In a perfect world, a buyer interested in a small business would have the cash needed to pay 100% of the value upfront. The seller receives money upfront, and the transaction is complete. As you probably know, this is a very unlikely scenario. So how do buyers finance a transaction that may be six or seven figures?

Many potential buyers consider a loan to acquire a small business, and one of the most common is an SBA loan. An SBA loan requires a buyer to meet specific requirements related to the capital injection, and a portion of this can come from the seller financing a part of the loan.

What is the Small Business Administration?

Sure, you have probably heard of the Small Business Administration (SBA), but what does the SBA actually do, and how is it relevant to selling (or buying) a small business?

Created in 1953, the U.S. Small Business Administration (SBA) continues to help small business owners and entrepreneurs pursue the American dream. SBA is the only cabinet-level federal agency fully dedicated to small businesses and provides counseling, capital, and contracting expertise as the nation’s only go-to resource and voice for small businesses.

What is an SBA Loan?

An SBA loan is a loan from an American lending institution that is guaranteed in part (usually 50 to 80 percent) by the U.S. Small Business Administration (SBA). There are many types of SBA loans. However, the most common and relevant to business sales is the 7(a) loan program.

Loan approval for an SBA loan is somewhat easier because the SBA stands behind the loan in the event of a default. The process often takes longer because both the SBA and the lender must approve the borrower.

What is an SBA Certified Lender?

An SBA-certified lender is a lender that works with SBA to provide financial assistance to small businesses through government-backed loans.

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How does a buyer find an SBA Certified Lender?

The SBA works with designated intermediary lenders across the country to provide financing to small businesses. Refer HERE to find an intermediary lender near you.

Different Types of SBA Lenders

The SBA partners with different types of lenders to ensure that small businesses have access to lenders with a range of credit standards. A buyer is not going to the SBA directly; rather the SBA backs the loan and the lending institution processes and distributes the loan.

Different types of SBA lenders are as follows:

  • Commercial Banks
  • Credit Unions
  • Financing Companies
  • Nonprofit Economic Development Organizations

Even though the loan to purchase a small business may be an SBA loan, everything is handled through the lender. The buyer does not contact the SBA directly regarding the loan.

Why Many Buyers Seek an SBA Loan

Due to their competitive interest rates and long repayment terms, SBA loans are generally the least expensive sources of capital available to a buyer.

It is usually easier to get approved for SBA financing when buying an existing business compared to getting approved to fund a startup. The reason for this is that the lender can better judge the buyer’s potential to repay the loan by looking at their potential business’s track record.

SBA Loan Terms and Cost

The typical rates, fees, and repayment terms are as follows:

  • Loan Amounts:  Up to $5 million
  • Interest Rates:  Rates vary based on the current U.S. prime rate, which you can find online from a variety of sources.  
  • Fees:  SBA loans have a guarantee fee starting at 3% of the loan amount for loans over $150,000. Other fees are also associated with the loan, such as application fees and third-party closing costs, as well as third-party reports such as environmental, business appraisal, etc.
  • Repayment Schedule: The standard term for SBA loans is ten years for a business acquisition loan and working capital and 25 years for real estate. A longer-term means lower monthly payments and better cash flow.

What buyers will need to have to qualify to get an SBA loan

Before even looking at your information, a lender will want to see if your business even qualifies for financing. The business will need to have a strong financial track record, as well as clean and orderly books. Three years of increasing revenues and cash flow is ideal.

The following documents are required:

  • Three years of business tax returns
  • Three years of profit and loss statements
  • A copy of any lease agreements (office, warehouse, or retail space for example)
  • Interim profit and loss statement
  • Balance sheet

Note that if there has been a decline in revenue over the past three years, a letter of explanation may be requested by the lender. All lenders must abide by the SBA SOPs (Standard Operating Procedures); however, each lender has the right to be more restrictive in its own procedures.  Often SBA lenders will request the following:

  • Inventory list
  • Equipment list
  • Aged receivables report

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SBA Loans vs. Seller Financing:  What is the difference?

SBA Loans

The SBA helps small businesses obtain needed credit by giving the government’s guarantee to loans made by commercial lenders. The lender makes the loan, and SBA will repay up to 85% of any loss in case of default. Since this is a bank loan, applications are submitted to the bank and loan payments are paid to the bank. The bank is also responsible for closing the loan and disbursing the loan proceeds.

SBA’s involvement is limited to reviewing the loan application submitted by the bank to assure they meet eligibility and credit standards. The SBA provides the bank with a written authorization outlining the conditions of the SBA guarantee; any material changes to this authorization generally require the SBA approval.

Seller Financing

Seller financing is when a seller of a business offers the buyer a loan to cover a portion of the cost.  The buyer makes a down payment in cash, typically in the amount of one-third of the sale price, as soon as the deal is closed.

The seller’s loan (financing) covers the remaining amount of the sale price. The buyer repays the loan from the seller in regular installments, plus interest, according to the terms set by the seller.

Usually, repayment terms for a seller finance loan are similar to those of a traditional business bank loan, with repayment lengths somewhere between three and seven years, monthly repayments, and low-interest rates between 6% and 10%.

Final Thoughts

When purchasing a small business, generally, seller financing will not cover the entire cost of the business, and buyers may need to seek another source of funding. If a buyer must seek another source of funding, applying for an SBA loan is a good choice. For more general information about SBA loans, refer to the SBA Loan Chart HERE.