plura Financial Blog

blog for plurafinancial.com, an online matchmaker between banks & small businesses

Top 10 List of 2012′s Top 10 Lists

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At some point in 2012 people decided they didn’t want to read stuff anymore. More specifically, people don’t want to read long informative articles anymore.  Instead, folks just want to read a series of headlines (Twitter) and picture captions (Pinterest).  Perhaps the biggest trend of 2012 was the proliferation of…lists; best of, worst of, most shocking, and various other “you name it” top 10 lists of every imaginable subject.

To close out the “year of the list”, we’ve created a…

Top 10 List of the top 10 lists of 2012.

  1. Top 10 Pictures of 2012 – Huffington Post
  2. Top 10 Adventures of 2012 - Business Insider
  3. Top 10 Sports Stories of 2012 – Wall Street Journal
  4. Top 10 Most Watched You Tube Videos of 2012 – USA Today
  5. Top 10 News Bloopers of 2012 – Liveleak
  6. Top 10 Most Viral Ads of 2012 – Business Insider
  7. Top 10 Tech Breakthroughs of 2012 – Popular Science
  8. Top 10 Mugshots of 2012 – The Smoking Gun
  9. Top 10 Worst College Majors for 2012 – Kiplingers (hint: any major including the word “art” is on this list)
  10. Top 10 Most Expensive Homes in America in 2012 – CNBC

We hope you had a great 2012, and we wish you a safe and prosperous 2013!

-Brandon Hinkle/plurafinancial.com

Top 10 List of 2012 pic v4

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Written by entrabanker

December 30, 2012 at 5:13 pm

SBA Small Business Loan Statistics – FYE 2012

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Compared to FYE 9/30/2011, the number of SBA loan approvals for FYE 2012 was down 13% (7,841 loans) and the loan $ volume was down 11% ($2.6 billion) YOY, according to data provided by the SBA.   100% of the decline was due to the 23% ($4.5 billion) decline in approved SBA 7A loan volume.

SBA 7A Loans:  Represented 80% of all SBA loan volume in 2011, falling to 69% by FYE 2012. The large YOY decline was attributed to the following:

  1. The SBA reinstated a 3% SBA guarantee fee for SBA 7A loans in 2012, which caused a surge in demand prior to 2012 due to borrowers trying to get the loan before the guarantee fee increased.  This made 2012 a difficult comp year for SBA 7A loans.
  2. Rural loans – The loan volume to rural areas experienced the largest decline, with $ loan volume falling 45% or $1.9 billion compared to FYE 9/30/2011 as many of these borrowers preferred the 504 loan to finance their fixed assets.
  3. Minority loans – Loans approvals to minorities dropped 20%, or $1.0 billion year-over year (“YOY”).
  4. Women – 7A loan approvals for women dropped 22% ($0.5) billion YOY.
  5. Veterans – Loans to vets declined 35% ($0.4 billion).
  6. All 7A loan categories experienced an annual decline of at least 8%.

SBA 504 Loans:  504 approval volume grew 39%, or $1.9 billion, over 2011 but was not enough to overcome the $4.5 billion drop in SBA 7A loan approvals.  The 504 growth was attributed to the following:

  1. The ability to refinance debt. For fiscal year 2012 the SBA permitted 504 loan proceeds to be used to refinance existing debt, where it was previously permitted only for the acquisition of new fixed assets (no refi’s).  Given the lower rates and fixed rates associated with 504 loans (compared to 7A loans) in 2012, many borrowers opted to take advantage of this window and refinanced owner occupied commercial real estate with a 504 loan.  In other words, the 504 loan volume increased at the expense of the 7A loans.
  2. Rural loans. Whereas 7A loan approvals to Rural borrowers was down 45% YOY, 504 loan approvals were UP 49% to Rural borrowers in FYE 2012.
  3. Minorities and veterans, in particular, took advantage of the 504 program (instead of the 7A program), as approvals for minorities and vets were up 31% ($0.4 billion) and 55% ($ $0.2 billion) over FYE 2011.

Summary: 

  • If you’re thinking about getting an SBA loan, we recommend you start the process ASAP before any additional unfavorable changes are implemented (loan purpose restrictions, higher fees, lower amortization, etc).
  • 504 loans cannibalized ~$1.9 billion of 7A loans in FYE 2012 due to the lower rates and fees associated with 504 loans relative to 7A loans.
  • SBA loan approvals to startups were down 8% or $0.4 billion YOY, while existing businesses experienced an 11% or $2.2 billion decline.

