Using an SBA Loan to Buy a Small Business
Using an SBA loan can be the best way to borrow money to buy a small business. However, the loan process is often extensive and requires planning to get the outcome you want. Lenders typically set a high bar that you and your potential small business need to clear to be approved.
Therefore, the more you can educate yourself about the process, the better your chances are of being approved. Don’t let the right small business slip away because you didn’t get the financing you need. The below guide to the SBA loan process can help you be ready to buy a small business.
What is an SBA Loan?
SBA loans are provided by traditional lenders and partially guaranteed by the U.S. Small Business Administration. This guarantee allows participating lenders to offer more favorable loan terms than typical bank loans. As a result, SBA loans are a popular funding source for small businesses.
SBA loans can be used for most business purposes, including working capital and acquiring fixed assets. Depending on the type of loan, the maximum funding amount is up to $5.5 million with loan terms of 5 – 25 years.
Existing businesses with a strong record of cash flow are often approved easier than start-ups – making SBA loans an attractive funding source when looking to buy an established small business.
SBA Loan Types to Buy a Small Business
There are several different types of SBA loans to choose from, with varying size and business requirements. For business acquisitions, however, the two most relevant are a 7(a) Loan or a CDC/504 Loan.
The 7(a) Loan suits many different business needs including buying a small business or adding more capital to a business. Offers loan amounts up to $5 million with repayment periods up to 7 years. These loans typically require borrowers to have 10% or more equity in the business.
The CDC/504 Loan program is for those buying owner-occupied commercial real estate or heavy equipment. Offers loan amounts up to $5.5 million with repayment period of 10 to 20 years. These loans also typically require borrowers to have 10% or more equity in the business as well as meeting SBA job creation or public policy goals.
SBA Loan Qualifications
SBA loans and lenders have unique requirements depending on the type of business and the type of loan. At a high level, the SBA requires businesses to be a for-profit business, operating in the U.S., that meets it’s size standards for a small business.
The specific loan requirements will vary by lender, and each will have their own flexibility in the qualification criteria. All lenders will want the applicant to provide a sound business plan and demonstrate the ability to repay the loan.
Typically lenders will want the business to have in excess of $100,000 in revenue and have been in business for at least two years. Additionally, they look for owners that have a strong credit score (680+), a 20% equity stake in the business, and prior management experience in the industry.
Lenders may also look for collateral to support the loan, which provides extra protection to them in the event the business fails. Common forms of collateral include: real estate, equipment, vehicles, and other personal or business assets.
Lenders will review both your personal financial history and that of the business. Documents requested for this often include:
- Personal and business tax returns
- Business income statement and balance sheet
- Information on any collateral
- Purchase agreement
- Business plan with financial projections
The purchase agreement and business plan are often critical to the application. Notably, these documents provide the lender with critical details on the business and expected future profits to repay the loan.
To learn more about what goes into a purchase agreement and business plan, see our posts and Five Deal Closing Tips for your Business Sale and The Importance of a Business Plan. Preparing these documents in advance can ensure a faster process and increase your chances of getting a favorable loan.
How to Apply for an SBA Loan
Applying for an SBA loan to buy a small business is a time consuming process. In fact, it can take weeks or even months from start to finish. Therefore, it is important to gather as much information as possible before applying.
LendEDU can help you get started with their resource guide and tools to compare various financing options. You can also find information and forms on the SBA website or speak with your local bank about the process.
Whether you go it alone or use a consultant service, make sure to use an SBA-approved lender. Approved lenders are experienced in underwriting SBA loans and are generally given more leeway to approve loans faster. In the event that you need help finding an approved lender, you can use the SBA Lender Match tool, which matches applicants with SBA-approved lenders.
What should I ask the lender?
To help find the right lender for you and your small business, you should ask the lender the following questions:
- How often do you make SBA loans?
- What types of small businesses do you typically underwrite?
- What loan size and term do you typically underwrite?
- How experienced is your staff with the process?
When you choose the right lender, that lender will help make the process go as smoothly as possible.
And finally, make sure you understand all of the terms of the loan. The last thing you want is to accept a loan you will have difficulty paying back. Some key terms to keep in mind are the interest rate, length of the loan, payment schedule, prepayment penalties, and if/when the lender can demand repayment.
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DISCLAIMER: The information contained in this article is for informational and discussion purposes only, and should not be relied upon without seeking your own professional advice. The Firm Exchange, LLC is not a law firm, accounting firm or professional services firm, and accordingly it disclaims any liability for any reliance on the contents of this article. As each situation is unique, you are encouraged to discuss your specific situation with a qualified attorney, accountant and/or other relevant professional services provider.