When it comes to financing options, business owners – including prospective business owners – will quickly discover that there are many to choose from. One of the most common loan options is the 7(a) loan from the U.S. Small Business Administration (SBA).
This article will cover the basics of an SBA 7(a) loan, specifically as it pertains to the potential sale of your business. You’ll learn what SBA 7(a) loans are, how they work, and what they are commonly used for.
What Is an SBA 7(a) Loan and What Is It Used For?
An SBA 7(a) loan is offered under the Small Business Administration’s funding program, and it’s the one most likely to impact the sale of your business.
The maximum loan amount for a standard 7(a) loan is $5 million. This funding can be allocated specifically for working capital, asset purchases, business expansion, and the refinancing of current business debt.
What Are Other Types of SBA Loans Available?
There are a few different types of loan programs offered by the SBA and the 7(a) loan is the most common. Below is a quick breakdown of the various SBA loan programs that may be available to small business owners.
Each loan program has its own eligibility rules, which may depend on things like the type of business that’s applying or the intended use of the loan.
- SBA 7(a) Loans: Offers up to $5 million for working capital or business expansion. There are multiple loan options available under the umbrella of this program.
- SBA CDC/504 Loans: Offers up to $5 million for the purchase of major fixed assets and new capital expenditures, such as commercial real estate.
- SBA Disaster Loans: Low-interest loans designed specifically to help those impacted by declared disasters.
- SBA Microloans: Offers up to $50,000 to borrowers as a working capital loan. This loan program is geared toward startups.
- SBA CAPLines: A line of credit designed to help business owners meet short-term, cyclical needs.
- SBA Export Loans: Intended for businesses that export working capital.
The loans that often cause the most confusion are SBA 7(a) loans and SBA 504 loans. A 504 loan is intended specifically for new capital expenditures like machinery, equipment, and real estate. It’s not used to buy an existing business. If you’re looking to purchase a company or your buyer is in search of business financing, you’ll want to focus on SBA 7(a) loans.
SBA 504 loans tend to have different criteria than SBA 7(a) loans. The loan application process is much stricter for 7(a) loans. Additionally, 7(a) loans tend to carry more risk, primarily when they are being used to purchase a business.
Many small businesses are “asset-light,” which means they don’t have much to offer as collateral. Lenders prefer collateral, as it allows them to reduce their risk. Many banks don’t like lending for the purpose of purchasing a business, which is why 7(a) loans can make these riskier loans more palatable.
How Do SBA 7(a) Loans Work?
SBA 7(a) loans work by providing financial assistance to businesses, including new business entities that buyers set up to acquire an existing business through an Asset Purchase. Once the loan is approved, the buyer/business owner will receive the loan proceeds upfront. This funding can provide them with the cash flow needed to complete the business acquisition.
The new business owner will then need to make monthly payments to pay off the loan. Information regarding repayment should be spelled out in the loan’s paperwork.
Although it depends on things like the industry, the borrower’s credit score, and other factors specific to your business, SBA loans can be advantageous for a few reasons.
- Typically have low interest rates that are competitive with other lenders
- Often require low down payments, perhaps not exceeding a 20% requirement
- Have loan terms extending as long as 25 years
- Come in both fixed-rate and variable-rate options
- Come backed with an SBA guarantee, which means the lender can recover a portion of the loan directly from the SBA should the business default on the loan
SBA-guaranteed loans are a great option for business buyers. As a seller, however, it’s imperative to fully understand how they work and how they will impact the sale of your business. SBA-guaranteed loans come with some additional red tape and requirements.
If you’re selling your business to a buyer who is using an SBA 7(a) loan to help fund the sale, then you will almost certainly be asked to hold at least 10-15% of the purchase price in a seller note. Payments on the note to the seller are sometimes interest-only for the first 24 months. This, in turn, could potentially delay your future retirement plans, as you may not receive capital from the sale of your business immediately.
Additionally, your seller note is typically subordinate to any senior debt the bank holds and may come with prepayment restrictions. The restrictions aren’t onerous, but they are definitely set up to make sure that the buyer succeeds as the new owner of the business (which stands to reason from the lender’s point of view).
This is one reason to hire a trusted team of advisors to prepare an exit plan and help facilitate the sale of your business. Advisors experienced with mergers and acquisitions (M&A) can help you navigate the difficult parts of the sale, such as the language of your contract and your intended payout dates, to ensure you receive a deal that best suits your goals.
How Can Businesses Secure an SBA 7(a) Loan?
Businesses looking to secure an SBA 7(a) loan have a few different ways to go about doing so. Owners may start by looking at banks in their area. However, they’ll want to make sure that the bank is an approved SBA lender who specializes in 7(a) loans.
Live Oak Bank is one of the leaders in the nation when it comes to SBA 7(a) loans. Buyers can also ask around their local or regional banks to find the best 7(a) lender — although they should be prepared to learn that the real 7(a) expert may be in another part of the state. Buyers shouldn’t care where the lender is located; just use the one with the most experience with 7(a) loans.
Buyers need to be particularly aware of this though when using their friendly neighborhood bank. They should perhaps consider the SBA tool designed to help business owners match with a preferred lender.
Another option is to speak with a small business loan advisor, like MultiFunding. Buyers can speak with the experts at MultiFunding about the type of small business loan they need, and they will look nationwide to find the best options.
Use SBA 7(a) Loans to Your Advantage in a Sale
When it comes time to sell your business, you’ll find that the process can be tricky. One of the most challenging parts is working with the buyer to determine how the deal will be financed. If a buyer wants to conserve as much cash as possible, one option they may want to consider is an SBA 7(a) loan.
SBA 7(a) loans are designed specifically to facilitate business acquisitions. Borrowers can receive up to $5 million in funding and the loans often come with low interest rates and an SBA guarantee, making them an option for small business buyers.
However, 7(a) loans can also come with a lot of administrative hurdles. As a seller, you should be prepared for this. One way to prepare yourself is by hiring trusted M&A advisors, like those at Allan Taylor and Company. Contact us today to learn more about how we can help you prepare for the sale of your business.