The Basics of SBA Lending for Business Sales

Use the SBA to Your Advantage as the Buyer and Seller of Businesses

Business sales which are financed by the Small Business Administration (SBA) may afford the buyer an opportunity to purchase the business of their dreams that they otherwise would not have.  Sellers of businesses may similarly take advantage of SBA-lending backed sales to realize a premium purchase price with more favorable terms.

How is the SBA used by Buyers to Purchase Businesses?

  • The SBA is the mechanism by which many buyers seek and obtain loans with which to purchase businesses.
  • The SBA essentially acts as the guarantor of the loan and such loans are administered by banks with whom they (and the buyer) do business.
  • The purpose of the SBA is to enable buyers to more easily purchase businesses.

A Knowledgeable Business Broker Informs Sellers of Possible SBA Terms

Before agreeing to a deal contingent on SBA financing, sellers should consider the following:

  • Buyers must be qualitatively qualified by the SBA.
  • The loan is ultimately contingent on the appraisal of the business.
  • The seller may be required to still have some skin in the game (through seller financing) depending on the structure of the deal.

Buyer Needs to Qualify When Purchasing Business with SBA

The initial SBA loan application process includes the buyer giving a resume or description of their prior work history and education. For many businesses – specifically in the construction or health-care related industries – the SBA will require that the loan applicant possess specific work history in relation to the business being purchased.

Example: Purchasing a Business in the Construction Industry via SBA Loan

For example, a buyer seeking to purchase a large kitchen and bath remodeling company through an SBA-backed loan typically is required to either have the trade license necessary to run the business (such as a General Contractor license) or to have specific work history in a construction-related industry within the last five or so years. The SBA realizes that the loan is far more likely to be repaid if the buyer has relevant work experience or industry knowledge.

The SBA Loan is Ultimately About the Appraisal

After the buyer is initially told by the bank that they are preliminarily qualified to proceed with the loan and after the buyer and seller agree on a letter of intent or purchase agreement, the buyer typically orders and pays for the appraisal. The SBA uses the appraisal to determine how much funding they are willing to commit to the loan (this amount is expressed in the commitment letter). The appraisal can be pricey and can amount to several thousands of dollars depending on the type of deal in question. It is a non-refundable expense for the buyer.

Factors Used in Appraisal

  • The main factor used in the appraisal is the financials of the business.
  • The financials reviewed include the tax returns and profit and loss statements for the last 3 years or more.
  • Unlike buyers, the appraisal does not typically take into account personal expenses that the owner may have used as business expenses nor does it take into account unrecorded sales or cash.
  • The physical equipment and leasehold improvements are also major considerations as that is collateral that the SBA can use against the value of the loan.
  • Lastly, the SBA often times may require that the business has a long term lease in place (sometimes as much as 10 years!), particularly if the business in question is in the retail industry.

Seller May Be Required to Seller-Finance Part of the SBA-Backed Deal

Like any lender, the SBA will want the loan to be repaid. In accordance with this goal, the SBA will want the seller to have some ‘skin in the game’ after the closing. This is crucial for any business where the seller himself or herself is an instrumental part of the success of the business. The SBA (and most buyers) will want sellers to pave the way for a smooth transition so the business does not lose any customers, suppliers, or employees after the sale.

Sellers Should Beware of Unfavorable Terms of Seller’s Note

In structuring an SBA-backed deal with seller financing, the SBA typically mandates that the Seller’s Note has certain terms that are (to put it mildly) unfavorable to the seller. This includes the obvious fact that in the case of a default, the Seller’s Note (typically 10-20 percent of the purchase price) be subordinate to the SBA’s loan.

Sellers Should Beware of Stand-By Provision

Moreover, the seller’s Note also may have a stand-by provision. This means that the payments of the seller’s Note (owed to the seller by the buyer) do not begin for a lengthy period of time of two years or even more. The reason for the stand-by provision is simple: The SBA wants to get paid first!

Business Broker Must Explain All Matters Ahead of Time

As with most other matters when selling a business, the requirement of a Seller’s Note may be waived if the buyer pays more money down at closing. A competent business broker should always explain such matters to all parties ahead of time so there are no surprises.

Give Martin at Five Star Business Brokers of Palm Beach County a call today with questions about the SBA process if you are a buyer or a seller of a business.