Demystifying SBA Loans for Buying a Business or Franchise
The Small Business Administration (SBA) is widely known for its small business loan programs. The most popular is the SBA 7(a) loan, which can be used for a wide variety of purposes, including buying an existing business or opening a franchise.
There are many reasons to consider an SBA loan, but they are often misunderstood as either too complex, too difficult to obtain, or too slow to process.
Read on for answers to common questions about SBA business acquisition loans and find out why they are usually the first avenue to investigate for financing a business purchase.
What advantages do SBA loans offer over traditional term loans?
- SBA loans typically have lower interest rates because they are partially guaranteed by the U.S. Government.
- They also offer longer repayment terms than traditional loans. SBA business acquisition loan terms are usually 7 to 10 years.
- More capital is also available for SBA loans. Borrowers can take out as much as $5 million.
What are the loan terms going to be?
SBA 7(a) loans are highly regulated. The interest rate cannot exceed WSJ published prime plus 2.75%. Lenders can compete for your business by offering a lower rate.
When the loan is for less than 50% real estate, the loan term is for 10 years with no prepayment penalty.
For loan transactions involving more than 50% real estate, the loan term can be up to 25 years with a declining prepayment penalty (5% for year 1, 3% for year 2, 1% for year 3).
How do you qualify for an SBA loan? What are the requirements?
In general, in order to qualify for an SBA loan program, the business must be:
- Small by SBA standards
- A for-profit business
- Located and operating in the U.S.
- Have owner equity invested
The business cannot:
- Get funds from any other financial lender
- Engage in prohibited activities
Finally, proceeds of the loan must be used for an eligible purpose. To learn about down payments, and other financial requirements, see Basic Eligibility Requirements for an SBA Business Acquisition Loan.
Can I borrow the down payment?
The down payment must come from cash, savings, investment funds such as stock or 401k, gift from a family member or friend (documented by a gift letter), outside investor or a home equity line of credit (HELOC).
The down payment cannot be borrowed from a family member or friend. You cannot use a credit card or personal line of credit.
Can you use an SBA loan to buy an existing business?
SBA loans that are used to finance a change of ownership (e.g. business acquisition) require an equity injection of at least 10% of the total project costs. The seller debt can be used for up to half the required injection and must be on full standby for the term of the loan.
Equity injections can be either cash, cash borrowed from a personal loan, assets other than cash, or standby debt for the term of the loan with no payments of principal or interest.
Can you use an SBA loan to open a franchise?
Yes. To make things even easier, the SBA allows franchisors to apply to be pre-approved for SBA loans and get an "SBA Approved" moniker. This helps reassure new potential franchise operators that they can secure favorable financing terms.
In order to get SBA approved, a franchisor must submit all required documents, including their franchise agreement, in order for eligibility determination.
Anyone interested in buying a franchise can access BizBuySell's directory of SBA approved franchises, and filter by their state to find franchising opportunities in their area.
Can the owner of a business for sale get pre-qualified for an SBA loan?
The owner can actually attract more buyers and speed up the sales process by getting their business pre-qualified for an SBA loan. To do this, the business owner needs to meet with an SBA-backed lender and ask if their business, along with an eligible buyer, meets their requirements.
In general, the lender can make this determination by reviewing the last three years of business's financial statements, including its tax returns, profit and loss statements and balance sheets.
For more detail on the process, see How Can Business Sellers Pre-Qualify their Business for an SBA Loan?
How long does it take to get approved for an SBA loan?
In short, between 45 and 90 days. If a lender gives you a time period less than 30 days, they are most likely using a working capital loan as an example.
Here are some guidelines for time frames relating to business acquisitions and the SBA business acquisition loan:
- Lender to review the proposed business acquisition loan and issue a letter of interest. 2 to 4 days
- Internal underwriting and buyer due diligence. 7 to 30 days
- Formal internal credit approval and closing. 30 days
- Lenders have processes in place to keep loan requests moving along. Most of the time during the process is spent waiting on documents to be retried and uploaded by buyers, sellers and business brokers. There are a lot of moving parts in a business acquisition and related loan.
What can an SBA 7(a) loan be used for?
Besides buying a business or opening a franchise, SBA 7(a) loans are flexible and can be used for a wide variety of business purposes. Rates are among the lowest available for business financing and terms can go for up to 25 years, depending on the purpose. Ultimately, how the loan may be used will depend on the lender. Just to name a few, here are some examples:
- Business acquisition (change of ownership)
- Franchise purchase
- Start a new business
- Working capital
- Refinancing existing debt
- Machinery and equipment
- Furniture and fixtures
- Marking and advertising
- Commercial real estate
- Remodeling and improvements
There are many options available for financing the purchase of a business. Business buyers can use not just one, but a combination of financing to fund their business. In many cases, the seller will carry part of the financing and the buyer will raise the remaining funds through an alternative option. If you’d like to learn more about SBA loans for buying a business, read SBA Loans 101, or contact a participating SBA lender.