If you’re considering buying an existing business, financing can be a significant concern. One of the most appealing options for many entrepreneurs is using an SBA loan. These loans, backed by the U.S. Small Business Administration, can help prospective business owners purchase businesses that might otherwise be out of reach due to cost. When looking at a business valued at $1.9 million, an SBA 7(a) loan is one of the most practical ways to make the purchase. However, there are several factors you need to consider, such as eligibility, the application process, and how much you can expect to pay upfront.
The SBA loan program has helped countless business owners successfully purchase existing businesses, providing favorable loan terms and relatively lower down payments compared to traditional loans. The $1.9 million business price tag may seem daunting, but with the right preparation and understanding of the process, you can secure an SBA loan that enables you to buy the business while keeping your capital costs manageable.
What is an SBA Loan?
SBA loans are designed to help small businesses secure financing that they might not otherwise qualify for through traditional banks or credit unions. The SBA itself does not lend money directly to businesses; instead, it guarantees a portion of the loan made by a lender. This guarantee reduces the lender’s risk, making them more willing to offer financing with competitive terms to small businesses.
The most popular program for purchasing a business is the SBA 7(a) loan. This loan can be used for a variety of business purposes, including buying an existing business. Because these loans are partially guaranteed by the federal government, they tend to offer favorable terms, such as longer repayment periods, lower down payments, and fixed or variable interest rates that are often better than what you’d get with conventional loans.
Eligibility Criteria for SBA Loans
To qualify for an SBA loan, both you and the business you’re purchasing must meet specific eligibility requirements. Understanding these criteria is crucial if you plan to finance a $1.9 million purchase.
First, the business you want to buy must qualify as a “small business” according to the SBA’s standards. These standards vary depending on the industry but are generally based on the number of employees or annual revenue. For instance, in some industries, a company may be considered a small business if it has fewer than 500 employees, while in others, the limit might be $7.5 million in annual receipts.
Next, your personal financial health will play a significant role in your loan application. Lenders will look at your personal credit score to assess how likely you are to repay the loan. Although the SBA does not have a strict minimum credit score requirement, most lenders expect a score of at least 680. A score above 700 significantly improves your chances of approval.
Additionally, lenders prefer borrowers who have some experience in the industry related to the business they’re purchasing. If you’ve previously owned or managed a business in the same industry, that can help your application.
Understanding the Down Payment Requirement
One of the biggest benefits of an SBA 7(a) loan is the lower down payment requirement compared to conventional loans. However, you’ll still need to come up with a significant amount of money upfront. Typically, the SBA requires a down payment of 10-20% of the business’s purchase price. For a $1.9 million business, that means you’ll need between $190,000 and $380,000 in liquid capital to cover the down payment.
For many prospective buyers, this down payment can be a significant barrier. Fortunately, the SBA allows for some flexibility in how you come up with these funds. You can use personal savings, business assets, or even a combination of the two. In some cases, the seller of the business may agree to carry part of the down payment through a seller’s note, which can reduce your upfront cash requirement. However, the lender will still expect you to have a certain amount of “skin in the game,” meaning you’ll likely need to come up with at least 10% in cash.
Lender Requirements and the Role of Cash Flow
One of the most important factors lenders consider when approving SBA loans for business acquisitions is whether the business generates enough cash flow to support the loan payments. Lenders will closely examine the financial health of the business you’re buying, including profit and loss statements, balance sheets, and cash flow projections.
The business you’re purchasing should be profitable and have a strong cash flow history. The lender will want to see that the business can generate enough income to cover the loan payments, as well as provide you with a reasonable salary. If the business has strong earnings and cash flow, it increases your chances of securing the loan.
In general, lenders look for businesses that have a debt service coverage ratio (DSCR) of at least 1.25. This means the business should generate $1.25 in net operating income for every $1.00 in debt payments. A higher DSCR improves your chances of approval, as it demonstrates the business’s ability to handle its debt obligations.
The SBA Loan Application Process
Once you’ve determined that you and the business meet the eligibility criteria for an SBA loan, the next step is applying for the loan. The process can be time-consuming, and it requires gathering a significant amount of documentation. However, being well-prepared will help the process go more smoothly.
Step 1: Find an SBA-Approved Lender
Not all banks and lending institutions offer SBA loans, so it’s essential to find one that does. Working with an SBA-preferred lender can streamline the process since they are more familiar with the program’s requirements and typically have faster turnaround times. Many lenders that offer SBA loans also provide prequalification services, which can give you an idea of how much you may be able to borrow and the terms you can expect.
Step 2: Gather Your Financial Information
The SBA loan application process requires detailed financial information from both you and the business you’re purchasing. You’ll need to provide personal financial statements, tax returns, and details about your assets and liabilities. Additionally, the business will need to supply its financial records, including profit and loss statements, tax returns, balance sheets, and a business valuation.
You’ll also need to create a business plan that outlines your strategy for running the business. Lenders will want to see that you have a solid plan for maintaining and growing the business post-purchase.
Step 3: Business Valuation
When buying a business, the lender will require an independent business valuation to ensure the asking price is fair and reasonable. This is especially important for a $1.9 million purchase. The valuation is typically conducted by a third-party firm that will assess the business’s financials, market position, and growth potential.
The valuation helps protect both you and the lender by ensuring that you’re not overpaying for the business. If the valuation comes in lower than the asking price, you may need to negotiate a lower purchase price or come up with additional cash to make up the difference.
Step 4: Approval and Closing
Once you submit your loan application and supporting documentation, the lender and SBA will review your application. The approval process can take anywhere from 60 to 90 days, depending on the complexity of the loan and how quickly you provide the required information.
If the loan is approved, the final step is closing, during which the loan funds are disbursed, and the business acquisition is finalized. Closing costs, including legal fees, will also need to be factored into your budget.
The Advantages of Using an SBA Loan for a $1.9 Million Business
Using an SBA loan to buy a business, particularly one valued at $1.9 million, comes with several significant advantages. These include lower down payments, longer repayment terms, and competitive interest rates.
One of the main benefits is that SBA loans offer more flexible financing than conventional loans. With down payments as low as 10%, it’s easier to get started with an SBA loan than with traditional business financing, which often requires 30% or more upfront. Additionally, SBA loans offer longer repayment terms—typically up to 10 years for business acquisitions—which results in lower monthly payments and better cash flow management.
Challenges of Securing an SBA Loan
While SBA loans offer many advantages, they also come with challenges. One of the biggest is the length and complexity of the application process. Compared to conventional loans, SBA loans require more paperwork, and the approval process can take several months.
Additionally, although SBA loans have lower down payment requirements, you’ll still need a substantial amount of capital to cover the down payment and closing costs. For a $1.9 million business, that could mean coming up with several hundred thousand dollars upfront.
Finally, not all businesses qualify for SBA loans. If the business is not profitable or has a weak cash flow, lenders may be reluctant to approve the loan. However, if you meet the eligibility criteria and the business is financially sound, an SBA loan can provide the financing you need to acquire the business and set yourself up for long-term success.
Conclusion
In conclusion, an SBA loan is a viable and attractive option for financing the purchase of a business valued at $1.9 million. With favorable terms like lower down payments, competitive interest rates, and extended repayment periods, SBA loans provide a flexible and affordable way to buy an existing business. However, to successfully secure an SBA loan, you’ll need to meet specific eligibility criteria, come up with a substantial down payment.