SBA 7(a) loans are the most common and advantageous for buyers in small market owner/operator and some lower middle market business acquisitions. These loans offer minimal up-front investment and longest payback term possible. SBA loans generally include purchase price consideration and working capital for equipment purchases, growth initiatives, and closing costs They are provided to small businesses though private lenders and are backed by the SBA which sets requirements and monitors the loan covenants throughout the term.
It is important to remember that not all lenders are created equal. While the SBA qualifiers are consistent and universal, each lender has their own set of investment criteria and specific nuances to their credit box. Working w/qualified, deal friendly lenders is a critical component to a successful transaction, so it is vital for buyers to get a handle on the lending process and speak w/multiple lenders in the SBA space.
Who Qualifies and What Lenders Evaluate
While SBA loans are the most efficient and effective pathway to business ownership for most individual buyers and partnerships, there are a number of eligibility requirements and covenants that buyer candidates must meet to qualify. Along with the standard SBA lending qualifiers, each lender will have their own requirements for potential buyers. Below are a number of standardized qualifiers that buyers must meet to qualify for SBA 7(a) lending.
- Must be a U.S. citizen or permanent resident with no recent bankruptcies or government debt defaults
- Minimum credit score typically 680 or higher (varies by lender)
- Relevant and demonstrable industry or management experience
- Must invest equity injection (10 to 20% total project cost) of unborrowed funds
- Six months of post closing liquidity beyond the initial down payment
- Collateral and assets available to secure debt coverage
- Personal guarantee on the loan for anyone with more than 20 percent ownership
Fee Structure
Acquisition funding is a significant piece of the overall deal structure but there are a number of soft costs associated with the fee structure that buyer candidates must be prepared to take into consideration. It is important to remember that while some fees are paid directly to the SBA and others to the lender, the SBA does not set specific maximums on lender fees, so it is vital for buyers to conduct their own due diligence and ask potential lenders to outline their fee structure and soft costs expectations.
- Loan guarantee fees
- Packaging and lender service fees
- Credit check fees
- Appraisal costs (for real estate-related loans)
- Closing costs
- Filing fees
- Late payment fees
- Prepayment fees
The Role of Seller Financing in SBA Deals
Seller notes are a common SBA deal structure component and can benefit both buyer and seller. The first time sellers think about selling their business, nearly 100% assume that the transaction will generate a big bucket of cash at close and they will be off to their next venture without any contingency. Unfortunately, business transactions do not work that way.
Interest rates on seller notes, which are generally higher than bank rates, accrue over the term note and can add significant $ to the total seller benefit. Seller financing can generate a higher sale price while simultaneously increasing the odds of selling; and limit the sellers immediate post closing tax exposure. In addition, seller participation in the financing structure signals a vote of confidence to both the buyer and the lender that the business is solid and the seller is confident of long term success.
Seller Valuation
The seller will provide access to the company’s full financial disclosure documents, including tax records, contracts, customers, vendors, etc. for lender underwriting. A thorough review will evaluate revenue trends and profit margins, customer mix, recurring revenues, competition, market positioning, and the seller’s daily operational responsibilities. A buyer’s due diligence will prove out the numbers that should generate confidence and validate well informed assumptions.
- Lenders evaluate 2 to 3 years of the target business tax returns and financial statements
- Debt service coverage ratio is critical. Business must generate enough cash flow to cover payments with margin
- Revenue trends, customer diversification, and industry stability all factor into approval
- Many SBA lenders require or prefer a seller note as part of the structure
- Seller note typically 5 to 15 percent of purchase price
- SBA requires full standby (no payments) on equity notes for the loan term, 24-36 month standby on stability notes where the buyer pays the full downpayment, and no standby payment requirement on amortization notes where the buyer pays the full downpayment and the business has an exceptionally strong foundation
- Signals seller confidence and aligns incentives through transition
- Buyers should communicate this requirement to the seller early to avoid friction at closing
Timeline, Common Pitfalls, and When SBA Is the Right Fit
It is critical to match buyers with vetted opportunities that align with their investment criteria. It is difficult to shove a round peg into a square hole. Connecting buyers with good cultural matches and creating relationships with aligned objectives helps streamline the transactional timeline, eliminate impasses and obstacles to close, while carefully managing multiple transactional components.
- Total process from application to close: roughly 90 to 120 days
- Start lender conversations early, well before signing an LOI w/a seller
- Common delays: incomplete documentation, unsourced equity injection, prolonged deal structure negotiations
- SBA 7(a) loans are generally ideal for acquisitions up to $7 million (in cases that involve para pari passu lending) with stable cash flow, clean financial reporting, and an owner-operator buyer
- Not ideal for deal sizes in excess of $7m, institutional buyers, inconsistent earnings, or special cases where time is of the essence (conventional bank loans, majority seller financing, or private equity capital may be better alternatives in those cases)
Next Steps
Thorough planning increases the odds of a successful M&A transaction. Consider speaking with multiple SBA lenders before you begin identifying potential acquisition targets. Understand what they require and how they measure up against the competition. Ask lenders about:
- Preferred Lender Program (PLP) status
- Closing department team (do they have a dedicated closer)
- annual SBA loan volume
- industry experience and types of loans closed in this specific trade
- interest rate variables
- institutional guarantee requirements
- prepayment penalty policies
- average approval to funding timeline
- specific credit score, cash flow, and liquidity requirements
SMP Capital Partners works with buyers and sellers to structure deals that align with lending requirements. Contact our team to discuss how financing fits into your acquisition strategy.