SBA guidelines for buying a business
SBA programs are specifically designed to help small busines owners. But they can also be a little complicated if you don't understand how the SBA works.
Author: Kelly Shaw
Date: Sept 2012
The recent economic turbulence in the US and around the world has resulted in significant changes for borrowing or lending money. Some lenders are tightening their lending criteria and others have completely withdrawn from considering any new loan proposals. The SBA has recently implemented changes that tighten their program in an effort to reduce risk. The following are some of the more recent changes:
- 20% from the borrower is expected. The SBA minimum of 10% did not change, but the lender who funds the loan has tightened in this area. Depending on the credit request and other lender criteria, the equity required by the lender can be even higher than stated above.
- Goodwill represents a portion of the purchase price that is unsecured by the borrower and considered at full risk by the lender. The SBA now asks that the lender ask for the seller to provide seller financing for the full amount of Goodwill. While this is usually not possible, a substantial portion of the goodwill is now expected in most transactions.
- Add Backs
- There have been significant changes in this area by both the SBA and lenders. For the most part, the only add backs accepted by the lenders are interest and depreciation. Part of this theory is that the new owner will likely have the same expenses, so they should not be added back. An exception can be a very large salary for the seller – a more normal salary for the buyer can be deducted from the past amount paid. All add backs must be amounts that are tied back to the income tax returns and documented.
- Real Estate
- The SBA 504 program was preferred because of the benefits to the borrower. While this program is still available, some lenders now prefer to structure these loan requests under the SBA 7a program instead.
- The SBA maximum loan is $2 million. As a matter of policy, most lenders require some additional outside collateral to be pledged to the loan by the borrower in addition to the assets of the business. This applies basically to the $250,000 risk exposure (75% guaranty by SBA) to the lender. They look for good assets that are free of debt. SBA regulations require that the lender take other additional collateral if it is available.
- An important and vital criteria is the experience of the borrower in the particular business or industry related to the loan request and experience with “bottom line” management. This has always been a vital area of consideration, but there is more emphasis now in this area to show the strong ability to manage for profit in a business he is familiar with.
- Debt Service
- This still varies with the lender, but the usual 1.25 times ratio of cash flow to debt service appears to have increased to 1.50 times. With the limited number of add backs being accepted, this means the existing cash flow as per tax returns should support repayment of the debt.