Small Business Administration (SBA) Lending to Buy a Business

Small Business Administration (SBA) Lending to Buy a Business

Small Business Administration (SBA) Lending to Buy a Business

The Small Business Administration (SBA) continues to be the primary source of financing when buying a business in Texas.

Technically speaking the Small Business Administration loan is not a loan but actually a guarantee to a bank who actually provides the loan. It’s commonly referred to as an SBA loan due to the standard regulations imposed on banks who offer loans under the SBA program ( known as a 7A or 504 loan).

In today’s market an SBA Loan for the purchase of a business that doesn’t have real estate as part of the sale ( the business is typically located in a leased space) will generally have the following terms:

  • 10 year amortization
  • Interest rate of 2.75% over the prime lending rate, adjusted quarterly
  • Buyer down payment equal to 15 – 25% of total business purchase price
  • Bank will likely add adequate working capital to the loan for business operations

The bank will have substantial due diligence requirements. Both the buyer (borrower) and the business (seller) must be able to pass the banks due diligence requirements. The bank will want all business financial information to be correctly stated on the business tax returns.

The bank will also want the buyer to me certain requirements regarding credit score, no problems with student loan payments, no issues with child support or alimony payments, clear history of any criminal issues.

A very important element of getting approved for an SBA backed loan is the banks comfort level with the buyers ability to succeed in the business they buy. A core element is known as buyer’s “applicable skills”. Basically this means what in the buyer’s experience can be applied to the new business.

Most small businesses that sell for under $1,000,000 are purchased by individuals who will own and operate the business on a day-to-day basis. These SBA Loans are rarely used for “passive” investments.

Sunbelt Completes the Sale of a Specialized Property Management Company

We are pleased to announce this successful transaction. The business is a 30 year old company operated by the same 2 partners since it’s inception. Both partners were ready to retire.

The sellers were referred to Sunbelt by Steve Drake a well known Houston, Texas financial planner and host of his own financial radio show call Money Matters.

The business specializes in the management of Homeowners Associations.

The buyer had experience in working for an association management firm and was able to finance the purchase with a very attractive bank loan from Allegiance Bank utilizing the SBA Loan Guarantee program. Gary Henderson managed the process for Allegiance Bank.

The buyer will assure the business lives on long past the time when the founders were able to operate the company.

We are proud to be a part of this transaction that enables long time business owners to realize the value created in their business and retire in the comfort they had worked so hard to earn.

Anatomy of a Successful Small Business Purchase


Although the names, location, types of businesses and other details have been changed for confidentiality purchases this Hub reflects real transactions in the world of buying and selling a business.


The Buyer


Susan, 45, had been employed in the corporate world for 15 years and had done well, worked hard and gotten good performance ratings. She felt like she would be with her company for a long, long time. She thought that right up until the moment when, on a Friday afternoon, she opened an email from the company CEO stating that the company had just agreed to be acquired and more details about what that means to individual employees would be forthcoming in the next few weeks and months.

This news wasn’t a total surprise since there had been rumors for months but now it was real. Susan felt like her group might get consolidated and that, though she might survive, she was fairly certain that would require a move for her family. However, within weeks it became apparent that no one in Susan’s group was likely to survive the merger and now they were just waiting on the details of a severance package, if there was to be one.

Susan began as many in her situation often begin, she updated her resume, did a quick analysis of her current financial situation and started thinking about where she might look for another job. She started going through her contacts and she quickly found out that another job at her pay grade was likely to be very difficult to find. In addition, she wondered what would happen if her job search went on for months or even years, would she need to use up her savings and 401k money just to live on while she was looking for work?


What other options did she have? One of her contacts asked her if she ever consider owning her own business. Susan had only occasionally given it a brief thought but decided to investigate it more closely since she had no idea what the process of buying a business entailed.


