Your Guide to Using SBA Loans for Buying a Business
For small business owners, SBA loans are a lifeline. They provide entrepreneurs with the funding they need to acquire real estate, improve their working capital reserves, and buy existing businesses, even at times when they’ve already been turned away from their bank or credit union.
In this article, we’re concentrating on SBA loans for buying a business. We cover:
What SBA loans are
Which types of SBA loans can be used for business acquisition
The types of businesses you can buy
The eligibility requirements for taking out an SBA loan
How to apply for an SBA loan to buy an established business
What Are SBA Loans?
SBA loans are loans provided by banks, credit unions, and commercial lenders for business purposes. What makes them different from standard business loans is that they are partly guaranteed by the U.S. Small Business Administration (SBA).
If a borrower defaults, the amount the SBA guarantees will be repaid to the bank. This reduces risk and encourages SBA lenders to offer loans to businesses that may not qualify under standard commercial lending guidelines.
The four main SBA loan types are:
SBA 504 loans: These are designed specifically to fund the purchase of major fixed assets, such as real estate or large equipment. They can also be used to refinance more expensive existing loans. The maximum loan amount for most businesses applying for an SBA 504 loan is $5.5 million.
SBA microloans: These small business loans are great for startup financing. New businesses can apply for up to $50,000 in funding.
SBA 7(a) loans: SBA 7(a) loans can be used for a variety of purposes, including working capital, equipment purchase, real estate and land purchase, and refinancing. The maximum loan amount for most businesses applying for an SBA 7(a) loan is $5 million.
SBA Express Loans: These are a special type of SBA 7(a) loans with much faster approval and turnaround. The maximum loan amount with an SBA Express Loan is $500,000.
All of the above are like bank loans in that they are term loans. That means you have to make monthly loan payments to repay the facility over an agreed period of time.
What SBA Financing Options Are There for Buying a Business?
There are two SBA loans that can be used for buying a business — the SBA 7(a) loan and the SBA 504 loan.
There are no hard-and-fast rules, but generally, you would use a:
SBA 7(a) loan to buy a business whose value is in its reputation and the relationships it has with its customers (like a retail or service business).
SBA 504 loan to buy a business whose value relied upon the use of assets (like a manufacturing or construction business)
There are advantages and disadvantages to both. It’s best to consult with your preferred lender during the application process to see which is better for your situation.
Eligibility Requirements to Get SBA Loans for Buying a Business
To qualify for an SBA loan for buying a business, you have to meet certain criteria.
For starters, you need to operate a for-profit business in the United States. You should have applied for funding elsewhere and had all of your applications rejected. Think of the SBA loan program as your final option when all other avenues have been exhausted.
Your lender will also have requirements around your ability to repay the loan. Each lender will have its own requirements, but they may look at your credit score, your revenue, and your existing debt.
In addition, you’ll need an upfront equity injection (sometimes called a down payment) of 10% to 20%. This is similar to the down payment you’d make when arranging a mortgage.
Many SBA loans allow seller financing when funding a business buyout. This is when the seller of the business lends money to the buyer to help them buy their business. For example, you could put 5% down, and the seller would put the other 5% down so you had your initial equity injection.
The SBA will require the seller financing to be on full or partial standby for a period of two years or more. If it's on full standby, you can't pay anything to the seller for the agreed period of time. If on partial standby, you can repay the interest but not the principal. The SBA loan is the senior debt in a seller financing arrangement and must be repaid first in case of default or the company goes into liquidation.
In addition to the down payment, you will almost certainly need to offer collateral to get your loan. Collateral can be personal assets like real estate or business assets like the equipment and machinery in the business you wish to buy or that’s currently in your business, if applicable.
The process of applying for an SBA business acquisition loan can be complicated and take a number of weeks or months.
What Types of Businesses Can You Buy With an SBA Loan?
SBA loan requirements prohibit certain types of businesses from applying, including rare coin dealers, gambling-related businesses, and speculative investments.
As long as the business you wish to buy is not in such a category, you can use SBA loans to purchase these types of businesses:
Existing businesses: These are companies that are already operational. Many entrepreneurs find it a lot easier to buy existing businesses and build on them rather than starting from scratch.
Business format franchises: These are businesses where the franchisee sells a franchisor’s products and services under their brand name and business model. For example, McDonald’s is a fast-food chain that operates under the franchise model.
Job franchises: Job franchises are typically low-investment, owner-operated businesses, many of which don't require you to take on staff. You can operate one from home or on a mobile basis across a wide range of sectors like cell phone repairs, cleaning services, and event planning. The franchise is like a "job" in that it provides an income, but there are often few opportunities to scale these businesses.
How to Apply for an SBA Loan to Purchase a Business
The application process for most SBA loans can be lengthy and complicated.
As a general rule of thumb, take the following steps when applying for SBA loans for buying a business:
Prepare a solid business plan: This plan should detail the current state of the business you want to purchase, projected cash flow, and your repayment plan.
Perform due diligence: Many of the assumptions you have in your business plan about the company you want to take over may be inaccurate. Make sure you perform due diligence on your target business to satisfy yourself that it presents the opportunity you believe it does.
Complete a loan application: This step requires you to provide a detailed account of how you will use the funds and how much you need. You will also need to provide an independent business valuation to show that the purchase price is justified. You should also provide the bank with a letter of intent that outlines the preliminary terms and conditions of the purchase.
Provide personal financial statements: The lender will expect to see documentation like balance sheets and tax returns for yourself and the business you want to purchase.
Once each of these stages has been completed, you then need to wait for the lender's underwriting team to provide you with a decision.
Use SBA Loans and Alternative Financing for Your Business Needs
SBA loans for buying a business offer entrepreneurs the option to grow their businesses through acquisitions as well as organically. The application process is lengthy and detailed but the SBA's backing means you have a greater chance of your loan being approved.
Although Backd is unable to help you buy another business, we can provide you with funding to help with post-acquisition financial needs. You can take out a working capital advance once you’ve been in business for at least a year, and you can take advantage of a business line of credit once you've been in business for at least two years.
With the Backd Working Capital Advance, you can borrow up to $2 million with no collateral required. With the Backd Business Line of Credit, get access to revolving credit of up to $750,000 that you can draw on whenever you need it.
Apply for funding today to get started.
