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How do I Finance the Purchase of a Property Management Company?

System - Friday, February 17, 2017
Property Management Blog

The question is important if you plan on growing your company. If you stop in to speak with your local banker he or she may not know the answer. Isn’t that scary? You would think everyone at the bank should know how to utilize all of their loan products right? Having spent eleven years in banking before acquiring my first management company there couldn’t be anything further from the truth.

When our parents went to the bank for a loan, it was usually to get a car loan, home loan, or a credit card. Now banks offer insurance, payroll, treasury management, health care finance, etc. When I was with Wells Fargo in 2013, there were roughly 87 lines of business provided by the bank.

I know some people will read this and think, they just need to get back to the basics; “that’s too many product lines”. I disagree, I think having all these options creates competition. Competition brings pricing down and allows the general public to gain access to financing tools that weren’t previously available.

I bring this up is because it’s now up to you as the consumer to know how to get your loan funded. You can’t expect the branch manager who specializes in opening checking accounts to know how to finance your next company. They may know the right person to call within the bank, but most likely they will not. In this high paced multiproduct world, you need to be the facilitator.

In my opinion there are three main avenues to finance a property management company:

1. Family Money – You hit the gene pool jackpot and your uncle is extremely rich! “Uncle Ted, I need 1.3MM to purchase a property management company”.

2. Investor Capital – You could get the seller to hold a note for a portion of the acquisition price and bring in a capital partner for the equity piece (down payment). Some sellers like this option because they avoid capital gains tax all at once and take a payout over time (while receiving interest). There are hundreds of ways to structure these types of deals and it really comes down to discussing what option makes the most since for the seller as well as your new business. We could write an entire book discussing this option alone.

3. Small Business Loan – The SBA 7a loan is the most common loan type used for business acquisitions ranging from 100K – 5MM. There are banks that will finance up to five million utilizing these types of loans.

I’m going to focus on the 7a loan because it is the most common. That being said, you can you use a combination of numbers one, two and three above to make an acquisition happen. I recently purchased a property management business using a combination of two and three. Had I not known an investor, I would have gone to section one and begged everyone I knew for capital. I hear people say; “I don’t want partners”. You can say that if you’re independently wealthy. I was not unfortunately, so I have to get creative!

SBA 7a Loans:

This is a very common loan used for the acquisition of small businesses. In fact, for the average American the 7a loan is one of the only bank products accessible for business acquisitions. The reason most of these loans are difficult to fund is because there isn’t any collateral for the bank to take in the event of default. Property Management companies do not have any hard assets (in most cases). You are essentially buying contracts. If you don’t make your payment to the bank there isn’t any tangible assets for a bank to seek as damages. The 7a loan is a government backed loan that guarantees a portion of the loan bringing down the level of risk for the bank. They still have liability, but it is mitigated with the government guarantee.

The bank is still going to require that you and the company you are purchasing are in good shape (financially). They won’t make a loan because you have a dream. You must show profitability and a good history of repayment on your previous debt. It’s frustrating as a banker to receive calls from potential borrowers who assume a loan should be given out because they have such a “great idea”.

Loan Terms:

7a loans are typically structured utilizing a 7 or 10 year term. Depending on the bank you choose these loans can carry a fixed or floating rate. There are several banks that will now fix the rate for the length of the loan. I always recommend seeking a fully fixed rate option. With a floating rate the payment can increase rather quickly if the prime rate begins to increase. In 2005 and 2006, the Prime Rate was increasing and I remember getting calls from business owners begging to refinance because in some cases their monthly payments had gone up 30%. By utilizing a fully fixed option on the 7a loan you are eliminating a potential risk down the road.

What is the downside to this type of loan?

The biggest objection that business owners have to these loans is having to use their home or other business assets as collateral. I had to use my personal residence as collateral when I received this loan as I had required so many borrowers to do over the years. To be honest, I didn’t mind doing so, I understood that if the bank is willing to take a risk on me then I better be willing to share in the up and downside of the project. If you think you may fail, you probably shouldn’t be buying the business in the first place.

Starting a property management business from the ground up is difficult. By utilizing the 7a loan, I could step away from my job at the bank and receive a decent salary while I fulfill the American dream of business ownership. If you purchase a business correctly, the business will pay for the loan and allow you to receive a salary.

If you don’t understand how to utilize debt efficiently, you will never reach your true potential.