SBA loans have a reputation for being hard to access, for good reason. They can be particularly tricky to secure if you’re using that capital to acquire a business. If you’ve never gone through the SBA financing process before, it can be confusing. Here are five tips for navigating the complex process of gaining SBA financing for a business acquisition:
Shop around for the right bank. // Although you may want to secure an SBA loan from your current bank, limiting your options may lower your chances of success. The SBA website has a list of the 100 most active SBA lenders. Find out who is in your area and go talk to them.
When you do, here are some good questions to ask:
» How many SBA deals has the bank done in the past two years?
» How many SBA deals has the loan officer done in the past two years?
» What was the average size of those SBA deals?
» Did the loan include real estate? (This will help you know how they expect to collateralize the deal.)
Understand the distinction between PLP vs. CLP. // There are two main SBA programs that banks can be a part of: Preferred Lenders Program (PLP) or Certified Lenders Program (CLP). Knowing the distinctions between each program can help you understand what type of lender is right for you.
In the Preferred Lenders Program, a PLP bank reviews and approves its loans without SBA intervention. The SBA doesn’t need to approve these loans, meaning you’ll only have to go through the bank (instead of the bank and a random SBA reviewer). This makes for a faster process.
On the other hand, banks often use the Certified Lenders Program for complex initiatives or deals that the bank doesn’t want to accept full liability for because of some obscure issue or request. CLP banks will need to pass off the loan to the SBA for the final decision to receive the government guarantee. Because of that additional step, it could take a bit longer to get approvals.
Expect to provide a personal guarantee. // If you are going to hold 20 percent or more of the company’s equity, the SBA requires a personal guarantee. If you default on the loan, your personal assets are on the line. Because of this risk, most SBA loans are refinanced within three to four years. You usually only have prepayment penalties of no more than 3 percent for the first three years of the loan, so refinancing at four years carries no additional fees. And don’t try to be clever here—10 people each holding 10 percent equity doesn’t mean you’ve sneaked past this. Someone always has to guarantee the loan.
Experience matters // The bank and the SBA will take your management team’s experience as well as the business’s experience in the industry into account when evaluating your loan. A lack of direct experience in the industry doesn’t mean you won’t qualify for a loan, but it will likely require you to explain more about your qualifications.
It’s also key that you have an attorney with some experience in SBA loans on your side, if possible. That said, your loan officer will be the biggest determinant of success.
Be prepared. // Remember: Banks want to see concrete plans for the deal you want to do. Don’t expect them to help you craft the deal structure from thin air. Go to them when you have a good idea of your proposed deal structure and then ask them to respond. Have the following ready to take with you:
» Letter of Intent
» Three years of tax returns and financials (plus any year-to-date information)
» Your personal financial statement
» A chart of your desired financing sources and uses
Getting an SBA loan for a business acquisition is far from impossible. It just requires some front-end homework. Seek out SBA lenders at banks you trust, or find a friend who has secured SBA financing, or research advisors who have experience putting SBA deals together. Bring these tips to conversations with those experts and you’re well on your way.
Terms and Conditions for SBA Loans
Once you’ve found a lender, you’ll need to understand terms and conditions for SBA loans. Being realistic about the terms and conditions is a good first step to increase your chances of success with SBA financing.
Expected Rates and Terms // SBA loans offer interest rates at a maximum of 2.75 percent over prime. The rate floats for most loans and adjusts quarterly. You can get up to 10-year terms (amortization) for growth capital and/or business acquisitions. Terms are longer for real estate and certain kinds of equipment. Your loan officer should explain how to adjust and/or blend amortization to get the best loan for your situation.
Coverage Ratio // Calculate coverage ratio as the sum of debt payments and estimated taxes due, divided by the EBITDA of the business. Banks are generally satisfied with a debt service coverage ratio of 150 percent. You could go lower in certain circumstances (e.g., if the bank is hungry, you have a lot of collateral, etc.). But plan to hit 150 percent to make life easier.
Collateralization // You don’t need to have 100 percent collateralization of the loan using your business and personal assets. A coverage ratio over 150 percent can and should make up for your lack of assets to pledge against the loan. We’ve done deals with service businesses that have had fewer than $500,000 of assets on the balance sheet, but they were able to borrow several million dollars of term debt because of the experience of the borrower and their cash flow coverage. That said, every bank is a bit different in what they can do, and collateral matters more to some than others.
Buydowns // Buydowns aren’t an option with SBA loans. The SBA wants you to take it all right away or not at all. A 100 percent buyout of the owner is required. Whatever amount is owned, you have to buy all of it.
Balloons and Earnouts // These creative options would be nice, but neither are allowed in SBA lending. The standard operating procedures can be found at https://bit.ly/2pV0I3r Here’s a secret: inventive ways around these limitations are found all the time. For example, you can use an escalating interest rate on seller financing to incentivize repayment on or prior to a significant increase in rate; this can substitute for a balloon or bullet requirement that is otherwise not allowed.
As always, seek out professionals—financial advisors, attorneys, bankers, and/or M&A advisors—who have expertise in this area when seeking a loan. They can help you work through the kinks and oddities of structuring an SBA deal.