Susan’s financial situation wasn’t great but wasn’t terrible either. She had some liquid assets (about $30k cash), not much debt, pretty good credit and her 401k plan had about $125k in it. She considered her 401k sacred and had no plans to touch it until retirement. Susan’s salary was $90,000 per year with the occasional bonus….although there hadn’t been one for the last two years.

Susan had no idea how to find a business to buy and didn’t know what are the right questions to ask when buying a business so she did the obvious, she googled buy a business Houston Texas.

That’s how Susan found us.

The Seller

Arthur had owned his small manufacturing business, XYZ, Inc, for 30 years and was comfortable. It had been a good business for him. Arthur had recently turned 68 years old and, although he had hoped otherwise, his children had their own careers and weren’t returning to run the family business.


Arthur was talking to his accountant about his taxes and mentioned he had had some health problems. His accountant asked Arthur if he intended to run the business until they carried him out on a stretcher or did selling the business make more sense for him? After talking with his wife Arthur decided selling the business was the right thing to do. He could get the value of his business to fund his retirement, relax, travel more and enjoy his family.


Arthur told his CPA he was ready to sell and his CPA referred Arthur to us.


That’s how Arthur found us.


The Business


XYC is a light manufacturing business that makes a variety of small parts used in the transportation industry. Arthur hadn’t really worked on growing the business for the last 10 years. He had a variety of regular customers and didn’t have any organized sales effort. At this point in his life he felt like growing the business would be more work than he wanted to do. He liked his 30-40 hour work week.


•   XYZ did $1,200,000 in annual sales most years and didn’t vary much from year-to-year


•   XYZ’s net profit available to Arthur was consistently around $180,000 per year. This $180,000 is often called Seller’s Discretionary Earnings (SDE) because it includes Arthur’s salary and all of Arthur’s substantial benefits. Many of these benefits are in pre-tax dollars so they can’t be directly compared to a salary that might be earned from working as an employee at a big company.


•   XYZ didn’t have any debts other than what was normal accounts payable owed to suppliers.


•   XYZ was located in a leased building and did not own the real estate.


•   Asking Price for the Business $675,000 – FYI- How we determined the asking price is too long for this post and I’ll create another Hub to describe the business valuation logic and methodology.


The Transaction


Susan came to us looking for a business to buy and based on her experience, skills, lifestyle and financial capability we decided to present XYZ company to her. (Here is a post about Confidentiality when buying a business). Susan liked the industry and the business location. We provided her with some high level financial reports for her review and Susan decided she wanted to look more closely at this opportunity.


We arranged for Susan and Arthur to meet to tour the business and for Susan to ask Arthur all the questions she felt were important. After due diligence, research and negotiations here is the final transaction that was completed and Susan purchased the business which she still runs today.


Selling price $655,000


Susan’s down payment was $110,000 which she obtained, tax & penalty free, from her 401k plan.


Susan received an Bank Loan with an SBA Loan guaranty for $605,000 (the bank included some working capital to assure Susan’s financial comfort). Terms: 10 years @ 6.0%. Click here for a Hub about using aSBA Loan to acquire a business.




•   The business was earning $180,000/year.


•   Susan’s bank note payment is $80,000 per year.


•   Earnings available to Susan in excess of debt payments = $100,000/year ($180,000 – $80,000)


•   The business is paying the debt. On a straight line basis Susan is building $60,500 per year in equity ($605,000 divided by 10 years). That’s a 55% investment return per year on Mary’s equity of $110,000, I doubt you can get that kind of return over 10 years in any other investment.




•   Susan was able to immediately replace her $90,000 per year, fully taxable salary with $100,000 per year of income that had significant tax advantages.


•   Susan had no worries about being laid-off ever again. She did have a business to run that comes with it’s on worries but at least Susan feels like she is in complete control and can manage any problems successfully.


•   When the day comes for Susan to sell the business she expects the value of the business to have far outgrown the value of her $110,000 had she left it in her 401k plan and relied on the luck of the stock market. Susan, like Arthur before her, is now in total control of her retirement investment.


