September 26, 2024
Except for the SBA 7(a) program, banks typically do not provide loans to individuals for purchasing a business—something that might come as a surprise to many.
Most people assume that a traditional bank loan is the first option when seeking financing for a business acquisition. However, based on decades of experience, I can tell you that banks rarely approve such loans. While their advertising may suggest otherwise, they often find reasons to decline business acquisition financing.
Ironically, after you've successfully bought and run the business for some time, the same bank that previously rejected your loan application may later approach you, seeking your business.
Fortunately, for prospective business buyers, banks participating in the Small Business Administration (SBA) 7(a) loan program offer a viable solution. Rather than issuing loans directly, the SBA guarantees a portion of the loan made by the bank, effectively co-signing the loan with you.
This is the SBA’s most popular business loan program. To qualify for a 7(a) loan for purchasing a business, both the borrower and the business must meet certain criteria, including:
Additionally, an independent third-party valuation must confirm that the business’s value matches or exceeds the agreed-upon purchase price. Furthermore, after accounting for the new owner’s salary, the business must generate a net cash flow of at least 1.25 times its debt obligations.
While some banks don't participate in SBA programs, many national, regional, and community banks do. Banks designated as “Preferred Lenders” by the SBA offer a streamlined application process and more localized underwriting authority. From experience, working with a Preferred Lender is usually far smoother than with banks that process only a few SBA loans annually. The top 100 most active SBA 7(a) lenders can be found here.
Admittedly, the SBA loan application process can be time-consuming and occasionally frustrating. However, SBA-backed loans are often approved in situations where no other financing options are available.
The maximum loan amount available under the 7(a) program is $5 million, with the average loan size in fiscal year 2018 being around $425,000. Interest rates on these loans are negotiable, but the SBA sets a maximum rate that banks can charge. Currently, the average rate for loans over $50,000 is approximately 6.00 percent.
Typically, a down payment of 15 to 20 percent of the purchase price is required. Some lenders will allow a portion of this down payment to be financed through a seller note (a promissory note from the buyer to the seller covering part of the acquisition cost). SBA regulations typically mandate a delay in principal and interest payments on the seller note for a specified period.
The loan term for business acquisitions can be up to 10 years, while loans involving real estate can extend to 25 years.
There are fees associated with applying for a 7(a) loan, but many of these fees can be rolled into the loan itself.
Banks, of course, prefer collateral, and they often seek as much as possible. However, many lenders will approve an SBA 7(a) loan even with less than 100 percent collateral coverage. Some banks are more focused on cash flow, meaning they rely more on the business’s future earnings as collateral rather than hard assets.
There are many great tools that the government offers to lenders looking to purchase small businesses. The good news is that we've partnered with top-tier Preferred Lenders who are experts at guiding you through the process. Your Customer Success Manager (CSM) will be available to steer you in the right direction, ensuring a smooth and efficient experience.