Outlook:

  • Absent the impact of the upcoming Presidential election, which creates much uncertainty surrounding the SBA loan program, it’s reasonable to assume that demand will shift back to 7A loans (away from 504 loans) now that the ability to refinance debt with 504 loans has been terminated effective 9/30/2012.
  • If in 2013, however, the SBA renews the ability to use a 504 loan to refinance existing debt we believe the mix will continue to shift from SBA 7A loans to SBA 504 loans.
  • If in 2013 the SBA lowers the guarantee fees to be more competitive with fees for traditional loans, than we believe overall SBA loan volume will increase by at least 2%-3% over FYE 2012.   If the guarantee fees remain as is, we believe the 504 loans will continue to cannibalize the 7A volume.

To apply for an SBA loan or just to learn more, check out http://www.pluraFinancial.com or see your local SBA Small Business Development Center.

-Brandon Hinkle/pluraFinancial.com

Written by entrabanker

October 23, 2012 at 3:40 pm

Strategic vs. Financial Buyers (the pros & cons)

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If you’re thinking about buying or selling a business, it’s important to know the types of buyers.  Buyers are generally classified into the following two different categories, including the pros and cons of each:

  • Strategic Buyers:  These are companies that believe your business fits well within their existing business, and there is a strategic reason for them to buy that might go beyond monetary gain.
    • Pros
      • Typically offer a higher purchase price than “financial buyers”
      • There may be some competitive advantages from joining forces with another company, including increased purchasing power with suppliers, cross selling to customers, cheaper cost of capital, etc.
      • No immediate plans to flip/sell the company again.
    • Cons
      • Tend to include their company stock as part of the purchase price (instead of giving you all cash at close).
      • They’ll probably fire a bunch of people, including management, because so many positions will be redundant (duplicative).  Part of the reason they pay a higher price than “financial buyers” is because strategic buyers can immediately cut so many costs out of the business; no need for two regional managers at the same company covering the same region.  And every $1 of cost savings the buyer creates is worth $5-$7 due to the EBITDA multiple effect in corporate valuation (companies are generally sold for 5x-7x EBITDA).
  • Financial Buyers:  Investors that are purely interested in monetary gain.  Similar to flipping houses.
    • Pros
      • Most employees, including management, will likely keep their jobs
      • Likely an all cash offer (versus buyer’s stock being part of the purchase price)
    • Cons
      • Increased leverage.  Financial buyers typically use debt to finance up to ~75% of the purchase price, leaving the business saddled with a significant amount of new debt that might strangle the company’s cash flow and limit its financial flexibility.
      • Lower purchase price.  Financial buyers typically pay less for a company than strategic buyers because there are fewer “synergies” to be had that might otherwise justify paying a higher premium.

-Brandon Hinkle / www.pluraFinancial.com

What is a Relationship Lender?

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I challenge you to find a bank that says they’re not a “Relationship Lender” these days.  When you think of the words “relationship lender”, does it conjure up images of your banker treating to a round of golf, buying expensive steak lunches, and giving you loan after loan at the lowest rate without regard for financial performance?  Think again.

Relationship Lender means the bank requires the company’s operating account in order to give you a loan (in addition to the standard credit criteria).  But the banker is not allowed to say this because of a federal law called “anti-tying” that says a bank cannot require you to sign up for one product (e.g. cash management) in exchange for receiving another (e.g. a business loan).  I’m not a lawyer, but that’s the explanation of tying given to me by our legal counsel when I worked at a bank.  Banks want your operating account (cash deposits) for two primary reasons: (1) if your loan is in default they probably have the right to “sweep” (take) all the cash in the checking account because it’s part of their loan collateral, and (2) banks are required to have a certain amount of cash for each $1 they lend.  The more cash people hoard at their bank, the more loans the bank can make and the more funds the bank can borrow from the Federal Reserve, etc.

Should you avoid “relationship lenders” when seeking a business loan?  Absolutely not; many of the most competitive banks also classify themselves as relationship lenders.   When a bank tells you they’re a relationship lender, should you ask what exactly that means?  Absolutely yes.  If nothing else, it will be an amusing conversation and a great way to start off your joyous relationship together!

