Business acquisitions are among the eligible uses for Small Business Administration (SBA) 7(a) loans. In fact, the SBA 7(a) program provides many advantages for acquiring an established business, including its attractive terms, allowing a buyer to finance up to 90% of total project costs.
Eligible Project Costs for SBA 7(a) Loans Include
- The acquisition of an SBA-eligible business and owner-occupied commercial real estate (owner-occupancy minimum of 51% is required)
- Working capital
- Closing costs
- SBA guaranty fee
- The franchise transfer fee, if applicable
- New equipment, if needed
If the acquisition does not include commercial real estate, the maximum loan term is 10 years, fully amortized with no prepayment penalty. If commercial real estate is included, the SBA allows a blended loan term with 10 years for the business acquisition and 25 years for real estate. However, if 51% or more of loan proceeds are allocated to real estate, the SBA allows a 25-year term.
A prepayment penalty applies to all loans with a term of 15 years or greater. The penalty is 5% in year one, 3% in year two and 1% in year three, and none after that. In addition, the SBA allows a borrower to prepay up to 25% of the outstanding principal per year without penalty.
The SBA requires a 10% equity injection. The entire 10% injection can be from the buyer or a combination of a 5% buyer down payment and 5% seller financing if the seller is willing to have their note on full standby with no principal and interest (P&I) payments for the life of the loan.
Eligible Sources of Buyer’s Equity Injection Include
- Cash in savings or checking accounts, seasoned for two months
- Home Equity Line of Credit (HELOC) if there is a secondary source of repayment not related to the business to be purchased
- Gifted funds that do not need to be repaid
- Seller financing on full standby of no greater than 5% of the 10% equity required
- Investor contributions from partners
Personal guarantees are required by all individuals who will own 20% or more of the business to be acquired.
SBA requires the lender to be in the first position on all assets to be acquired. In addition, if there is less than one-to-one collateral coverage, the SBA requires the lender to take a lien on all real estate owned by personal guarantors with 25% or greater equity.
To pre-qualify for an SBA loan to acquire a small business, the lender will typically need the following:
- Most recent three years of business federal tax returns
- Interim Profit and Loss (P&L) and Balance Sheet as of the last month’s end
- Broker’s Confidential Information Memorandum (CIM)
- Accounts receivable (A/R) & Accounts Payable (A/P) aging reports as of the last month’s end
- Customer concentration information, if applicable, for customers accounting for 20%+ revenue
- Last three years of personal Federal tax returns and W2s, if applicable
- SBA Personal Financial Statement (PFS), form 413
- Credit authorization to obtain their credit report
- Buyer’s transition plan
- If the buyer owns 50%+ of another business, the lender will need the last three years business tax returns, interim P&L and Balance Sheet as of the last month’s end and a business debt schedule
- Executed letter of intent between buyer and seller, if available
Upon providing a pre-qualification package to your lender, you can expect a loan officer to complete their review and respond with any initial questions before they issue a proposal letter. Timing varies from lender to lender, but typically, a proposal letter will be sent within a few weeks of submitting the documentation.
To explore SBA loans for a small business acquisition, we suggest you connect with a lender from the SBA Preferred Lender Program (PLP) list. PLP lenders can underwrite, approve and close loans without SBA review. This results in a significantly expedited process. Additionally, SBA preferred lenders are generally going to have a proven track record and SBA loan expertise that will be valuable to borrowers.