Category: SBA Financing
5 SBA Loan Myths & Steps to Getting an SBA loan for Business Buyers-Sellers
Getting an SBA Loan to buy or finance the sale of a business is a great way for buyers to leverage their cash to obtain a lower down payment and buy a bigger, more profitable business. SBA financing also offers benefits to business sellers because it gives them cash at closing rather than having to finance the transaction themselves with a large Seller Note. SBA financing is a win-win for business buyers and sellers.
In addition to the obvious benefits of a low down payment for the buyer and cash at closing for the seller, SBA financing other significant benefits. SBA financing offers 10 year financing at a maximum rate of Prime + 2.75% as compared to Seller Notes that are typically 5 years at 8%. The reduces the buyer’s debt service and increases their net after debt service dramatically. SBA lenders will also often finance the purchase of the seller’s receivables (A/R) which provides additional working capital for the buyer and again cashes the seller out at closing since he doesn’t have to wait to collect the outstanding A/R.
5 SBA Financing Myths, busted
- It takes months to get an SBA loan!
It’s a common myth that it takes several months to get an SBA loan, some think it can take 6 months. At Pacific Business Sales we SBA financing typically takes 45 days to 60 days and we run the SBA financing in parallel with Due Diligence and Escrow resulting in the bank being ready when escrow is ready to close. We work exclusively with a select group of SBA PLP (Preferred Lending Program) banks that have excellent underwriting teams and quick closing processes. We do not work with loan brokers that will “shop” the loan around and do not work with non-PLP lenders.
- SBA Loans are nearly impossible to get!
SBA loans do have a lot of paperwork and yes, both the buyer and business must qualify, but if the deal makes sense, SBA financing is a viable option. At Pacific Business Sales SBA financing is our preferred transaction structure and in fact over 90% of our transactions use SBA financing.
- SBA Loans require a ton of paperwork!
OK, this one is not a myth, SBA loans do require paperwork from both the buyer and seller. But if you are working with an organized lender, and broker knowledgeable about SBA financing, it goes smoothly and is well organized. We start the SBA application process as soon as the offer is signed and run it in parallel with Due Diligence. Our lenders send a checklist and work with our clients to track the status of the loan application. Our lenders also have secure file sharing systems where buyer and seller can easily upload their documents.
You’ll spend weeks trying to get an SBA loan and get rejected at the end!
This does happen with inexperienced brokers and when buyers use a non-PLP lender or a lender that doesn’t pre-qualify the deal. At Pacific Business Sales we pre-qualify all of the businesses we represent. This ensures the business qualifies for SBA financing upfront. When an offer is accepted the first step in our transaction process is to have our SBA lender review the transaction and pre-qualify the deal. This eliminates ugly surprises later in the transaction process.
- You have to have a lot of collateral to get an SBA loan
You don’t necessarily have to have a lot of collateral to get an SBA loan, in fact, some transactions are done with very little collateral. Having strong collateral absolutely helps in getting the financing approved, but it is not necessarily a deal killer if you don’t have a lot of collateral. Underwriting approval depends on many factors including, the overall strength of the deal, buyer’s experience. Buyer’s credit score, business financials, and collateral.
7 Steps to Getting an SBA Loan
- Find the Right SBA Lender
Finding the right lender is a critical first step. The “right” lender may not be the one you found on the internet that is hard-selling you and is certainly not one of the big-box retails banks. If you are shopping SBA loans you hear lots of promises and sadly will have lots of broken promises if you choose the wrong bank. You want a PLP lender that will close the loan and closes quickly.
The buyer will be choosing the SBA lender and it is critical to choose the right lender. There are many SBA lender choices and it is difficult for a buyer to know with certainty which bank is the best choice. Every bank has different industry preferences and underwriting practices. Much of the bank selection is a matter of knowing which bank will “like” this deal.
It is best to work with a bank directly and only use a loan broker in rare and extenuating circumstances. Loan brokers make a lot of promises they can’t deliver on and the banks cannot necessarily follow through with.
- Approvals and more Approvals; Pre-Approval, LOI, and Final Approval
There are lots of “approvals” along the way to funding and closing. First, the buyer will get a “pre-approval” which isn’t a promise or commitment to the deal, it mean exactly what is says, after initial review, the buyer appears to be qualified. Next is an LOI (Letter of Intent) from the lender which again is not a promise to offer financing. This comes after the lender has done an initial review of the buyer and business and it looks good, but still needs to go through full underwriting review. The last approval is the Final Approval letter from the lender which comes after underwriting review is complete and appraisals on the business and collateral are complete. Once Final Approval is received the bank is typically ready to fund in 5 to 7 days.
- Business Pre-Approval
At Pacific Business Sales the first SBA approval for the business is handled shortly after listing. We want to ensure that we have a lender in place that will approve the financial parameters of the transaction as well as the industry. It is important to know which lender is willing to close on the loan with the right buyer and how much of a down payment they want 10%, 15% etc. and what they will lend. If the business was not pre-approved or reviewed in advance by the lender then this will be step one along with buyer pre-approval since the bank is starting from scratch with the business.