Looking for a bank or business loan?  pluraFinancial.com creates relationships between banks & businesses online, or you can ask your local Small Business Development Center which bank might be best for your business.  Both are free ways to find the best bank for you & your business.

http://www.plurafinancial.com

Written by entrabanker

September 12, 2012 at 3:14 am

Growth Capex vs. Maintenance Capex vs. Internally Financed Capex

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Capital Expenditures

Growth Capex vs. Maintenance Capex vs. Internally Financed Capex

There are generally two reasons companies spend money on capital expenditures “capex”: to grow the business, and to maintain the business.  Once a company determines it needs to make a capex investment it must decide how to pay for the capex, either using company cash or debt.  Let’s explore each element of capex in more detail to get a better understanding:

  • Maintenance Capex: The necessary expenditures required to keep existing operations running smoothly.  Perhaps a new conveyor belt for the old machine, or new computers to replace the outdated technology.  These expenses don’t attract new customers or create the capacity for a bigger business; they just enable the company to keep running at status quo.
  • Growth Capex: The discretionary investments used to attract new customers or create the capacity for a bigger business.  Perhaps a new customer requires you upgrade your software before signing a contract, or maybe you need another machine to process all the upcoming orders from new customers.  These are the expenses/investments in additional assets to help facilitate growth.
  • Internally Financed Capital Expenditures: Spending internal cash (instead of debt) to pay for capex.  When banks are determining your credit-worthiness, they are evaluating all the sources & uses of cash.  Capital Expenditures (capex) is a big use (drain) of cash for many companies, particularly manufacturers.  The more cash is spent on capex, especially growth capex, the fewer funds are available for debt payments.  Capex financed with external cash (bank debt or owner equity) doesn’t reduce company’s cash flow, but capex financed with company cash does.  Internally Financed Capex is part of the FCCR, the ratio used to determine a company’s ability to repay its debt.  The bank often asks for an estimate of internally financed capex because that number won’t be included in any financial statement, but is necessary to calculate your company’s ability to repay debt!

If you have capital expenditures, it’s helpful to keep track of how much was spent to grow versus maintain your business, and how much was financed with company cash instead of bank debt!

-Brandon Hinkle/www.plurafinancial.com

Commercial Real Estate Cap Rates and Valuation

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Anyone new to the commercial real estate valuation game is probably beginning to hear words such as “cap rate”, “rent roll”, and “NOI” used often in the marketplace.  The goal of this article is to help you decode this kind of language in order to determine how to value investment commercial real estate.

Whereas the acquisition of a business is primarily valued based upon an EBITDA multiple, Investment Real Estate (e.g. apartment buildings) is generally valued based upon using a capitalization rate “Cap Rate”.  A detailed explanation of the EBITDA multiple and how to value a business can be found here.  But this article will solely focus on explaining the methodology and rationale of using a Cap Rate to value commercial property.

To value commercial real estate using a Cap Rate, there are three primary steps (below).  To simplify explanations, we will assume the real estate property is an apartment building.

1)    Determine Income

A Rent Roll is a spreadsheet/report that provides unit-by-unit detail of a property that helps investors calculate the Gross Potential Rent (best case scenario) for a given property.

  •  Gross Potential Rent is derived from the Rent Roll and is the maximum annual income at full occupancy and current market rent. This is one’s starting point to which adjustments have to be made such as loss-to-lease, vacancy, non-revenue units, bad debt expense, and concessions must be deducted from. In order to calculate the income one must consider, among other deductions/increases, the following adjustments:
  1. Loss-to-lease: If you have a Rent Roll as of today, and you have leases that were signed several months ago, those lease actual rates (in a rising rent environment) are probably below “market”.  Loss-to-lease totals the amount of this deduction for all units for their respective remaining lease terms. Note, should the property be experiencing a gain-to-lease (in a falling rental environment), this will be a positive number.
  2. Vacancy: This is a standard deduction that accounts for any vacant units.  If the market rent on an apartment unit was $1,000 per month and the unit remained vacant all year, then the vacancy expense would be ($12,000) for this unit.  Vacancy is the sum of all vacant units over the period analyzed.
  3. Non-Revenue Units:  This is the deduction for any units that no rental income will be collected on.  For example, if an apartment building has two model units and allows one leasing agent to live in the building for free, then there will be a total of three non-revenue units.  If the market rent on them is $1,000 per month then for the year the Non-Revenue expense would be $36,000.
  4. Bad Debt Expense:  Bad debt accounts for any uncollected billings that are deemed uncollectible.
  5. Concession Expense:  Concessions account for financial incentives provided to tenants to sign leases.  For example, an apartment building may run a special for new tenants that sign a 12-month lease to get the first month free.  Assuming that the apartment could be rented for $1,000 per month, then the total concession for this unit over a 12-month period would be $1,000.
  • Other Income:  Most properties have several streams of additional income.  It is important to add these additional streams.  Some examples could be garage space rental income, antenna income, pet fee income, utility reimbursement income, late fee income, etc.

