An SBA loan is often used as a tool to start or grow your business. Did you know that SBA loans can also be used to purchase a new business or buy out the remaining ownership of a partner?
This is one of the most powerful uses of the SBA 7(a) loan program and can be a stable and affordable way for you to enter a new market or expand your business. An SBA business acquisition loan can be used whether you’re looking to buy a new company, or buy out other partners in your business.
In this article, you’ll learn why the SBA 7(a) loan program is a good tool to use for business acquisitions, and what to expect when applying.
Be ready for you and the business to be reviewed
When lenders evaluate a potential deal, they’re looking at the health of the business you want to acquire, your financial situation, and your industry experience. The business you want to acquire has to have a healthy balance sheet. That means that it shows a history of handling debts and a balance between retaining profits and paying them to the business owners. The business must also be able to afford the new debt.
In a business acquisition loan, the combined funds of the loan and the equity you put in will pay out the departing owner who will be replaced by you. Because the business will be carrying this new debt moving forward, it needs to have a history of profitability high enough to cover the monthly debt payments.
Another important factor to consider is whether your business will have any interruptions without the departing owner. For some businesses, there will be a “transition period” where the departing owner slowly shifts their responsibilities to others. For others, it might not be possible to continue the business as-is without the departing owner. They may need to rename or rebrand, and develop a strategy for carrying on customer relationships of the former owner.
Finally, your lender will also look at your personal finances, as you’ll be their secondary source of repayment. If you’re thinking of applying for a business acquisition loan, do a quick assessment of your personal finances to review your:
- Net worth: How do your assets compare to your debt? Think about any investments, real estate, personal property, credit card debt, student loan debt, and mortgages you might have. Having “positive” net worth is a big first step in getting qualified for an acquisition loan.
- Outside income: Do you make any passive income? Do you have another job that provides a stable income to you? Having outside income means the business won’t have to pay you quite as much and will have more money available to make its loan payments.
Appraisals and down payments
Just like when you buy a home, buying a business requires an appraisal and down payment. This is divided into two tracks.
If the business acquisition loan is for more than $250,000, then the lender will hire (at your expense) a third-party business valuation service to estimate the business’s value. If the loan is for less than $250,000 then the lender will do their own business valuation.
Make sure you’re prepared for this step of the process. The appraisal will determine the true value of the business and will influence how much of a down payment you’ll need to make. Lenders can only lend against the appraised value of the business.
If the seller is asking for more than the appraised value you’ll need to pay that difference through an additional down payment unless you renegotiate the price. The additional down payment won’t be counted as equity towards the business acquisition. Instead, it’s seen as paying a premium for the business.
The minimum down payment on any business acquisition is 10% for the SBA loan program. So, if you’re buying a business for $100,000, then you can expect to make a down payment of $10,000 and finance $90,000 through an SBA loan. Of course, your lender may require a higher down payment depending on the strengths and weaknesses of your specific request.
A seller’s note can be an alternative
If you’ve done the math on your SBA business acquisition loan and can’t afford the down payment, another option to fill the funding gap is a seller’s note. This is when some of the acquisition cost is paid off slowly over time instead of as a lump sum.
A seller’s note can be used to fund this premium or it can count as a portion of the required equity. A seller’s note can also be an effective way to manage the “transition” of an exiting partner as it ties their compensation to how well they handle their exit from the business.
Make sure to seek expert help when acquiring a business
Your SBA lender will do a lot of diligence on the acquisition on their part, but you need to have your own representation. This means an accountant, lawyer, or valuation expert that can provide another set of eyes on how the deal is shaping up. With the right help in place, your business acquisition stands the greatest chance of success. Many businesses have worked with Pursuit on using an SBA 7(a) loan for business acquisition. Reach out to Pursuit today and see how we can help.