The U.S. Small Business Administration (SBA) 7(a) loan program is an excellent way for lending institutions to support clients who want to acquire existing small businesses, including franchises. Through this program, SBA loans are available up to $5 million and recent modifications to SBA requirements have made this program even more accessible for small business owners.
In this brief overview, Prudent Lenders highlights basic information and updates for SBA business acquisition loans, including the types of acquisitions that are eligible, buyout options, equity contributions and valuation requirements.
As always, our team is here to help with questions, opportunities and concerns as they arise. If you’re not partnering with Prudent Lenders yet, contact us today and we’ll help you get started.
How does the SBA define “business acquisition”?
The SBA considers a business acquisition to be a change of business ownership in which all (or essentially all) of the assets are purchased through asset or stock purchases, and the business’s operations continue.
1. Who can use an SBA 7(a) business acquisition loan?
- New owners: New owners include a person or entity that’s not currently an owner who purchases 100% ownership; another small business that’s acquiring 100% ownership of a different, existing small business; or an employee stock ownership plan (ESOP), or equivalent, that purchases a majority share (51%) in the business.
- Existing owners: Existing partners/owners can use 7(a) loan proceeds to buy out other owners, resulting in 100% ownership by the new owners.
2. Required equity contribution for new owners
When the purchase involves a complete change of ownership, the SBA requires the new owner to make a 10% equity injection, based on the total of all costs involved to complete the transaction.
It’s important to note that seller debt can only be considered as part of the equity injection if it totals 50% or less of the required equity injection and it’s fully subordinated for the life of the SBA-backed loan.
3. Business valuation: Internal vs. third-party
When it comes to business valuations, the 7(a) program looks at the business’s value, not including appraised real estate and equipment. In addition, the SBA considers whether there’s a close relationship between the seller and buyer, such as whether they’re family members or business partners.
- When the financed amount is $250,000 or less and there’s not an existing close relationship, your institution can complete an internal business valuation. When you work with Prudent Lenders, we can prepare an internal valuation for your review.
- When the amount being financed exceeds $250,000, or if there’s a close relationship between the buyer and seller, then a third-party valuation is required.
It’s also important to note that the loan proceeds in a change-of-ownership transaction can’t exceed the value of the business.
4. Partner buyout for existing businesses
When the business acquisition involves one or more partners purchasing the ownership stake of another partner or partners, the SBA requires that the purchasing party certify it has been actively involved in the business’s operations, and has been an owner, for at least the two years prior to the purchase.
In addition, the SBA requires that the owners submit balance sheets for the most recent completed fiscal year and current quarter, and that the business’s debt-to-worth ratio, as documented by the required financials, isn’t higher than 9:1 prior to the change in ownership.
In addition to these key points, the SBA has additional requirements regarding specifics such as the roles that sellers can and cannot play in the newly acquired entities.
When you work with clients who are interested in purchasing existing small businesses using the SBA 7(a) loan program, contact your Prudent Lenders representative. We’re here to provide our oversight and expertise during the entire process to make it much easier for you and your borrower.