A business owner who used an SBA loan for acquisition holds the door open to her store and a sign that says "open"

Using an SBA Loan for a Business Acquisition

Many business owners take on an SBA loan to cover the costs of an acquisition. Named after the Small Business Administration that guarantees them, these loans enable buyers to finance up to 90% of the costs of acquisition.

 

What kinds of loans does the SBA offer?

The SBA offers 7(a) loans to small business owners to cover up to 90 percent of their startup costs, working capital, and equipment needs. Many use these loans to help finance the purchase of a business.

Depending on your needs and the level of financing you require, you may consider one of the three types of 7(a) loans that the SBA offers:

 

Standard 7(a) loan

 

Maximum loan amount

$5,000,000

Collateral requirements

Loans that are $350,000 or more are collateralized to the maximum extent possible. If a business’s fixed assets can’t fully secure the loan, lenders may include trading assets and will take the available equity in the owner’s real estate as collateral. Any shortfall may be covered by a life insurance policy that names the lender as the beneficiary.

Maturity terms

  • 25 years for real estate
  • 10 years for equipment
  • 10 years for working capital or inventory

Other terms and conditions

The SBA sets a maximum interest rate for the loan, and lenders and borrowers can negotiate the loan rate up to that maximum. Eligibility and credit decisions are determined by the SBA or certain preferred lenders. The loan turnaround time is generally 5-10 days.

 

7(a) small loan

 

Maximum loan amount

$350,000

Collateral requirements

Loans between $25,000 and $350,000 are generally collateralized through a lien on the assets being financed with the loan proceeds and a lien on the applicant’s fixed assets.

Maturity terms

  • 25 years for real estate
  • 10 years for equipment
  • 10 years for working capital or inventory

Other terms and conditions

The SBA sets a maximum interest rate for the loan, and lenders and borrowers can negotiate the loan rate up to that maximum. Eligibility and credit decisions are determined by the SBA or certain preferred lenders. The loan turnaround time is generally 5-10 days.

 

SBA express loan

 

 

Maximum loan amount

$350,000

Collateral requirements

Loans between $25,000 and $350,000 are generally collateralized according to the lender’s policy.

Maturity terms

  • 25 years for real estate
  • 10 years for equipment
  • 10 years for working capital or inventory

Other terms and conditions

The SBA sets a maximum interest rate for the loan, and lenders and borrowers can negotiate the loan rate up to that maximum. Eligibility and credit decisions are determined by the lender. The loan turnaround time is 36 hours or less.

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The SBA also offers 504 loans to cover the purchase of existing buildings, the purchase of land or land improvements, the construction of new facilities, the renovation of existing facilities, and the purchase of long-term machinery. Unlike 7(a) loans, 504 loans must be used for a specific purpose, which cannot include working capital or inventory or consolidating debt.

While 7(a) loans are provided by SBA-approved lenders, 504 loans are granted through a collaborative effort from participating lenders, SBA-regulated certified development companies (CDC), and borrowers. In most 504 arrangements, the SBA lends 40 percent of the total project costs. Lenders provide 50 percent of the total project costs, and borrowers provide the remaining 10 percent.

 

504 loan

 

 

Maximum loan amount

$5,000,000; however, business owners are generally required to create or retain one job for every $65,000 the SBA guarantees

Collateral requirements

The financed project assets are often used as collateral, and personal guarantees from owners who have a 20 percent or greater in the business are required.

Maturity terms

10-, 20-, and 25-year terms

Other terms and conditions

Interest rates align with the current market rates for 5-year and 10-year U.S. Treasury issues and are fixed for the life of the loan.

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Which loan program is right for me?

Whether you choose one of the 7(a) options or the 504 loan will depend on what you plan to do with the funds you raise. If you’re planning to raise capital for a specific real estate project, such as buying your target business’s facility or engaging in renovations, you’ll likely choose a 504 loan. If you plan to fund other startup costs or working capital needs, you’ll choose a 7(a) loan or another financing option.

It’s important to note that some SBA loans include additional fees and prepayment penalties. You should speak with a lending officer before proceeding with an SBA loan to make sure that it’s a suitable choice for your needs and that your business is eligible for SBA funding.

 

What are the qualifications for a 7(a) loan?

To qualify, you must be attempting to purchase a small, for-profit business that’s based in the United States. You must be able to make a down payment, equal to 10-20% of the purchase price, and have exhausted other options for financing. Additionally, you and the business you’re acquiring should be on solid financial footing: Applicants should have a credit score greater than 640, and businesses that will be acquired should be able to demonstrate at least two years of profitability and growing annual revenues. Lenders may also require a debt service coverage ratio of at least 1.15 to ensure that the business has enough cash on hand to service debt, interest, and lease payments.

You can find additional requirements for the 7(a) loan options here and the 504 loan here.

At present, some types of businesses are ineligible for SBA loans. You can study the current list of ineligible businesses at SBA.gov.