If you have the skills to operate a successful small business the financial rewards can be tremendous.

If you want a good book on Buying a Business here is our recommendation:


How to Use an SBA Loan in Acquisition of a Business

When looking at businesses you might want to buy you should always keep in mind how you are going to finance the purchase of the business. Most small businesses are purchased using bank lender financing in the form of a small business SBA loan. This post discusses the Small Business Administration (SBA) loans that are available and what are the general requirements to qualify for an SBA loan. Keep in mind that specific banks may have slightly different requirements but the main issues will be the same across all banks. The SBA supports small business development centers throughout the U.S. which can provide information about the SBA Loan process.


What is an SBA Loan? What are the SBA guidelines for small business acquisition loans?

Commercial banks and the SBA agree to certain ground rules whereby if the bank adheres to the SBA loan rules, guidelines and regulations and makes a loan to a borrower under those rules, then the SBA will guarantee a significant portion of the loan (up to 90% in some cases). This SBA loan guarantee makes the loans very low risk for the banks and therefore the banks have an incentive to make these loans to small business borrowers. Not all banks participate in this program and it involves a lot of paperwork!

What do I need and what can I borrow?

Here is a basic formula that will get you a good idea of what’s possible when it comes to getting a bank to provide an SBA loan to finance the acquisition of a business.

Assumptions: You purchase an on-going, operating business that meets the requirements and criteria below. For this example, it assumes the business is in a leased space and you plan to take over the existing facility lease and keep the business in its current location. If you are buying a business which includes the purchase of real estate there are some differences. Generally a down payment on the real estate portion can be as low as 10 -15% and a longer amortization – as long as 20 years.

Typical Loan Structure for Purchase of an Operating Business:

Loan Term – 10 years

Interest Rate – Prime Rate +2.75% adjusted quarterly (currently this would mean a 6% interest rate)

Here’s the formula 20%/70%/10%

20% – Unencumbered cash required from the buyer should equal approximately 20% of the total purchase price of the business. Unencumbered means pure equity… which means you can’t borrow this amount. However, if you’re lucky enough, a significant portion of this can be a gift, if you have friends and relatives willing to do that. Do not try to disguise loans as gifts. Committing bank fraud is no way to start a business.

Here’s the good news, you can use your IRA or 401k Plan funds tax free and without any early withdrawal penalties to generate your equity. The rules for this are complicated and you will need to work with professionals who specialize in this area of very complex tax law. But the decision to use your retirement funds is easier. Would you rather use your retirement funds to bet on your self or would you prefer to leave your retirement funds in the hands of Wall Street?

70% The SBA backed loan would equal 70% of the total purchase price. Again this is usually a 10 year loan at an interest rate of Prime Rate plus 2 3/4% adjusted quarterly.

10% The bank will likely ask the seller to finance 10% of the purchase price. The theory is this 10% note is an incentive to the seller to help the buyer succeed. While in some cases this may help, the real reason the bank does it is to reduce the banks risk. This 10% seller note will be subordinated debt to the bank which means the seller will have little recourse against the assets of the business if the loan is not repaid by the borrower. It is important that a seller have confidence in your ability to run the business successfully so that you can pay the seller note according to the terms.

The above breaks down the source of money for a purchase. Now let’s look at the qualitative requirements so that a bank will actually lend you 70% of the purchase price.

You’ve found a business you want to buy, now what?

Getting an SBA loan from a bank to acquire an operating business has its own special rules and requirements. There are 3 primary elements of the qualification process – the borrower, the business and the financial elements. Let’s take them one at a time although as you will see there is some overlap.