The grand total after each of the above sources of income and deductions to market rent is commonly referred to as the Effective Gross Income.

2)    Calculating Net Operating Income “NOI”

  1. Think of this as your annual net profit from the property
  2. NOI Calculation: (Effective Gross income – Expenses”).

                                            Expenses are generally grouped into the following buckets:

  • Payroll: Accounts for all payments to employees at the property
  • Marketing: Expense for all efforts to attract and retain renters at the property.  This may contain items such as locator fees where third party agents are paid a lump sum in exchange for bringing a signed lease to the property.
  • Contract Services: Accounts for all payments for recurring services to the property such as landscaping, security, trash removal, snow removal, etc.
  • Repairs & Maintenance: Expense for all ongoing repairs that are made at the property.  However, this does not include large capital items life roof replacements that may be amortized over time.
  • Turnover: The expense related to apartment units switching tenants which includes items such as carpet replacement, painting expense, etc.
  • SG&A: Expenses typically include administrative expenses like supplies and miscellaneous items that don’t fall under the other buckets.
  • Management Fee:  This is generally tied to the rental income that the property makes and is the fee paid to the third party management company (if applicable).
  • Utilities:  This is the expense related to electric, gas, heating, water, HVAC, etc.  This may or may not be charged back to the individual tenants depending upon whether a RUBS (Resident Utility Billing System) is in place.
  • Insurance:  Property insurance on the building
  • Real Estate Taxes: Taxes on the building

NOI:  After each of the above expenses is deducted from the Effective Gross Income, one can determine the NOI.  However, some asset classes like apartments will also deduct a Capital Reserve after the NOI before applying the cap rate.  Capital Reserve is, for lack of a better description, a cushion that banks/investors assume must be maintained for each unit in case there’s prolonged vacancy, repair needs, etc.  (e.g. for apartments, the capital reserve is generally $250-$300 per unit, depending upon the age of the building.)

3)    Identifying Market Cap Rates for comparable properties

  • The best way to determine the value of anything is to find out what a similar item recently sold for…a comparable (“comp”) property.
  • Cap Rates are generally calculated by dividing a property’s NOI (from the year it was sold) by its sale price.
  • Cap rates are one of the primary metrics banks use to find the market value of investment commercial real estate; if a similar building down the street was sold for a 7% Cap Rate, your building might be given the same Cap Rate to create a fair starting point for valuation purposes.  Cap rates should really only be used on stabilized assets, meaning the properties have achieved the maximum expected on-going occupancy level.  Note, 100% is rarely considered stabilized since tenants will create natural vacancy when they move in and out.
  • Market Cap Rates can be found in online resources such as costar.com and realcapitalanalytics.com (just to name two, neither of which we are associated with).
  • Wick Kirby from HFF LP cautions that tax implications can have a significant impact on a sale process: “In most cases if a property has been held by the same investor for 20 years, there will be a much larger tax “pop” than if the property was held for just 3 years.  Therefore, it’s sometimes necessary to look at a Cap Rate with the current taxes as well as what the cap rate would be with the post-sale taxes (post tax pop and therefore lower NOI).”
  • According to Rob Stanek from The John Buck Company, “Once you’ve found a Cap Rate for properties that most closely match your property type/location, plug that Cap Rate into the following calculation: ($NOI / Cap Rate%).  This is the estimated market value of your property.  Cap Rates generally range from 5% to 10% depending on the size, occupancy rate, location, and characteristics of the rent roll at each property.”

Let’s use an example to illustrate the calculation for a 3 unit building:

4) Valuation:  Since the property was previously sold at a 10% cap rate, has meaningful vacancy, and is most similar to Comp 1 that had a 10% cap rate, we’ll assume the buyer will also assume a 10% cap rate.  With an NOI after capital reserves of $79,100 and a 10% cap rate, the property will likely be sold for at least $791,000 ($79.1k NOI / 10% cap rate).  When a buyer sees that they might be able to increase rents to market rate, they may be willing to pay a higher sale price, especially in a competitive market.

You may have noticed there’s one key difference between the EBITDA Multiple method used to value a business, versus the Cap Rate method used to value investment real estate; the multiple is a factor multiplied by your operating income…the Cap Rate method, however, divides operating income by a factor.  In essence, the EBITDA multiple assumes value is based upon the cash the company will generate in the next 5-7 years (a 5x-7x multiple).  By dividing cash flow by a factor, the Cap Rate method assumes the property will generate the current operating income in “perpetuity” (forever).  As a result, the Cap Rate is a much more aggressive methodology to value an asset, which is great for the seller!  Buyers, be sure to always ask about the Cap Rate assumptions before buying any property to ensure you’re paying a market price.