If the business has not already been pre-approved the bank will require the following information from the seller:
a) last 3 years tax returns
b) last 3 years P&L and Year to Date P&L
c) Current Balance Sheet
d) A/R and A/P aging report
e) Owner’s W2s last 3 years and year to date Payroll report
f) verification of seller’s expenses and add-backs
- Buyer Pre-Approval
After the offer is accepted the buyer will submit the financials and personal information with an application to the lender (usually within 15 days of signing the purchase agreement). Transactions move fairly quickly so it is important to know that you are with the lender that will close the transaction rather than risk losing the transaction.
During the pre-approval process, the buyer will submit the following information to the bank:
a) copies of their last 3 years tax returns
b) authorize a credit check
c) provide a copy of their resume
d) complete an SBA Personal Financial Statement and Application
The buyer will be asked to sign a LOI from the bank which will indicate the proposed loan amount, down payment, and loan terms. When the LOI is signed the bank will require a deposit to start the business valuation, collateral appraisals, and underwriting.
The lender will evaluate the business financials to determine the net after debt service, cash flow and generally does it support the deal. Next underwriting considers if the business net after debt service supports the buyer’s income needs. Finally, underwriting obtains appraisals on the business and the buyer’s collateral (usually their personal residence).
- Final Approval and Closing!
When underwriting is complete and approved and the appraisals are complete the Buyer will receive a Final Approval letter. When this is signed by the buyer the bank will fund the transaction within 5 to 7 days and escrow will close.
At Pacific Business Sales we believe SBA financing provides sellers and buyers with the best transaction financing. SBA financing is our preferred transaction structure for deals under $5 million (SBA financing limit) and has proven to be a win-win for both buyer and seller.
How to Sell Your Business with SBA Financing
Financing is a critical and frequently overlooked aspect of selling your business. The fact is all cash transactions are very rare other than for very small businesses. Nearly all business sales have financing, and there are essentially two choices, SBA financing or Seller financing which involves the seller carrying a note.
SBA Loans; More Cash at Closing for the Owner
SBA 7a loans will finance up to 90% of the acquisition value with a 10% down payment from the buyer. With this transaction structure the seller receives cash for the full value of the business at the close of escrow. Bank underwriters often require a small seller note, typically 10% of the transaction value. With this transaction structure the seller would receive 90% of the transaction value at closing with a note for 10% of the transaction value. Seller notes are typically 5 years (60 months) ranging from 6% to 8% interest.
SBA financing requires the business and buyer to qualify for the loan. The business will be required to provide the last 3 years tax returns plus year to date P&L and Balance Sheet. The business must generate enough cash flow to service the debt with sufficient income remaining for the buyers income requirements. The buyer must also qualify, buyer requirements are a credit score over 700, sufficient cash for the down payment, working capital, and closing costs plus related business experience.
There is a common misconception that SBA loans are very difficult to get and take several months. This can be true in some instances, but this is not the case with the majority of transactions. Pacific Business Sales uses SBA financing on nearly all of its transactions. We have direct relationships with several PLP (Preferred Lender Program) banks and we are thoroughly familiar with their underwriting requirements and which banks will lend to specific business types and various deal structures. By virtue of our experience and banking relationships we typically close our transactions with SBA financing within 60 to 90 days.
Seller Notes, Quicker & Easier Closing BUT More Risk
The other option for financing the sale of a business is Seller Financing, a Seller Note. The typical transaction structure for seller financing is 50% down and 50% of the transaction value financed by the seller for 5 years at 6% to 8% interest. With Seller financing the owner will receive 50% cash at closing and the balance over the next 5 years. There is substantial risk with Seller financing because the only collateral for the loan is usually the business and if the buyer defaults on the seller note the only recourse is to contact an attorney and take the business back through a judgement.
There is a tax advantage with Seller Notes. The owner is taxed as the income is received, thus the seller is taxed on 50% of the transaction value at closing and the balance as payments are received.
Minimizing Taxes on the Sale of Your Business
The good news with SBA financing is that you can receive 90% to 100% cash at closing, the bad news is you will be taxed on these proceeds, and depending on the transaction type the tax rate could be high. We work with several CPAs that have tax strategies that can substantially reduce the taxes on the transaction. These tax strategies defer the taxes due at closing by approximately 90% and can reduce overall taxes by 30% to 40%. These tax strategies allow you to invest the proceeds in a trust and pay taxes as funds are withdrawn. The investments in the trust appreciate tax free until you take funds out. We can arrange a complimentary meeting with one of our CPA partners where they will explain your options, the cost of the plan and what the tax savings could be.
ADDITIONAL INFORMATION ON SELLING A BUSINESS