What is an SBA 7(a) loan?
An SBA 7(a) loan is a loan made by a commercial bank of which 75% of he principal is guaranteed by the Small Business Administration. Buyers use debt to leverage their equity in buying your business as this allows them to generate a higher overall rate of return on their invested capital. Your buyer will make an application for an SBA 7(a) loan through one or more banks and the bank is required to follow the SBA guideline in turn for the SBA taking on 75% of the default risk should the buyer fail to repay the loan. The buyer will in turn pledge your business post-acquisition to guarantee the loan and can only use the loan to acquire a business that is profitable and has been in existence for at least 2–5 years.
The buyer will need to supply at minimum the following paperwork to satisfy the lending bank - which is why they require certain information from you as the seller during the detailed due diligence period.
Business tax returns for the past three years
Any outstanding business debt
Long-term business contracts
Documentation of business assets
Business lease agreement
Incorporation documents and/or business license
Business plan
What does an SBA 7(a) loan mean for you as the seller?
The typical SBA 7(a) application process will take 60-90 days to complete and can slow down the sale of your business by 45 - 60 days in comparison to a buyer who has an all cash offer.
Advantages
The buyer must have a strong financial position and in good standing to quality for an SBA loan, the following are some of the boxes they must be able to check to have their application considered:
A credit score of at least 690
A record free of any bankruptcies in the past three years
At least a 10% down payment
A clean criminal history, or the ability to explain any misdemeanors
No current Federal debt
Industry or managerial experience (to prove you’re qualified to run the business you want to buy)
Negatives
During the period your buyer is securing their SBA 7(a) loan your company will be in a no-shop period for longer than if selling to a non-SBA 7(a) loan buyer.
The bank and SBA will impose certain covenants on the business that will shape the definitive sale agreement on points such as an earn out or payment of principal on any seller financing.