 

Where do I go to attain one of these loans?

Many commercial and community banks issue all three forms of 7(a) loans, and they can guide you through the steps you’ll need to take to start the 504 loan process. Most will direct you to the appropriate contact at a certified development company (CDC) in your region.

Some online banks also offer these loans. GoKapital and Commercial Loan Direct are two popular lending services many business owners use to access SBA financing.

 

What should I do before applying?

There are four steps you should take before applying for an SBA loan:

1

Make sure your finances are in good order.

You and any partners who will hold at least a 20 percent ownership share in the business should gather three years of tax returns, determine your net worth, and ensure that your credit scores are 650 or greater. If the business you already own will be acquiring the new entity, you may also be required to provide three years of financials and tax records.

2

Develop a plan for covering the down payment.

As a borrower, you’ll be expected to make a down payment that equals at least 10 percent of the business’s acquisition cost. If you’re using seller financing as a second form of financing, you may be able to reduce the down payment to 5%. Read our article, Why Seller Financing Can Be a Great Source of Capital, to learn more about this option.

Many applicants leverage the assets of another business that they own to accumulate the cash that’s needed for a down payment. Others dip into their personal savings, stock accounts, home equity accounts, or retirement funds. You may wish to speak with a certified public accountant (CPA) who can help you understand the risks of using each of these sources of funding.

Would you like to connect with an accountant? Check out some of our favorite firms here:

 

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3

Select an SBA loan provider.

You can work with any commercial, regional, or community bank that offers this service. Of course, you may want to choose one with a team dedicated to serving small businesses. It's also important to choose a bank that offers favorable terms and competitive interest rates. GoKapital and Commercial Loan Direct are popular SBA lenders.

If you need help finding a lender, visit SBA.gov and use their Lender Match tool.

4

Gather the documents you’ll need to complete the application.

You’ll need to gather or create personal and business documents to demonstrate your business’s viability, your creditworthiness, and your ability to run the business effectively. Key items include:

  • Three years of personal tax returns for you and any partner holding at least a 20 percent stake in the business
  • Documentation of your personal, your business’s, and the business you’re acquiring’s assets and liabilities
  • A signed letter of intent (LOI) to buy the business you plan to acquire
  • Up to three years of your business’s tax returns (if you plan to involve your current entity in the transaction)
  • Up to three years of your target business’s tax returns
  • Three years of both business’s financial statements, including profit-and-loss statements, balance sheets, and cash flow statements
  • A debt schedule that lists your business’s debts and liabilities and, if you will be acquiring the debt of the new business, that business’s debts and liabilities
  • Proof of the business licenses and registrations that are required for you to conduct business, which may include articles of incorporation, franchise agreements, copies of contracts that you hold with vendors and key customers, and leases on the property
  • A third-party valuation of the business
  • A business plan that describes the company, the target market it serves, its competitive positioning, and its plans and projections for the future
  • A resumé or other proof of your experience or ability to manage a business

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How do I apply?

Your lender will provide you with a loan application and SBA forms specific to the loan you’re seeking. These will include SBA Form 1919 and SBA Form 413 for the standard 7(a), 7(a) small loan, and SBA express. You’ll also complete SBA Form 1920 for the standard 7(a) and the 7(a) small loan. For the 504 loan, you will complete SBA Form 1244.

Your lender may offer creditor insurance, which assures that the loan will be repaid in the event of your death or incapacity. Learn more about creditor insurance in our Small Business Financing 101 article, What Is Creditor Insurance?.

Once you complete the required forms and demonstrate you can provide collateral for the loan, the lender will begin the loan underwriting process. During this time, the lender will evaluate your assets, liabilities, and managerial experience and assess the business’s financial positioning.

If your lender is an SBA-preferred lender, the team you’re working with will decide whether to approve the loan. Others will need to work through the SBA for loan approval. If your loan is approved, the lender will work quickly to distribute the funds you need to buy your target business.

 

How can I boost my chances of being approved?

Here are some strategies you can use to boost your odds of approval:

 

What else should I know?

One of the conditions of an SBA loan is that the seller must fully exit the business in order for it to be eligible for funds. This means that you cannot hire the seller as an employee of the business.

The problem is that many owners offer to support the business post-sale, and this support can be invaluable. To navigate the SBA’s requirement and accept the seller’s support, consider retaining the owner as a consultant rather than an employee. Speak with an attorney to formalize this arrangement and ensure that your agreement won’t jeopardize your ability to attain financing.

Are you interested in connecting with an attorney? Click the Connect button below to get started:

 

What’s next?

SBA loans aren’t your only funding option. Check out this guide to find more ways to access capital, which can include term loans, asset-backed loans, 401(k) access, and seller financing:

 

Need more support? We can help. Visit your owner’s portal for articles and advice that’ll help you source a small business, conduct due diligence, compare forms of financing, and conduct the work that’s needed to make your venture a success.

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