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SBA Loans 2024 Explained


SBA loans are provided by an SBA-approved lender, primarily in the form of a bank or credit provider. In this way, they are similar to other business loans. The difference is that the SBA (the Small Business Administration Governmental Department) guarantees the loan, backed by the US federal government.

If you default on the loan down the road, the SBA covers the unpaid loan amount. This mitigates the lender’s risk and encourages lending.


Why would a Buyer use an SBA Loan?

 

The SBA loan program expands access to financing and incentivises acquisitions of small businesses. This helps small businesses and entrepreneurs to access capital and fosters economic growth.

As a buyer, SBA business loans can help acquire a business if you don’t have the resources for the acquisition. With an SBA loan, you can put down as little as 10 percent of the value of the business and have the rest covered by the loan.


Even if you do have the required cash to buy a business outright, SBA loans also enable you to make a purchase with less up-front investment. A buyer can then use this capital to grow the business or pursue other investment opportunities. Since you have invested a smaller amount of cash in the business, it is possible to achieve a higher ROI (return on investment) in a shorter amount of time. This can be true even when accounting for debt service payments.


How would a Seller benefit from an SBA Loan? 


Buyers are not the only ones to benefit from SBA loans. When selling their company, many small business owners prefer to receive the full sale price in cash at the time of closing. In other words, they want a clean break. Depending on the available offers, this may not always be possible. SBA-financed deals are often all cash for the full sale price at closing. By providing buyers with more financing options, SBA loans increase the pool of potential buyers. As a seller, this increases your chances of finding a qualified buyer with acceptable deal terms.


General SBA loan requirements


As with traditional loans, applicants must meet certain requirements to gain SBA loan approval. This is to help ensure that the borrower is able to repay the loan.


To secure a SBA loan, a business must:


  • Show that the business you want to buy has enough cash flow to repay the loan.

  • Prove that you’re qualified to run the business.

  • Ensure the deal structure adheres to SBA deal term requirements.

The SBA will assess whether the borrower and business have enough cash flow to repay the monthly loan instalments. They will analyse data regarding the debt-to-income ratio of the business. They may also take into account any personal debt or income that you have. Generally, they’ll look at the previous three years of tax returns to make this determination. Secondly, you must show that you are capable of running the business you plan to buy. The SBA will assess whether you have relevant previous experience. You may also be assessed on your current income and expenses, credit score, and assets and debts. The planned deal structure must meet SBA loan requirements to win approval. This could include full vs partial buyouts, consulting agreements, seller financing, and more. The recent SBA loan criteria update impacts deal structure requirements. We take a look at these updates in the next few sections.


Partial-Buyout SBA Loan Update: Partial buyouts approved


Before, individuals using an SBA loan to buy an existing business had to completely buy out the seller. That is, there were rules prohibiting sellers from retaining any ownership of the business for one year post-closing. Now, partial buyouts are allowed under SBA guidelines. Instead of only being allowed to purchase 100 percent of a business or nothing at all, buyers can buy only a portion of a business. 

For example, it would be possible to purchase 70 percent of a business and leave 30 percent to the owner. Of course, the owner would need to agree to this in the first place. While many sellers prefer a clean break, some may prefer to stay involved in the business after the sale. This new rule change allows for this.


As a seller, it is important to know that any owner in the borrowing entity or the business is required to personally guarantee the loan if they own 20 percent or more of the subject business.


Benefits of partial-buyout rule changes


There are multiple key benefits to this change of rules. For starters, it opens up SBA loans as a financing option for any situation where the seller wants to stay involved in the business after the sale. This increases the pool of potential buyers for these types of situations, which can raise competition and make it easier to find a qualified offer.


Acquiring any business is notoriously difficult, and whilst buyers can protect themselves via incorporating handover terms, a core benefit of the partial buyout for an SBA loan is enabling a buyer to benefit from the Sellers experience. As a consequence, sellers can stay involved in the business after the sale, the SBA is easing the transition process and decreasing the chance of business failure.


The SBA has loosened the rules around seller financing


Previously, if a seller helped with any portion of the 10-percent-or-greater cash injection required for an SBA loan, they needed to make certain concessions. These concessions made seller-financing any portion of an SBA loan deal unattractive to most sellers. 


Under the updated rules, sellers can provide the entirety of the required 10 percent SBA loan cash injection. It simply requires a 10-year amortized seller note and a two-year standby period. (That is, they forego repayment for two years.) If the buyer covers 25 percent of the 10 percent cash injection, the seller can cover the rest with a 10-year amortization note. In this scenario, the remainder is subject to a two-year interest-only period, not a full standby.


Sellers can now also trade seller equity for the loan down payment. Of course, these deals are scrutinized for approval by the lending institution. This type of arrangement is popular when a key employee buys out the owner but doesn’t have enough cash saved up for the loan down payment.

As you can imagine, sellers were not likely to accept seller-financed offers under the old rules. The recent changes make seller financing much more palatable. This opens up the possibility of seller-financed deal structures, increasing the likelihood of buyers and sellers reaching mutually agreeable deal terms.


Conclusion


SBA loans can be a terrific way to finance the purchase of an online business. As a seller, the availability of SBA loans widens your potential buyer pool and increases your chances of getting an all-cash offer. 

Recently, the SBA made several important rule changes, including:


  • Allowing partial buyout deal structures

  • Loosening rules regarding seller financing requirements

These changes open up SBA loans as a financing option to more potential buyers and sellers, facilitating deals and making it easier to buy or sell an online business.




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