SBA Lending Terms Facilitate Business Sales

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The SBA Facilitates Business Deals

Many South Florida business buyers are frequently choosing to fund deals through lending backed by the Small Business Administration (SBA). The SBA guarantees loans issued by banks for the purchase of businesses. Without the SBA-backed guaranty, traditional banks typically do not loan money toward the purchase of small businesses. The SBA is able to value and lend capital based on the goodwill of a small business whereas traditional banks are typically too risk averse for such lending activities. Let’s explore exactly how SBA-backed lending can be so advantageous for both buyers and sellers of South Florida businesses.

The SBA 7(A) Loan Helps Business Buyers and Sellers

  • Almost all businesses are eligible for an SBA 7(A) loan unless the business is not-for-profit or the business is involved in lending, rental real estate, or investing activities.
  • The maximum amount for an SBA 7(A) loan is $3,000,000, and the minimum is roughly $30,000.00.
  • The business buyer must also qualify by virtue of their own credit and finances, along with their own work history and knowledge of the subject business and industry.
  • An SBA 7(A) loan may be used for the purchase of a business, whether or not the value of the business consists mostly of hard physical assets compared to intangible assets such as goodwill.
  • Even franchises may be re-sold via SBA 7(A) loans.

General Terms of SBA 7(A) Loans for Business Purchases

For SBA 7(A) loans used to buy real estate, the length of the loan may be up to 25 years.  For SBA 7(A) loans used to buy a business, the length of the loan may be up to 10 years. For loans less than $150,000, the SBA will guaranty 85% of the loan. For loans more than $150,000, the SBA will guaranty 75% of the loan. This of course means that the physical assets of the business itself or personal collateral from the buyer will have to guaranty the balance of the loan. The interest rate on SBA-backed loans are 2.25% to 2.75% above the prime interest rate. The prime interest rate in the winter of 2021 is 3.25% (a very low rate historically speaking), which means the interest rate for the typical SBA 7(A) loan would be 6%. Note that the typical loan terms are fixed rate over the life of the loan, with monthly payments of both principal and interest.

Example of Using SBA 7(A) Loan for Purchase of Business

  • Let us suppose that Barry the Buyer is interested in purchasing a large home healthcare company from Susan the Seller.
  • The negotiated purchase price for the business (with no real estate) is $1M.
  • Barry decides to inquire about receiving an SBA 7(A) loan at his local bank.
  • Assuming Barry is properly qualified by virtue of his own finances, employment history, and experience in the healthcare industry, the bank will first require a copy of the signed Letter of Intent (LOI) between Barry and Susan.
  • Then the SBA will conduct an appraisal of Susan’s healthcare business (Barry will be paying for this appraisal).
  • This will involve a close analysis of the financials and corporate documents of the business, any licenses the business has or may need, and making sure there are no outstanding liabilities of the business.
  • Assuming the appraisal matches or exceeds the purchase price as reflected in the LOI, Barry may then receive a loan term sheet from the SBA.

Example of SBA 7(A) Loan Term Sheet

Barry’s loan term sheet will spell out the length of the loan, the rate of interest, the payment schedule, and other terms of the loan. The total loan amount is $900,000 since Barry will need to put down $100,000, or 10% of the total purchase price. The monthly payment (including principal and interest) is $9,991.85 for 120 months, based on a total interest rate of 6%. Note that Barry will be paying nearly $300K of interest over the length of the loan. Another way to look at the loan term is that Barry will have to put $100K down and pay $120K/year toward repaying the loan.

Evaluate SBA 7(A) Loan Terms

  • Barry must weigh the terms of the SBA 7(A) loan against the cash flow of Susan’s business.
  • Let us assume the business generates $300K/year of adjusted owner benefit.
  • Since Barry will be paying $120K/year toward the loan, he will still earn $180K/year from buying the business via an SBA-backed loan.
  • Moreover, Barry is only paying $100K of his own money toward the purchase of the business.
  • There are however fees involved in obtaining an SBA appraisal and loan, so let us assume Barry is actually paying $150K of his own money in furtherance of purchasing Susan’s business.
  • Barry’s Return on Investment (ROI)  – or ratio between net income and investment – is thus $180K/$150K or 120%.
  • In other words, Barry will recoup his entire investment back within the first year of owning the business.
  • Of course, if things go sour and Barry defaults on his loan, then the SBA will seek redress from Barry personally.

Compare SBA 7(A) Loan against Seller-Financed Deal

If Barry were to instead seek a seller-financed deal with Susan, how would these terms compare with the SBA 7(A) backed loan? Typically, seller-financed deals involve the buyer putting up half of the purchase price at closing, with the seller holding a Note for the balance of the purchase price over a 3-5 year time period. In our example, let us thus assume that a seller-finance deal would necessitate Barry putting down $500K at closing. The balance of $500K is owed to Susan over a four year time period at the same 6% interest rate as the SBA-backed loan. This results in a $11,742 monthly payment owed to Susan, or about $140K/year.

Buyer Must Weigh Lending Terms Carefully

During the first four years after the closing, Barry realizes that the SBA-backed lending terms are far superior with less annual payments owed and far less down at closing. However, over a longer term horizon, Barry may still consider the seller-financed loan because he avoids lending fees and saves about $240K of cumulative interest payments over the life of the SBA-backed loan.

By carefully examining the terms of an SBA 7(A) loan, a business buyer may decide to use the power of leverage and realize their dream of owning a business through the use of an SBA-backed loan.

Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.

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