SBA Loans - An Overview

The SBA is many things to many people, and the one that is most user friendly and available to both existing and prospective business owners is the 7a program. The 7a program is the program that is available to qualifying individuals who wish to purchase a privately owned business or to an existing business owner who wishes to buy out an existing partner or expand operations, etc.

It should also be noted that while people talk about ‘SBA financing’ the reality is that the SBA does not make loans; however, the SBA under certain circumstances will guarantee 75% of the amount that lenders loan on SBA approved loans. This means that if an approved SBA guaranteed loan becomes a total 100% loss then the SBA will reimburse the lender 75% of the original loan amount. Why does the SBA make loans? It is one of the government’s efforts to {a} stimulate the economy, {b} provide some financial liquidity where none would otherwise exist, and {c} other reasons best known to those who dole out government sponsorship and/or funds. The SBA charges points – which vary with loan size but generally in the 2% to 3% range – on all loans that they guarantee, and those funds are intended to cover both SBA operating expenses and provide loss reserves for bad loans.

Many years ago a prospective borrower had to interface directly with the SBA, and it was a time-consuming, bureaucratic nightmare of complicated government forms, busy and harried SBA clerks and a real zoo to maintain any sanity or timelines during the process. The procedures have since been streamlined with the SBA designating ‘preferred lenders’ {most banks} who do all of the application, screening and processing work and make the actual loans. This has dramatically improved the process; however, not all preferred lenders are as efficient and expedient as others - some specialize and have good departments that know what they are doing, and others seem to have difficulty in functioning in an efficient manner. You will find that virtually all banks proudly proclaim their preferred status.

As you are most probably aware, virtually all lenders are asset based lenders in the sense that they approve or disapprove of loans based upon the estimated liquidation value of the assets (collateral) that can be pledged to secure the loan. ‘Assets’ can range from equity in real estate to ownership of stocks and bonds, equipment, accounts receivable, etc. You will also find that some businesses that you might be interested in buying have lots of assets and others have very few assets. While either category does not make one or the other a good or a bad business, it clearly impacts how a lender will view a prospective loan. Thus, if you want to buy a business with lots of hard assets {machinery, rolling stock, inventory), then the lender will probably be less concerned with having you pledge other additional assets. If the business has few assets {perhaps a service business}, the lender will be highly motivated to have you pledge other assets.

The SBA 7a program is unique in that it is not asset based, but they lend based upon a proven and established cash flow within a business. In other words, if a business has had ‘x’ level of profitability for a number of years, an applicant and the business can basically pledge that future cash flow to get an SBA guaranteed loan. While that seems simple enough, the applicant must be able to {a} demonstrate an ability to operate the business, {b}make a suitable cash down payment, {c} be paying a reasonable price so that ‘cash flows’, and {d} also have a reasonably clean personal and/or business credit rating.

So while an SBA guaranteed loan might be a cash flow loan, the SBA requirements are such that if the borrower has other additional collateral, the lender is obligated to place liens as additional security on those other assets.

The maximum guarantee under a 7a loan is 75% of a $2,000,000 loan, and thus it is extremely rare to see 7a loans in excess of two million. With the purchase of businesses, the typical down payment is 20%; however, it can be as low as 10% under certain types of circumstances. Interest rates are variable and generally range from a low {with strong outside collateral} of about 1.5% over prime to somewhere around 2% to 2.5% over prime on most 7a loans.

Amortization periods can vary from 7 to 10 years and do not have prepayment penalties. The loans are almost always in first position on all of the assets being acquired {i.e. existing debt typically has to be paid off},and liens of outside collateral can either be in a first/second/third position, subject to the nature of the asset and the equity involved.

The amount of time to get an SBA loan approved and then the timelines necessary for funding vary tremendously from lender to lender, regardless of what they say at the outset. In our involvement with referring buyers to SBA financing, we have just two lenders who we believe are worth the time of day, and both give us very rapid turn around times and can close transactions in less than 30 days. Over the years we have tried many other lenders and have always regretted straying from the two tried and true lenders with whom we have worked for years.

In summary, SBA guaranteed loans are ‘the only game in town’ if you are looking to buy a privately owned business. They are the ‘cash flow’ loans, as opposed to typical banks loans that require that your pledged collateral be equal to or exceed the amount of money that is borrowed.