the, the large pool of data, to try to figure out how this one compares to 1000 other units, that's always a plus. And then, you know, startups, it also makes the startups a lot more possible. Because when you're starting up a business, and you're, you're not a franchise, all we have to go off of is the buyers projections, and they can tell us how they came to these projections. But it's also ultimately going to be based on them and what they think but with a franchise, you can then use this FTD and the financial representations that are laid out in there to validate what the projections are showing and say, hey, well, these, sometimes I'll get projection to be like, Hey, if you do this, you'll be like, the best unit in their whole system by like, two. I'm like, how do you get to these projections? And so it gives us a little bit more to play with, I get

Ed Mysogland  48:31  
two more questions. 2024 Crystal Ball time, because I know lots of people look to you for some for what you see coming. So SBA Ray, tell us what what you see in 24. So

Ray Drew  48:44  
2023, so we go like fiscal years and the like, we're now in 2024 fiscal year. And 2023 was, really, I would say, the best year of SP lending in history, because there's one other year that was bigger. And that was the year in 2021, where they were giving out free money. So I don't count that year. But last year, considering the rates double considering economic headwinds, considering all these different factors, we did 27 billion of seven a volume, which is the biggest year except for the one caveat year in the history of the program. And so this year coming up, I see that growing. I do see that growing because the thing is conventional lending. If that tightens up SPS coming in to fill the gaps and we've already seen the tightening but it's going to continue I think and so SP will definitely step up to the plate. You've got more lenders coming in you have new non bank lenders. Now they just gave three licenses to new non bank lenders. They haven't given a license out since 1982. So you have one of them was funding circle now. They're their competitors so I'm gonna have to, you know, destroy them in the market but I still have to respect what they're doing, you know, and they have big high hopes. So I think that SBA lending originations is going to be really strong. Now, I think there's going to also be higher defaults on the existing portfolio, which is expected with, you know, the interest rates being where they're at. And most of those folks were on floating rate loans and got into the program at five 6%. And now they're at, you know, 11%. And, yeah, of course, that's going to be a little tight if you didn't really stress test your deal at an extra 5%. Because who did that? And you know, 2020, right.

Ed Mysogland  50:39  
All right, this has been awesome. I know. You're a wealth of knowledge, but I knew you would be so that that's not that's not any anything new for me, but, you know, where, where can we find you?

Ray Drew  50:54  
You can find me, you find me in a lot of places. But you know, I'm, I'm putting out a new video this week on my YouTube channel. So definitely check out SBA Ray on YouTube. I work at fun deck solutions, you can go to fund x solutions.com. And you can find me there as well. Okay.

Ed Mysogland  51:09  
All right. Thank you for your your time, and we're recording it the Monday before Thanksgiving, so I'm certainly thankful for you and your time and it's been great. You were everything that that I anticipated, it would be so bad yourself. This