For both business owners looking to sell, or entrepreneurs looking to buy a business, SBA loan requirements and the process is confusing, varied, and full of surprises. I wanted to share a bit of a primer about SBA loans, from the point of view of someone that speaks to many different lenders…as each lender you’ll speak to has different requirements, rules and ways that they lend.
So read on for the officially not-official, SBA loan 101 guide or, perhaps more aptly:
What is a SBA Loan?
Before answering that, it’s helpful to know WHO is the SBA.
The SBA (Small Business Administration) is NOT a bank and is NOT a lender. The SBA is an independent agency of the federal government, and provides guarantees for up to 75% of SBA approved loans that banks make to small businesses. So- the bank is still the lender—and performs their own underwriting and approvals for a loan. The SBA guarantees to banks that if the loan defaults and the bank cannot collect their full loan from a business owner, the SBA will pay back what the bank lost. In short, the SBA lowers the bank’s risk to lend to a small business.
Ah, so this is why I get 5 different answers from 5 different banks about a loan?
Yes. Given the SBA is just supporting banks, they have broad lending requirements that banks interpret and use differently. For example, debt-coverage ratios (EBITDA/loan amount) vary. Seller Note terms vary, terms, timing, etc.
It is often advantageous to work with a bank that is a SBA Preferred Lender. Given the volume of SBA loans they do, these banks can perform their own underwriting and decisions- and don’t have to submit every. single. loan. to the SBA. This can save you—the seller or buyer-- weeks of waiting for approvals. (Time kills deals after all!)
Ok- so again, what is an SBA loan?
An SBA loan is a loan that a bank can make to a small business that has a lower down payment (compared to conventional loans) and is partially guaranteed by the government (via the SBA).
There are several different types of SBA loans – but the most popular is the 7(a) – so we’ll focus here.
Per the above, given each bank can write their own rules about lending – SBA 7(a) loans have variable interest rates and variable rules.
Some items are variable by bank- but here are some solid standards for the 7(a) loan:
A 7(a) Loans go up to $5M
The business must be located in the United States, and must be for-profit
The owner(s) must be U.S. citizens or permanent residents, and have a strong credit score
Businesses must have a (tangible) net worth of less than $15M, and net income of less than $5M.
The business needs to show with historical financials that it’s cash flow can pay back the loan (but I’ll note- every bank has different ideas and requirements for what cash flow needs to look like to pay back the loan…)
Structure of a Transaction that Uses an SBA Loan
When selling or buying a small business, the deal typically has these parts: The full value of the offer that is split into the Equity Down Payment, and the SBA 7(a) loan, and then don’t forget about Cash potentially needed for working capital, transaction fees, and loan and bank fees.
Equity Down Payment for a 7(a) SBA Loan
Another varied feature per bank and per deal – but any SBA loan needs a down payment. As of 2018, the down payment for an SBA loan can be as little as 10% - but often banks like the equity down payment to be 25%. This can be split between Buyer cash and Seller financing.
Why so often 25%? If the SBA is guaranteeing 75% of the loan (for loans over $150,000), and the Buyer/Seller put down 25% equity – the bank has virtually no risk making this loan!*
Each bank will require different amounts down, and often require a seller to carry a promissory note (more on this on another day!). But they will require enough down so that the company can carry the principal and interest payments in addition to maintaining strong cash flow.
Buyer Fees when Buying a Business
Buyers, be ready! In addition to the down payment for a company -there are fees associated with the transaction that you need to factor in. This, like everything varies – so here’s an examp
SBA gurantee fee (3%-3.5% depending on the size of loan)
Third-party appraisal and or valuations costs (Usually a flat fee, est. $2,000 - $5,000)
Bank/Lender “packaging” fee
Escrow and closing costs
Attorney (est. ~1% of deal cost) and accountant fees (est. ~0.5% of deal cost)
Cash, if needed, for working capital
Also a note for buyers – though not a ‘fee’ – but the lender is required to get as much collateral as possible (up to the loan amount). And you will likely have to pledge a ‘Personal Guranty’ to the Seller Promissory note.
Working Capital Cash and Closing Adjustments
Depending on what was agreed to in the LOI and Sale Agreement – there is likely some post-closing adjustments that will be made. Depending on the adjustments, the Buyer may have to bring more cash to the table to make sure working capital remains at a target level—or the seller may have to leave cash or other current assets in the business to keep working capital at a specified level. It could be significant swing for one side if both parties aren’t carefully monitoring the financials through the due diligence process.
Funky Rules
Last but not least – there are so many changing ‘rules’ …depending on the deal, the buyer, the seller, the lender. So here are a few items that pop up when putting together a deal and loan structure that works:
Lease terms for the target business may need to be aligned with the life of the SBA loan
Seller Promissory Note may have to be on standby for the first 24 months of the loan
Seller’s must carry some amount of Promissory Note
Seller’s may stay engaged with the business as a consultant – but for no longer than 1 year
Debt Coverage Ratio will vary depending on the bank
What Add-backs the underwriter will consider when reviewing the cashflow
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