There are a number of ways to secure financing for the acquisition of a small business.  Selecting the right debt structure for yourself can mean the difference between hitting your Return on Investment (‘ROI’) targets or missing them badly.  There are multiple loan options and each has pros and cons.

Conventional loans through a traditional bank are one primary debt vehicle. For these types of loans, which are usually amortized over 5 years, lenders will normally require a significant down payment (30% or more) plus outside collateral to cover their loan exposure. The amortization period is fairly short and the interest rates can be on the high side which puts cash flow pressure on the business if it is not structured properly.  These loans, however, usually don’t require a personal guaranty.

There is however, another very viable option. The Small Business Administration (SBA) provides loan guaranties for lenders that lend under their 7a loan program. This program is designed to help owner operators obtain favorable acquisition loans with a low down payment of just 10 percent, a longer term amortization of 10 years and perhaps longer if real property is bundled into the loan and very favorable interest rates. Also, there is no need to make up a collateral shortfall as these SBA backed loans can have an unlimited amounts of goodwill.  On the con side, a personal guaranty will be required along with secondary liens on real property.

These SBA loans, which are provided by banks or other lenders and partially guaranteed by the SBA, are based upon the cash flow of the business being acquired.  The lender’s underwriters will examine the historical cash flows of the business and after allowing for the buyer’s household expenses, determine if the company’s cash flow is sufficient to adequately cover the projected debt service associated with the SBA loan and a subordinated seller note, if appropriate.

Because the SBA 7a loans are based primarily upon cash flow and the lenders are obtaining the SBA’s guaranty, the lenders can lend more than their conventional underwriting standards would dictate.  They can absorb larger amounts of “Goodwill” which is often a large component of a business’ purchase price.

The maximum loan exposure allowed to any single individual, under the SBA 7a regulations, is $5mm. The minimum required equity injection from the buyer for a given acquisition loan, is typically 10 percent  of the project cost. The project cost is normally defined as the purchase price plus the SBA fee and the bank’s closing costs.  The SBA fee is the fee charged by the SBA to provide the loan guaranties to the lenders.  The SBA fee ranges from approximately 2.25% to 3.5% times 75% of the loan amount and the lender’s closing costs can range from $6,000 to $12,000 depending upon the lender and whether or not real estate is involved in the purchase price. These closing costs are designed to cover the lender’s legal costs, searches, appraisals and a third party business valuation.

Acquisition loans that do not involve real estate are normally set up on a 10 year term.  If real estate is being purchased along with the business, the combined term can be up to 25 years, depending upon the percentage of the combined purchase price that is made up by the real estate purchase price.  This extended amortization can really help to lower the debt service and enhance the EBITDA of this business.

The interest rates on SBA 7a acquisition loans will vary from lender to lender and depend upon the size and strength of the transaction, but they generally range from 1.75% to 2.75% over prime. These are very favorable compared to conventional loans – this combined with longer amortization periods can boost the ROI of most acquisitions.

The underwriting process for SBA 7a loans is fairly comprehensive and covers some key elements that go beyond the simple cash flow coverage of the loan.  The lenders will be looking at three main aspects of the buyer:

1. Equity injection funds – They will need to understand where the buyer’s equity injection funds are coming from.  They cannot be borrowed.  They can come from the buyer’s savings, they can come from an equity investment from a third party or they can come from a gift from family members or friends.
2. Personal Credit history – All individuals who will own 20% or more of the acquiring entity (who will be required to personally guaranty the loan) will need to have acceptable personal credit histories.  Generally, a FICO score of 640 is a minimum allowable score.  Lenders may turn down a transaction if the any of the guarantors have previous recent bankruptcies or multiple collection accounts and slow paying accounts.
3. Transferable Management Experience – Underwriters will want to ensure that buyers possess the necessary skill sets to own and operate the subject business.  They will look at the roles that the seller(s) have performed and determine if the buyers have the experience and skills to step into and take over the seller’s role(s).  This experience may take many forms.  It may be previous small business ownership experience, previous industry experience or previous management experience from which they can see that the buyers have such skill sets as sales and marketing, human resource management and financial understanding.

One of the big things to understand is that not all SBA lenders are equal.  The SBA has awarded “Preferred Lender” status to lenders who have demonstrated a sound and effective approach to processing SBA loans.  Preferred Lenders are allowed to approve their SBA loans internally based upon the SBA guidelines.  Non-Preferred Lenders must submit each loan request to the SBA for the SBA’s approval which adds time to the process. If you are working with a Preferred Lender, Underwriting should not take more than 2 weeks and the closing process should take approximately 4 weeks. With non-preferred lenders those timeframes can be considerably longer.

Every SBA lender has its own underwriting and credit approach.  They all have certain industries that they prefer and approval thresholds. Some are more aggressive in their approach to approving loans, while others are more conservative and may want a given borrower to have direct industry experience, especially for a larger loan. Some lenders are better at smaller transactions, others are a better fit if real estate is involved. Interest rates and loan structures will vary from lender to lender.

SBA 7a acquisition loans are a wonderful vehicle for qualified buyers to obtain needed financing with as little as 10% down and understanding your lending options is critical to making good acquisition decision.  For more information on how a SBA 7a loan can help you secure the best financing for your acquisition, please call 773-243-1603 and we can help you navigate the intricacies of acquisition lending so you can find the right debt package.