SBA 7a loan to buy an existing business
We work with many entrepreneurs looking to the SBA’s 7(a) loan program to fund a business acquisition. While much of the eligibility and SBA loan requirements for a business acquisition loan are the same as any SBA 7(a) loan, there are some unique aspects to acquisition loans we want to highlight to help you navigate the exciting mergers and acquisitions (“M&A”) journey.
SBA acquisition loan advantages vs. a traditional commercial loan
SBA loans offer distinct benefits over traditional loans: no collateral requirements, lower down payments, longer repayment terms, and a lack of loan covenants.
No Collateral Requirement
Unlike traditional loans that often require collateral to secure the financing, SBA loans provide more flexibility in terms of collateral. While all available collateral must be secured by the SBA lender, SBA loans do not require a fully-secured loan by hard assets such as real estate, equipment, inventory, etc. Rather, SBA loans focus on the borrower’s ability to repay the loan rather than solely relying on physical assets. An SBA loan is considered as “cash flow” loan, where as traditional loans are frequently asset-based loans. Cash flow loans are particularly advantageous for business acquisitions as there often is not sufficient or readily available for collateral to secure 100% of the loan. By not burdening borrowers with strict collateral requirements, SBA loans open doors for a wider range of entrepreneurs to pursue their business ownership dreams.
Lower Down Payment
Another significant benefit of SBA loans for business acquisitions is the lower down payment requirement. Traditional loans often necessitate a substantial down payment, typically 20% or more of the total loan amount. In contrast, SBA loans enable borrowers to secure financing with lower down payments. The SBA’s 7(a) loan program, for instance, historically allowed for down payments as low as 10% of the acquisition cost. Beginning in August 1, 2023, the SBA modified its rules to allow for seller financing for part of the purchase price, thereby affording a buyer from having to put any cash into a transaction. Seller financing could take the form of a seller rolling equity into the new company (i.e., selling less than 100% of the business) or the seller taking a promissory note for part of the purchase price in lieu of cash. This reduced initial cash outlay offers financial flexibility, enabling borrowers to preserve capital or allocate it to other essential business needs, such as marketing, renovations, or working capital.
Longer Repayment Terms
SBA loans provide borrowers with extended repayment terms, which is a notable advantage when purchasing a business. Traditional loans often come with shorter repayment periods of five to ten years, leading to higher monthly payments and potential interest rate risk at loan maturity. In contrast, SBA loans offer more generous repayment terms. For real estate acquisitions, the repayment period can extend up to 25 years, while business acquisitions can have repayment terms of up to 10 years. The longer repayment period eases the burden on borrowers, allowing them to manage their cash flow more effectively and allocate funds to other critical areas of business growth.
Loan covenants are financial restrictions imposed by lenders to maintain certain financial ratios or performance benchmarks throughout the loan term. With SBA loans, borrowers are not subject to such covenants, allowing them greater flexibility in managing their business operations and financial decisions. Examples of traditional commercial loan covenants include debt service coverage ratio (DSCR), loan to value (LTV), and debt to equity. A breach of one or more loan covenants may trigger an event of default, which affords lenders with additional rights to sell assets to cure the loan default.
SBA business acquisition loan terms
- Longer payback periods – 10 years for traditional SBA loans; 25 years for real estate
- No collateral mandate (but available collateral must be pledged)
- No loan covenants
- Variable SBA interest rates
Costs of SBA acquisition loans
SBA loans cost more than traditional commercial loans. In general, borrowers can expect top the following costs associated with an SBA loan:
- Interest rate – 10% to 11% is the current typical range for most SBA loans (Summer 2023).
- Guarantee fee – Up to 3.75% of the loan amount. Paid one-time at closing. In addition, there is a .546% guarantee fee paid on an ongoing basis. This fee is being waived during until September 2021 as part of a Covid relief bill.
- Third-party service fees – For an acquisition loan, the SBA must have a business valuation completed. Typically cost around $3,000. In addition, borrowers acquiring real estate must have an environmental study done on the property, and an appraisal of the value of the real estate. These two services will cost around $3,000 each as well.
Required initial lender information request
At a minimum most SBA lenders will ask for the following to ascertain the financial strength of the business and the borrower(s):
- Last 3 years financial statements (balance sheets and income statements)
- Current year-to-date financial statements
- The Company’s last 3 years federal tax returns
- Your personal last 3 years federal tax returns
- Copy of LOI, purchase agreement, and/or key deal terms
- Bios of key management personnel and/or LinkedIn profiles
If numbers and financial statements are not you strong suit, engage someone who is strong in this area who can help. We can tell you the number one request the bankers ask the borrowers to whom we refer them is to see financial data for the past three years. It is critical and if you do not have it, we recommend waiting to approach banks until the financial data has been received and reviewed.
