January 11, 2023
Adam Hoeksema
Every year there are roughly 5,000 SBA loans used to buy a business in the US. Although the maximum loan amount for an SBA 7a loan is $5 million, the average SBA loan used to finance an acquisition is $1,045,193 over the last 6 years (2018 - 2023).
In this article I want to start by providing you with some key data on SBA loans specifically used for business acquisitions, and then we will dive into more about the process of getting an SBA loan.
Top SBA Lenders for Buying a Business
Live Oak Bank is the top SBA Lender for business acquisitions. Over the last 6 years Live Oak Bank has closed 2,524 SBA 7a loans for acquisitions. Below is a list of the top 50 SBA lenders for business acquisition loans ranked based on their loan volume between 2018 and 2023.
Finding an SBA Lender for your Industry
Although the list of the top 50 SBA lenders is a helpful starting point, what you will find is that SBA lenders have specialities. Some SBA lenders like certain industries more than others. For example, if you are looking to buy a laundromat with an SBA loan you might be surprised that Live Oak Bank doesn’t even appear in the top 10 SBA lenders for laundromat acquisition loans. Hanmi Bank is the leading lender in this industry. This underscores the importance of finding an SBA lender that not only has acquisition experience, but a lender that likes your particular industry.
Next, I want to give you an overview of the SBA loan process for business acquisitions.
The SBA Business Acquisition Loan
An SBA acquisition loan is a loan that is used to purchase a business.
The main reason these loans are good for small businesses and startups is that they’re effectively insured by the SBA, allowing banks to be more flexible with what they can offer. With only 10% of the overall project, you can get a loan that covers the remaining 90%.
This reduces both buyer and lender risk and ultimately makes it a lot easier for small businesses to get started. In most cases these loans are not directly lent by the SBA, instead, the bank remains the official lender and the SBA takes on some of the risk by guaranteeing a percentage of the loan.
SBA loans are typically more flexible in terms of their requirements. They can have lower equity and collateral and can have longer repayment periods. They’re designed to encourage entrepreneurship and small business profitability and are competitive with this in mind.
SBA loans are generally high risk, given the requirements they set, and as a way of mitigating some of this risk, they do require a lot of paperwork. However, these requirements aren’t usually significantly different from those you’ll find from conventional lenders, and the results can be a much better deal for borrowers.
Because of all of this, it’s advisable to recruit qualified and experience help in the process from someone who knows how to work with the SBA. They’ll have the best understanding of how to determine whether you’re eligible, which documents you’ll need, and the best loan structure for your needs.
A good lender can save a lot of time on the application process, particularly if they’re a preferred lender, in which case they will be able to have the loan approved without the need to wait for the SBA.
Changes to the SBA Business Purchase Loan in 2023
Historically, SBA loans could only be used to purchase an entire business, but in 2023 the SBA made some key changes that now allow for SBA loans to be used to purchase a portion of a small business. This unlocks some significant new opportunities for SBA lenders and borrowers.
The 2023 budget has been set to support more under-served entrepreneurs and boasts a $31 million increase over last year, and increases support for women, POCs, and veterans, among other groups traditionally overlooked for loans.
These loans are great for starting a new business, but they’re also a strong option for buying an existing business. Let’s take a look at some of the types of businesses you can buy using an SBA loan.
Using an SBA Loan to Buy a Business: Your Options
Businesses eligible for an SBA loan typically fall under two categories:
Franchise businesses
Franchises are eligible for SBA loans. This business type comes in two forms:
Product/Tradename – Commonly, these are businesses such as automobile, mobile home, or farm equipment dealerships, but gas stations, auto accessories, and beverage distributors also fit into this category.
This type of franchise operates independently, selling products ordered by its franchise. These businesses are typically given territories by their franchisor in which they’re licensed to sell the products of their franchise, which are managed in a way to avoid competition between their products.
The nature of a franchise will limit you in what you can sell, as the product list will be set by the franchisor.
