If you have $100,000 in cash to purchase a business with, you might be able to find a business that will bring in around $50,000 in owner benefit or seller’s discretionary earnings per year. However, if you were to leverage that $100,000 and use it as a down payment on an SBA (Small Business Administration) loan to purchase a business, you could turn that $100,000 into some serious buying power. That would result in you being able to buy a superior business that brings in significantly more owner benefit per year, even after the debt coverage.
What Is An SBA Loan?
As Business Brokers, we are not experts in lending, but we do partner with some amazing lenders and banks to assist our buyers. We sat down with Denise Clements from Dogwood State Bank, to learn more about SBA loans and how they work. According to Denise, the SBA doesn’t make direct loans to entrepreneurs to start or grow a business. Instead, it provides a guarantee to banks and lenders for the money they lend to small businesses owners. This guarantee protects the lenders interests by promising to pay a portion of the loan back if the business owner defaults on the loan. So, when a buyer or business applies for an SBA loan, it is actually applying for a commercial loan through a bank or authorized SBA lender, structured according to SBA requirements with an SBA guarantee. Essentially, SBA loans alleviate the risk associated with lending money to business owners and entrepreneurs who may not qualify for traditional loans – thus opening up lending opportunities to thousands of entrepreneurs, start-ups, growing businesses, minorities, and veterans.
What Can An SBA Loan Be Used For?
There are several types of loans that a business can take advantage of, each developed to suit the needs of the business. The 7(a) loan program, for example, can be used for a number of purposes including working capital, revolving funds, equipment purchases, refinance existing debt, and the purchase of an existing business.
SBA Loan Basics
Buyers need to qualify for the loan, as well as the business that’s being financed. Banks like to see that buyers have experience of running a small business and a background in the industry of the business that is being purchased in. The business needs to have solid financials, and make enough profit to support the repayment of the loan, as well as the running of the businesses and the owner’s salary. The seller cannot be employed by the new buyer for longer than 11.9 months. If the business requires a specific state license (like contractors), most of the time, the buyer must hold the license, or the loan might not be possible. If the business location is leased, a new lease will need to match the term of the loan. For example: a 3-year lease with options to renew for 7 years with a 10-year loan. Closing costs for the loan will vary, but we were told to budget on average 3.5-5% of the loan amount. Another interesting fact about SBA loans is that the buyer will most often be required to carry life insurance and the lender must have the original assignment.
How Much Do I Need To Put Down?
Down payments will vary, based on the lender and the business. Typically, we see them range from 10-30%. Terms on an SBA loan are either 10 or 25 years (25 years is only when real estate is purchased). There is a $5,000,000 maximum for an SBA loan. Franchises must be approved by the SBA (list available on their website).
Buyer Profile For Qualification
Here is some of what Denise looks for in a buyer and a business, when considering a loan application. The business’s cash flow is most important to the SBA. The buyer’s character (experience in industry, owning a business, legal background) is also taken into consideration, as well as their credit score (680+ score is ideal, but they will judge each application and situation independently). They also consider the buyer’s capacity to run the business, as well as the collateral (personal or business, most important in a commercial real estate purchase) that the buyer has to put against the loan. Furthermore, ideally, the bank would like to see that the buyer has 6 months of personal and business liquidity in the bank, but it is not a requirement.
Prepare And Apply For An SBA Loan
As a buyer, preparing in advance to apply for your SBA loan is a good idea. There are lots of documents and financials that will be requested, so it is smart to have them ready to go. Below are a few items that a lender might request:
- Business Plan (need to know it and be able to explain it)
- Projections for sales and revenue (need to be able to explain reasoning)
- Personal Tax Returns
- Bank statement showing equity injection (down payment) amount
- Anything else on a lender’s requirement checklist
What Does “Lender Pre-Qualified” Mean?
Often listings of businesses for sale will be advertised as “lender pre-qualified,” which means that a lender has already looked through the business’s financials and they are reasonably confident that it will be approved for an SBA loan. The buyer doesn’t have to use the lender that has pre-qualified the business, but certainly can. It does make the process much easier, since that lender already has the business's financials.
If you are considering the purchase of a business, and would like to learn more about the SBA Loan program or process, please don’t hesitate to reach out to us and we can put you in contact with some fantastic lenders.