SBA business acquisition loan requirements
Each SBA lender is different in terms of their SBA financing requirements, but in general the SBA lenders in our network like to see the following:
- Personal credit score > 640 from any >20% owner.
- EBITDA > 1.15 SBA loan payment (SBA loan calculator)
- Buyer to inject equity of at least 10% of total purchase price into the transaction .
- Buyer has at least 10% personal liquidating after buyer’s equity infusion.
- Acquisition target > 2 years in business with at least two filed corporate tax returns.
- Buyer must have industry experience or relatable business experience.
- No business or personal bankruptcies from any >20% owner during the last five years.
- No criminal records (other than minor traffic violations) and not material active lawsuits.
- No unfiled tax returns from seller’s business.
- No unpaid liens or tax obligations (unless completely paid off with loan proceeds).
- Nonprofit business or a passive income business (e.g., rental apartments) are ineligible for SBA business acquisition loans.
Top SBA financing hurdles we see at SBALenders.com
1) Lack of adequate cash flow. Typically the maximum loan amount for a small business acquisition is 5x to 6x earnings before interest, taxes, depreciation and amortization (“EBITDA”) of the consolidated post-acquisition business. For example, a business that makes $500,000 in EBITDA would have a maximum loan capacity of $3,000,000 or less.
2) Lack of a sufficient down payment. As noted above, borrowers will need to inject a minimum of 10% of the purchase price into the transaction. Roughly one-third of all borrowers inquiring about an SBA acquisition loan at our Find me a Lender tool incorrectly assume banks will finance 100% of the purchase price. That is not the case.
3) Lack of industry experience. SBA lenders tend to avoid making loans where the principal(s) do not have direct industry experience or “relatable” industry experience for the targeted business. For example, a manager of a floral shop may be deemed to have relatable experience for the purchase of an ice cream shop since both are retail establishments serving the general public.
To overcome these three acquisition hurdles, a borrower may have to pull some or all of the following levers to finance the transaction:
- Lower purchase price
- Seller financing (i.e., the seller take a promissory note for a portion of the proceeds), or less than 100% purchase (i.e., the seller maintains some stock). In the past, the SBA required a borrower acquire 100% of the stock of the selling company. Since May 11, 2023, borrowers can now acquire less than 100% of a business.
- Finding equity investors
- Add an operating partner(s) who have relatable or direct industry experience.
The 5 Cs of credit
All bankers will look at the “5 Cs” regardless of the use of the loan proceeds (business acquisition, real estate, partner buyout, etc.). The 5 Cs are cash flow (aka capacity), credit, character, condition of the business, and collateral. Let’s take a look of each (in our perceived order of importance):
- Cash flow – No SBA lenders will lend money if they do not think the borrower can repay the principal and interest. Most SBA loans are 10 years or 25 years if a real estate loan. For a 10-year loan, the business needs to generate cash flow (cash revenues less all cash expenses including owners’ salaries and equipment purchases) of at least 15% of the loan amount. For example, a business loan of $1 million would need a business cash flowing at least $150,000 per year to cover the loan payments (in banking parlance “debt service).
- Credit – All SBA banks will run credit checks on all owners who own at least 20% of the business (“significant Owners”). A personal credit score in the mid-600s is the minimum banks will want to see. Anything lower will need a good explanation. High 600s or above is ideal.
- Character – Small business lenders will review any personal or business bankruptcies of all Significant Owners. Some banks vary, but most will want to see no bankruptcies in the past five years. Some SBA banks will go as low as three years if there is a good explanation. In addition, the bankers will review management bios of all 20%+ owners. If the management team has little or no industry experience for the business they are acquiring, banks may require a higher down payment. Per SBA requirements, the minimum cash injection from a buyer is 10%. Entrepreneurs with no industry experience or “relatable” experience may be asked to put 15% to 20% into a transaction.
- Condition of the business – The general trends of the business over the past three years – is the business growing in terms of revenues and cash flow, remaining stable, or shrinking? These are all important consideration for the banks.
- Collateral – Many small businesses have little to no collateral (e.g., real estate or equipment) to back up their loan, which is why the SBA loan program is ideal for many small businesses as banks lend against collateral and not cash flow, which is different from traditional loans. However, all components being equal, banks would rather have loans with collateral than no collateral.
