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Getting an SBA loan to buy a business typically involves identifying a suitable enterprise, determining eligibility for an SBA loan, matching with a lender, and then following these five steps to apply for the loan. An SBA loan can offer a favorable route to financing, but the process does have costs and risks to consider. Learn the details here.
Key Points
• SBA loans may offer small business buyers favorable interest rates, longer repayment terms, and minimal collateral requirements compared to traditional financing options.
• Eligibility can require meeting buyer credit and down payment standards, while the target business must operate for profit within the U.S. and meet size criteria.
• Securing an SBA loan involves finding an eligible business, signing a letter of intent, matching with a lender, and completing underwriting and third-party valuation.
• Key expenses typically include a 10% down payment, SBA guarantee fees, lender charges, and interest payments, plus valuation fees for deals exceeding $250,000.
• Borrowers owning 20% or more of the business must sign a personal guarantee, making them responsible for debt repayment if the business experiences financial difficulty.
Why Use an SBA Loan for a Business Acquisition?
There are several good reasons why you might use an SBA loan for a business acquisition: favorable interest rates, long repayment terms, and little or no collateral requirements. These features can make an SBA loan an accessible source of funding to buy a business and either start or continue your entrepreneurship journey.
Other sources of funding can include small business loans, investor funding, and owner financing. Here, learn more about SBA loans for a business acquisition.
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Eligibility Requirements for Buyer and Business
If you’re thinking of acquiring a business with SBA loan funding, it’s critical to understand the requirements – such as credit scores, cash flow, and necessary financial documentation — for both the buyer/borrower and the business being bought. After all, if you’re not eligible for an SBA loan for the intended purpose, you’ll likely want to move on quickly and pursue other sources of cash.
| Which Company? | Eligibility Requirements for an SBA Loan |
|---|---|
| The buyer |
• Citizenship: Must be U.S. citizens or nationals • Personal guarantee: Any individual holding 20% or more equity in the company must sign a personal guarantee • Credit score: Typically a score of 640-680 or higher is required • Valuation: If the transaction will be $250K+ or there’s a close relationship between buyer and seller, an independent third-party business valuation is needed • Credit elsewhere: Must show that they cannot access credit at favorable rates elsewhere • Industry experience: Preference for borrowers with relevant experience/credentials • Down payment: Buyers usually must contribute 10% (often known as an equity injection) of the total purchase price |
| The business being acquired |
• Business type: Must be a for-profit company • Location: Must operate within the U.S. or its territories • Size: Must meet SBA small business size standards • Sector: Must fall outside the SBA’s list of prohibited businesses • Cash flow: Past financials and cash flow forecasts must cover the new loan payments • Financing: If the seller provides part of the down payment (or equity injection) as a seller note, it cannot exceed 50%, and the note must be on standby for the life of the loan • Financial documentation: Three years of business tax returns, current P&L statements, balance sheets, and a debt schedule |
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How To Get an SBA Loan To Buy a Business
If you can meet the requirements above, you may be ready to apply for an SBA loan to buy an existing business. This will involve such steps as signing a letter of intent and matching with an SBA lender. Below is a look at the typical process to get a loan to buy a business.
It’s worth noting that when using an SBA loan to acquire a company, you will probably be applying for a standard SBA 7(a) loan, with a limit of $5 million. In some circumstances, you might be seeking a 504 loan or a microloan.
Step 1: Find the Business and Vet Financials
If you have not already done so, you’ll need to search for an appropriate business that you’re interested in acquiring. It should meet the SBA eligibility requirements. You might use such websites as BizBuySell and BizQuest to connect with companies that are looking to be acquired.
Once you have a business in mind, you will generally need to do a deep dive into its financials. As noted above, it’s important to have a few years’ worth of documents so you feel assured that the cash flow will cover debt payments.
Step 2: Sign a Letter of Intent
Next, you and the entity you want to acquire will need to negotiate, agree to terms, and then execute a letter of intent (LOI). This is a formal document that confirms the parties involved, the purchase price and terms, the structure of the transaction, and any contingencies. At this stage it can also be wise to start gathering documentation for your loan application.
Step 3: Match With an SBA Lender
To move your loan application ahead, you’ll need to match with an SBA lender by searching for one that issues the kind of loan you’re seeking. Worth noting: Borrowers don’t receive funds from the SBA; the SBA backs, or guarantees, a portion of these loans, which are disbursed by lenders.
You’ll usually have a few options when looking for a lender:
• Navigate to the SBA website and review its list of lenders.
• Use the Lender Match tool on the SBA website, which can pair you with potential lenders based on information about you and the business you’re seeking to acquire.
• Check whether your current financial institution issues these loans.
Step 4: Underwriting and Valuation
Once you’ve been matched with a lender, you can gather your documentation and submit your application. Your package will then go through the underwriting and valuation process. This involves the SBA lender and possibly the SBA itself evaluating the application and making a decision about whether to approve the loan. The lender will review the borrower’s qualifications, how the deal is structured, and whether the business’s cash flow is sufficient to repay the debt, among other factors. (Worth knowing: Lenders known as SBA PLPs, or preferred lending partners, can make decisions without SBA approval.)
In situations in which the business acquisition loan is $250,000 or more, a valuation is also required. This is generally done by an independent third-party appraiser with CVA, ABV, or ASA credentials. This phase ensures that the business justifies the purchase price.
If the loan is approved, the borrower will receive a commitment letter and move ahead to the closing process.
Step 5: Closing
The last stage of getting an SBA loan to acquire a business is the closing.This typically involves managing final documentation, coordination between lawyers, and the funds disbursement and transfer of assets. When these matters are wrapped up (typically within 30 to 90 days after the application was initiated), the business acquisition is complete. Installment payments of the SBA loan then begin.
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Costs and Risks To Consider
Before pursuing an SBA loan for buying an existing business, it can be important to understand the costs and potential risks involved. These can include down payment requirements, SBA guarantee fees, and the possibility of default ramifications. It can be wise to carefully consider these costs and risks of an SBA loan as you plan to acquire a business so you can make an informed decision and plan appropriately.
Costs of an SBA Loan
An SBA loan, like any form of funding, involves potential costs. These may include the following.
• The down payment or equity injection usually needs to be 10% of the total purchase price. (If that’s not possible, you may need to seek seller financing or else investigate no-money-down business loans.)
• There is typically an SBA guarantee fee as well as lender fees, such as origination fees, closing costs, and possibly other charges.
• If purchasing a business with a valuation of more than $250,000, you will generally have to pay for an independent, third-party valuation of the company, which can cost a few thousand dollars or more.
• The interest rates charged on the loan may be more favorable than other options, but they are still a cost to be paid and need to be carefully budgeted for.
• Prepayment penalties may apply if you pay off your loan early or refinance it. The amount charged for these actions typically declines over time.
Risks of an SBA Loan
An SBA loan also brings certain potential risks. Here are some of the most common.
• Anyone who owns 20% or more of the business must sign a personal guarantee, which certifies that if the enterprise fails, the signer will be unconditionally responsible for repaying the debt, potentially using personal assets.
• If you default on your SBA loan, the lender or the U.S. Treasury can seize assets, place liens, and garnish your wages when seeking repayment.
• Business assets may be used as collateral, but if they aren’t sufficient, you may need to put up personal assets.
• The SBA and SBA lenders typically require borrowers to prove that the business being acquired meets cash flow requirements to repay the debt. If the acquired enterprise has a slump in revenue, it may be challenging to stay current with your payments.
Recommended: A Guide to Small Business Expansion Loans
The Takeaway
An SBA loan can be a valuable option when seeking to acquire a business. These loans may offer favorable terms and accessible down payment and collateral requirements. Understanding how these loans and the approval process work can help you move through the process with clear expectations and heightened confidence. This kind of SBA funding does, however, come with its own set of costs and risks, so it can be wise to explore all your options (such as small business loans) to find the source of financing that’s the right fit for you.
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FAQ
How much down payment is needed for an SBA loan to buy a business?
Typically, a 10% down payment, or equity injection, is needed for an SBA loan to buy an existing business. However, the number could be more, depending on such factors as the size of the loan and whether the business is a recent startup or an established entity. There may also be the possibility of the seller financing some of the down payment.
Can an SBA loan cover the full purchase price of a business?
No, an SBA loan can’t usually cover the full purchase price of a business. These loans typically require a down payment of at least 10% of the full purchase price.
How long does it take to get an SBA loan for buying a business?
It typically takes 30 to 90 days to get an SBA loan for buying a business, though depending on the specifics of a purchase and an application, it might be considerably faster or slower.
Can you get preapproved for an SBA acquisition loan?
While the SBA itself doesn’t preapprove loan applicants seeking an SBA loan for buying an existing business, some lenders offer preapproval. Typically, this will involve a review of personal and business credentials, including tax returns, business financials, cash flow statements, and credit score.
What credit score is needed for an SBA business acquisition loan?
There isn’t one single credit score requirement for an SBA loan to be used for business acquisition, but lenders typically look for a credit score of 640 to 680 or higher.
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