Business Format – In this model, you pay a fee to a franchisor for the rights to buy and sell their products and follow a strict process set by them. This franchise is more of a system that needs to be followed, though the franchisee is expected to design and execute an independent business model to achieve success with the system provided.
The Franchise system provides a lot more in terms of structure and guidance, though this comes at a cost to your creative freedom and company direction. Essentially, a franchise is a membership to a much larger parent company, and this can be a very simple business to run as a result, but you won’t get to make any decisions relating to the brand.
If you are looking for more control, you can consider buying a traditional business.
If buying a business with an SBA loan is your goal, a Quality of Earnings Report can provide the detailed financial analysis lenders value.
Traditional Businesses
These businesses also come in many forms. Corporations, limited companies, partnerships, or sole proprietorships are all examples, but they all come with benefits to the flexibility offered in relation to how the business is run and presented.
The obvious downside to this is that there will be no recipe book available for you to follow, meaning they will likely require more preparation and experience to run to the same degree of success as an established franchise.
In buying a traditional business, there will be stipulations by the SBA that will need to be met, which we will cover in some detail below.
Buying a Business with an SBA Loan
The SBA requires that where possible, lenders take collateral but if collateral is lacking, it is not enough alone to disqualify the borrower. This means that even borrowers without collateral can obtain a loan if they otherwise qualify.
Eligibility criteria can be found in detail at the SBA.gov website, but in summary, the vast majority of businesses that fit the following criteria will be eligible:
- The business must operate for profit
- It must be engaged in, or propose to do business in, the U.S. or its territories
- There must be reasonable owner equity to invest
- And use alternative financial resources, including personal assets, before seeking financial assistance
This loan eligibility is set by the SBA and applies to all lenders within the program. Lenders are still able to apply their own discretion and will be responsible for establishing the Five Cs of Credit.
This means you’ll need to persuade bankers of your:
- Capacity – This is your ability to repay the loan. It will involve checks on your revenue, expenses, and credit score, among others.
- Capital – You’ll need to have some amount of money to put down for the loan. This should be covered in the SBA requirements, however.
- Collateral – As mentioned, the SBA will ask you to use collateral if you have it, but this shouldn’t disqualify you. Banks may still look into this.
- Conditions – You might need to prove to the bank that your business has a viable market. This is something that should become obvious very quickly when buying a company that’s already up and running.
- Character – They’ll also want to know whether you’re educated or qualified in the field you’re getting into, to get a feel for how well you’re equipped to keep the company running.
These eligibility requirements are why it’s important to work with a lender that has experience in your industry, and we’ll talk more about that in a moment as part of the steps you’ll need to take to apply. If buying a business with an SBA loan is your goal, a Quality of Earnings Report can provide the detailed financial analysis lenders value.
Using an SBA Loan to Buy a Business: A Step-by-Step Guide
The first thing you’ll need to do is set up a budget and an idea of what kind of business you want to run.
For this, you need to know exactly how much you’re willing to spend. Then, you’ll have to decide on a target company. This should come down to the tools you have at your disposal. If you have sales or marketing experience, you’ll be able to narrow your scope when it comes to the type of business you’ll be able to benefit from purchasing.
Likewise, if you want to get involved on the ground, this can help direct your decision. Franchises allow you to become more involved in the front-line processes, whereas if you’re already experienced in running a business, a stand-alone model might be within your capabilities and would allow you more freedom and none of the franchise fees.
Then, it’s a matter of doing the groundwork.
1. Ask the right questions
Once you have a business in mind, you can approach an SBA lender immediately for advice and they should be able to help you with information on the documents you’ll need and the types of loans that are available.
Don’t be afraid to bring in expert help from elsewhere, though. Accountants, attorneys, financial advisors, and other qualified people can help you formulate a roadmap to reach your goals and explain how to find the information a lender might be looking for based on your specific case.
2. Identify the type of sale
There are different types of sales. If you’re buying a company that has shares of stock, this may or may not be a public company but will involve a stock sale. A stock sale allows you to acquire a company simply by purchasing the majority of shares.