Cash flow vs. collateral
Entrepreneurs looking for an SBA loans frequently tell us “this business has a ton of collateral.” Collateral is nice but is only a secondary consideration for an SBA bank as the bank receives a partial government guarantee for the loan, which provides the bank with collateral. The three most important metrics for SBA lenders are cash flow, cash flow, and cash flow.
Which one of these deals gets done?
Deal A: $1M purchase price for a business with $2M in collateral. Cash flow of $75,000 per year.
Deal B: $1M purchase price for a business with $200,000 in collateral. Cash flow of $175,000 per year.
Most entrepreneurs would say Deal A since the bank can liquidate the collateral if the borrower stops paying on the loan. The correct answer is actually Deal B.
SBA banks want to see cash flow of 15% – 20% of the loan amount to cover the loan payments. Deal B is generating sufficient cash flow to make the loan payments. Deal A is not, and therefore banks would be loathed to make that loan. Banks do not want to make a loan and have to liquidate collateral down the road.
Picking the right SBA lender for your business purchase
Many SBA lenders will decline SBA business acquisition loan opportunities based on a variety of factors, such as geography, industry, buyer’s industry experience, and the size of the loan. Acquisition loans are simply riskier and more time consuming for banks, so it is critical that you find an SBA bank that is a good fit early in the process. For example, many SBA lenders will not consider an SBA business purchase loan if the loan size is under $400,000.
We work with many of the top SBA lenders in America and know the types of acquisition loan opportunities they prefer, so when you connect with SbaLenders.com we will route you to banks who we believe may be a good fit for your business thereby saving you hopefully time. We ask many questions via our Find me a lender tool, which allows us to better match borrowers with interested banks.
Business purchase financing milestones and timelines to close
From the initial identification of an opportunity to the final funding, each milestone achieved is an important step in the acquisition process. First-time buyers frequently underestimate how long a business acquisition will take. We recommend buyers signing a term sheet, letter of intent (LOI), or purchase agreement with a seller ask for a minimum of 120 days, ideally 180 days, to close a transaction. Major milestones along the business purchase journey include:
- Buyer identifies an opportunity. An NDA may be signed.: The journey begins as the buyer discovers a potential business opportunity. At this stage, a non-disclosure agreement (NDA) might be signed to protect confidential information during further discussions and due diligence.
- Buyer negotiates a deal in writing via a term sheet or letter of intent. Once the buyer expresses serious interest, negotiations commence, resulting in a written agreement, typically in the form of a term sheet or letter of intent. This document outlines the key terms and conditions of the proposed transaction and is almost always non-binding, except the confidential provision. (15 – 30 days)
- Buyer discusses acquisition financing with potential lenders. With the deal structure in place, the buyer initiates discussions with potential lenders to explore financing options. This step allows the buyer to gauge lender interest and evaluate the financing feasibility.(15 – 30 days)
- Lender conducts due diligence on borrower and target business and issues a financing term sheet. Upon selecting a preferred lender, the due diligence process begins. The lender evaluates the buyer’s financial position, creditworthiness, and the target business’s financial performance. Based on their findings, the lender issues a financing term sheet outlining the proposed terms and conditions.(30 – 60 days)
- Lender sends deal to underwriting department, and lender and borrower work on all documentation requests, aka creating a full file. Once the financing term sheet is agreed upon, the lender sends the deal to its underwriting department. Both the lender and the borrower work together to fulfill any additional documentation or information requests, creating a comprehensive file for review. (30 – 60 days)
- Deal is approved by the lender’s credit committee. The lender’s credit committee reviews the complete file and makes a final decision on whether to approve the loan. This stage involves a thorough assessment of the borrower’s financials, credit history, and the viability of the target business. Upon approval, the lender proceeds to finalize the loan terms. (15 – 30 days)
- Business purchase is funded by the lender. With the loan approved, the lender proceeds to fund the business purchase. The necessary funds are disbursed to complete the acquisition, enabling the buyer to take ownership of the business. (15 – 30 days)
- Total time: 4 to 9 months. Considering the various stages involved, the entire process of purchasing a business typically takes between 4 to 9 months. This duration accounts for negotiation periods, due diligence, documentation gathering, credit committee evaluations, and funding.
The timelines provided are general estimates and may vary significantly depending on several factors. These factors include the expertise of the SBA lender, the borrower’s experience, the proficiency of the borrower’s acquisition team (including lawyers and accountants), the loan size (larger loans typically take more time), the involvement of real estate, and the responsiveness of both the buyer and the seller in promptly addressing the numerous information requests from all parties involved.
Further reading materials
We encourage you to review the following articles other potential borrowers have found helpful: