Financing guaranteed by the Small Business Administration is widely misunderstood, and thereby underutilized, by business owners. It can be used for a plethora of purposes ranging from real estate and equipment acquisitions to buying entire businesses. And the definition of “Small Business” for these purposes includes companies with as many as 1,000 employees in many industries. The SBA admirably fulfills its mission—making capital more readily available to a large swath of the American economy. However, SBA financing remains underutilized—for example, in 2016 the SBA 7(a) program was authorized for $26.5 billion but only $24.5 billion was actually deployed.
We will focus here on two related purposes: buying a business and selling your business to key employees using SBA financing. Unless otherwise indicated, we will be discussing the SBA 7(a) program which has a lending limit of $5 million.
First, a few common misperceptions. The SBA does not actually lend any money in a 7(a) deal. Local banks are the lenders and the SBA provides guarantees for a portion of the loan—typically 75%. Since their risk is reduced, banks will lend in situations that wouldn’t normally qualify per usual credit standards. Second, you must apply for a loan directly to a bank—not the SBA. Although there are some general SBA mandated rules, every bank that participates in the SBA program has its own lending requirements and standards.
So why use SBA financing when buying a business? Scott Stevens, first vice president for SBA lending at 44 Business Capital states that “the biggest reason is that SBA financing rules are much more generous to borrowers than standard commercial bank financing.” For example, we recently participated in the sale of a specialty contracting business for $2 million. Total hard assets—equipment and inventory—were valued at $100,000. Receivables were $60,000. Yet the buyer was able to obtain bank financing of $1.5 million at a 6% interest rate fixed for the 10-year term of the loan, with $200,000 cash down and $300,000 of seller financing. (SBA interest rates are currently prime + 2.75% fixed for 10 years. Variable rate terms are available as well.) Commercial lenders typically require business acquisition loans to be collateralized by hard assets—they might lend an amount of perhaps 60% of equipment and receivables value. Most commercial lenders would not consider a loan in our example where 90%+ of the assets were intangible (i.e. goodwill). Some more aggressive lenders might lend up to 40%–50% of the deal value, compared to the actual financing of 75% of the sale price here. For smaller deals, where the total intangible value is less than $500,000, SBA will finance up to 85% of the purchase price. Scott Stevens also notes that the SBA 504(c) program will finance 90% of real estate acquisitions up to about $10 million in value for a term up to 20 years.
As indicated in the example above, if the SBA is financing 75% of the purchase price, up to 15% of the equity can be in the form of seller financing. In an 85% financing situation, 5% of the equity can be from seller financing with only 10% cash/equity required in either case.
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