Special thanks to Wick Kirby from HFF and Rob Stanek from John Buck Company for their thoughtful contributions to this article.

~Brandon Hinkle/www.plurafinancial.com

Written by entrabanker

August 2, 2012 at 4:25 pm

Posted in Uncategorized

The Impact of the Proposed Changes in Capital Gains Rates

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Much has been discussed in the media, and in family circles, regarding the potential implications of the “Bush tax cuts” set to expire at the end of 2012.  Not being tax folks, but interested in the impact, we decided to research the issue to get a layperson’s understanding of what exactly is supposed to change and how it might affect most people.  After much research, two sources proved to be the most helpful – the IRS.gov and the Goldman Sachs (www.gs.com) websites.  Here’s a summary of our key findings from these sources:

Background

  • All of the primary Bush era income tax cuts are scheduled to expire at the end of 2012 under the law’s “sunset” provisions if Congress does not act (and “sunset” occurs).
  • While the Administration has proposed continuing to tax dividends at capital gains rates in the future, if no action is taken and sunset occurs, qualified dividends will be taxed at ordinary income rates instead of the lower capital gains rate at the end of 2012.

Potential Impact

  • The 2013 income tax rates for most taxpayers will increase.
  • Income tax rate changes from 2012 to 2013 that would result in the event of sunset are listed in the chart to the right (tax brackets for married couples filing jointly):
After giving effect to all the sur-taxes and stealth taxes, the effective tax rates for the highest bracket of earners will be as follows:
  1. Includes marginal income tax change, investment income surtax and stealth tax change
  2. Includes marginal income tax change, stealth tax  change and Medicare tax change

Proposed Tax Law Changes – A Detailed Look

  • The highest earners (>$379,150 of household income) will realize the largest tax % increases in 2013.
    • Ordinary income rate goes from 35% to 39.6% (a 13.1% increase)
    • Long-term capital gains rate goes from 15% to 20% (a 33.3% increase)
    • Qualified dividends rate goes from 15% to 39.6% (a 164% increase).
  • Itemized deductions to be less favorable
    • The tax rule reducing a taxpayer’s itemized deductions by a specified percentage of the amount by which adjusted gross income (AGI) exceeds a threshold does not apply in 2012 but returns in 2013. The limitation occurs on Schedule A, tax Form 1040.
    • In 2013, the reduction will equal the lesser of (i) 3% of that excess income or (ii) 80% of the itemized deductions (such as charitable contributions) subject to this rule.
    • For a taxpayer with $5 million of AGI in 2013, deductions will be reduced by about $145,000.
    • This rule is often referred to as a “stealth tax” because reducing deductions by 3% of the excess AGI potentially increases the 2013 marginal tax rate thereon from 39.6% to 40.8%.
  • Investment income may receive a 3.8% surtax for folks making >$200k.
    • The health care reform law enacted in 2010 includes a new 3.8% surtax on investment income (such as gains, interest and dividends) for individuals with AGI in excess of $200,000 and married couples with AGI in excess of $250,000. This surtax begins in 2013.
    • Surtax increases the top marginal rate on investment income, other than long-term capital gains (and possibly qualified dividends), to 43.4% (or 44.6% taking into account the aforementioned “stealth tax”).
    • Surtax increases top long-term capital gains rate to 23.8% (or 25% taking into account the “stealth tax”).

At first glance, it would appear that the wealthiest people are being punished the most.  Though some would argue that, based on the chart below, the rich have been getting favorable tax breaks for the last thirty years that are finally going away; here’s a chart of the historical Long Term Cap Gains tax rates per IRS.gov and the US Treasury Department:

Regardless of your opinion about the fairness and distribution of the tax changes, the implications are significant for all; be sure to consult with your tax advisor if these changes take place!

-James Timberview/www.pluraFinancial.com

Disclaimer: As Goldman points out, information related to amounts and rates set forth under U.S. tax laws are drawn from current public sources, including Goldman Sachs’ April 2012 report on “The Potential Impact of Planned Tax Rate Increases on After Tax Values” and  the Internal Revenue Code of 1986, as amended, as well as regulations and other public pronouncements of the U.S. Treasury Department and Internal Revenue Service. Such information may be subject to change without notice. In some cases, rates may be estimated and may vary based on your particular circumstances.

Written by entrabanker

June 21, 2012 at 8:38 pm

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