An asset sale involves the complete purchase of the company’s assets. In this case, the shares remain with the seller, but you’ll be paying to have the name, the inventory, the accounts, and anything else that comprises the company transferred to you.
Resource: Asset Sale vs. Stock Sale - The Ultimate Guide
3. Obtain the necessary documentation
When applying for an SBA loan, you’ll need to have the appropriate documents from the seller. The complexity of this step will correlate with the complexity of the company you’re looking to buy, but there will be three types of financial statements you’ll likely need to retrieve from the seller before you can approach a lender.
These are the fundamental documents you’ll likely need to apply:
- Letter of intent
- Confidentiality agreement
- Contracts and leases
- Financial statements
- Tax returns
- Sales agreement
- Purchase price adjustment
But there may be more, so be sure to get help identifying your requirements to save you from going back and forth with the lender and the seller at the time of application.
Free Resource: Buying a Business Due Diligence Checklist
4. Start with Your letter of intent
With all the information you’ve gathered in the previous steps, you should be able to form a document that lays out everything that’s going to be transferred and how the process will ideally be executed. This will describe what’s being sold, who’s selling it, who’s buying it, and how much it’s being bought for.
This document will not represent the sales agreement, but it will be an agreement that if everything goes to plan and all of the claims made are accurate, the sale can take place. It will then be signed by both parties. The letter of intent should include an NDA, binding both parties to confidentiality clauses.
5. Find a Qualified Lender
As a way of making all this work worthwhile, you’ll want to find someone who has experience in your industry. Without this familiarity, they will look for hard assets as collateral and won’t feel as confident in your other eligibility factors such as the nature of your cash flow. Finding a lender who understands your business is one of the best ways to maximize the leverage of your SBA loan and get the deal that will benefit your company the most.
In order to find the perfect SBA lender for your unique location, business type, stage of business and loan amount request, you may need to do a deeper dive. We have developed an SBA Lender Analysis Tool as pictured below that can help you sort SBA loan data by State, Industry, Business Stage, Franchise Name, and Lender Name which can allow you to truly customize a report and find the perfect lender for your business.
We hope this information has been helpful, and if you need any help finding the perfect SBA lender in your area please don’t hesitate to contact us.
SBA Stipulations that you Need to Consider
As we touched upon, in order to receive an SBA loan, there are some stipulations in place that are designed to facilitate the buyer in the best possible ways.
One key requirement is that the previous owner must not stay in the business for more than a year. This is to protect buyers from being exploited in cases where the owner sells the business and then remains on indefinitely as a high-value employee. Meanwhile, the 12-month grace period gives new buyers plenty of time to learn the ropes and make the transition as smooth as possible.
Another stipulation that’s important is that the new business needs to have immediate cash flow. This means the business needs to be capable of paying any debt service. Learn more about SBA cash flow requirements.
You’ll need to be able to show profitability for at least three years, and have projections that extend for at least two more years on top of that. A good place to start for your financial projections is our acquisition financial projection template which enables you to create 5 years of reliable projections based upon historical financials you have. The pro forma statements generated in a simple to use manner and formatted in a way familiar to lenders.
To work with the tax transcripts necessary, the seller will need to grant permission to the lender to check tax transcripts from the IRS to verify the tax reports with the original returns. This is only a problem if they’re unlikely to match, so any honest and competent seller will have to agree to this for you to move forward.
Ultimately, it’s unlikely that you’ll be able to buy a new business without these figures, regardless of where you look for funding. A profitable reputation is not going to be persuasive enough for lenders to grant capital; they will require financial documentation to back it up.
Conclusion
Buying a business with an SBA loan is a great opportunity for entrepreneurs to receive funding for buying an established business. They're competitive, have low fees, and are designed specifically to aid small businesses and startups.
When looking for an SBA loan to buy a business, it’s important to gather the right documents and do your due diligence, but with the right advice and qualified help, this doesn’t need to take any longer than it would with a conventional loan and could give you a much better deal.
