Except for the SBA 7(a) program, banks generally do not make loans to individuals to buy a business. This statement will surprise a lot of people.
Most people will think first of a conventional bank loan when seeking financing to buy a business. But I can tell you from decades of experience, this just doesn’t happen often. The bank’s advertising will lead you to believe they do, but they will usually find some reason not to make a business acquisition loan.
However, after you’ve bought the business and been operating for a while, the irony is this: The same banker that turned you down for a loan to buy the business will come by your office soliciting your business.
Now this is a true and humorous story. One of my clients who had been turned down by a local bank for a business acquisition loan, had the same banker visit him two years later soliciting his account after he had used other means to buy the business. The business owner assumed a serious air and in a somber tone, replied, “Well now Mr. Banker, we’ll be happy to consider your application for our business. Let’s see, we’ll need your financial statement and a list of references and your business plan for five years into the future. Once we have your completed application, I’ll be glad to take it before my committee and let you know of our decision.”
The banker was taken aback.
But fortunately for individuals considering buying a business, participating banks have the Small Business Administration 7(a) loan program to offer. Except for some specialized programs, the SBA does not make direct loans to borrowers. Instead, the SBA guarantees a percentage of the principal amount that the bank loans to you. In a practical sense, the SBA is co-signing the loan with you at your bank.
What is the 7(a) program?
It is the SBA’s most popular business loan program. To be eligible for such a loan to buy a business, the borrower and the business must:
- Operate for profit
- Be small, as defined by SBA
- Be engaged in, or propose to do business in, the United States or its possessions
- Have reasonable invested equity
- Have a minimum personal credit score of 660
- Use alternative financial resources, including personal assets, before seeking financial assistance
- Be able to demonstrate a need for the loan proceeds
- Not be delinquent on any existing debt obligations to the U.S. government
- An independent, third party valuation of the business must meet or exceed the agreed upon acquisition cost.
Additionally, after deducting a reasonable salary for the owner, the business being acquired must produce a net cash flow of 1.25 times debt service.
Some banks do not participate in the SBA loan programs, but fortunately many national, regional and community banks do participate. Some banks are designated by the SBA as “Preferred Lenders” which means they have a streamlined application process and more local underwriting authority. My experience is that you’re much better off using a Preferred Lender compared to a bank that only processes a few SBA loans per year. The top 100 most active SBA 7(a) lenders can be found here.
Admittedly, the SBA loan application can be time consuming and sometimes frustrating. But keep in mind, the SBA-backed loans are approved in a lot of instances where no other financing options are available.
Amount Available, Down Payment Required, Interest Rate and Collateral
The maximum amount that can be loaned under the program is $5 million. The average loan in fiscal year 2015 was $371,628. Interest on the loans is negotiable with the SBA setting the maximum rate that a bank can charge. As this is being written, the maximum rate for loans over $50,000 is 6.25 percent.
The down payment required is usually 20 percent of the price of the business being acquired. Some lenders will allow a portion of this 20 percent to be covered by a seller note (ie: a note payable from the buyer of the business to the seller for a portion of the acquisition cost). SBA restrictions on this seller note usually do not allow repayment of principal and interest for a stated period of time.
The length of the loan for business acquisition can be up to 10 years, or for real estate, the term can be up to 25 years.
There are fees involved in applying for a 7(a) business acquisition loan but in many cases, these fees can be added into the loan amount.
Banks love collateral and will usually reach out and grab whatever collateral is available; however, many lenders will approve a SBA 7(a) loan even when there is less than 100 percent available collateral coverage. Some banks are more “cash flow lenders” than others, meaning that they will look more to the future earnings of the business being acquired as collateral for the loan rather than current hard assets.
My office stays up to date on the loan preferences and appetites of many lenders. If you need a recommendation of a bank most suited for your particular situation, just shoot me an email at Will@WilliamBruce.org.
For further reading, here are additional related articles:
- How to Use Valuation Guidelines to Estimate the Value of a Business
- How to Analyze a Business You’re Considering Buying
- How to Make a Written Offer to Buy a Business
- Seven Negotiating Rules When Buying or Selling a Business
- How to Conduct the Due Diligence When Buying a Business
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William Bruce is an Accredited Business Intermediary and Appraiser assisting buyers and sellers of privately held businesses in the transfer of ownership. His practice includes consulting services nationally on issues of business valuation and transfer. He currently serves as president of the American Business Brokers Association. He may be reached at (251) 990-5934 or by email at Will@WilliamBruce.org.