Here’s a good book about getting an SBA Loan

The Business I Buy

A bank will look at a business to try to determine the risks in the business that could affect the borrower’s ability to pay the loan back. As a buyer these risks affect you the same way, so in this respect the borrower and the bank are on the same side of the issue. Here are some, but not all, common red flags:

Customer concentration – there are many businesses that have 1 customer doing 50-75% of the total revenue for the business. What happens if this customer leaves? 75% of the business goes with it. When looking at businesses to buy remember this – less customer concentration is better unless there are some long term, ironclad, contracts

Vendor Concentration– A business may have a great deal from a vendor but if the business loses the vendor the buyer would need to pay more for the product and their profits would be harmed.

Regulatory Issues– Are there new laws, regulations or licenses coming into play that will require the business to significantly change their operations? How will those changes affect their profits and cash flow? For example – Back in the 90s nearly all dry cleaners used a chemical that was basically outlawed. The dry cleaning businesses had to invest significant money to change their business. For a couple of years you couldn’t give away a dry cleaner , many of them were losing money due to the cost of the conversion and with the uncertainty of the effect on profits, it was nearly impossible to sell a dry cleaner.

Location Issues – Let’s say you own a great business on the corner of the busiest intersection in town. Things have been great for 10 years. But what if the state decides to widen the road and condemns your building?

Financial Issues

Assuming the business passes all the operational reviews it’s time to look at the businesses financials.

Cash flow and profits – The bank (and I’m sure the borrower) wants to be certain that the business can pay the debt incurred to buy the business. And in addition to being able to pay the debt the bank wants enough free cash flow to pay the debt with room to spare! The banks room to spare is officially called the “Coverage Ratio”. The coverage ratio is best described in simple terms. If a banks coverage ratio is 30% it means that for every $100 of debt payments required the business needs to have $130 to pay it. Another way to look at it is 30% can go wrong and the business can still pay the debt.

What are the “real” earnings and cash flow of the business?

The smaller the business the less likely it is that you will find what would appear to be well-kept financial records for the business. I emphasize the word appear. The simple fact is small business owners are, for the most part very, very tax averse. If they can manage their affairs to minimize their tax burden they will do so. By the way this is no different from large corporations. Business tax returns seems to bare little resemblance to their profit and loss statements. Don’t be surprised to see small businesses with owners living really well but the business tax returns show the business barely breaking even or even losing money.

There is a process that you can go thru with the business owner (or Business Broker if one is involved) that can identify the true earnings and cash flow of the business. If you use experienced advisors and you can’t get to the numbers that make sense you just need to move on. There are lots of businesses whose financials will stand up to due diligence.

Determining the real earnings of the business is key to determining if the business will generate the free cash flow needed to pay back the bank loan.

What is the value of the business and will the bank make a determination as to the business value?

Since the banks and the SBA have an interest in getting the loan re-paid they have an interest in making sure that the buyer is paying a fair and reasonable price for the business. Most SBA lenders will, as part of the loan packaging process, require that an independent Business Appraisal (often called a business valuation) is completed on the business. The bank normally picks the valuation firm and the buyer pays for the valuation. This valuation is part of the banks risk mitigation system. The basic idea is that even if the buyer and seller agree to a price and the cash flow debt service work… the deal still has to pass the fair market value hurdle.

Business Plan for Success – As part of the business loan application process the buyer/borrower will need to produce a business plan.Here’s a piece of advice you may find to be very valuable. Before you start looking for a business to buy you should invest in good business plan software. Start building this business plan before you get serious about a search. That way when you do find an interesting business you just plug in their specific numbers and you’ll have a very quick answer on many critical questions including cash flow available for debt service, working capital required for the business and capital expenditures effect on cash flow.

Borrower Guidelines

Credit History – As you might imagine, when you are borrowing money a good credit score is important. If your credit score is below 680 it will be very difficult to get an SBA backed loan even if all the other requirements are met.

Other financial obligations and resources – The buyer can’t have a heavy personal debt burden that will require the business cash flow to pay. Similar to a home mortgage loan the bank will look at the buyer’s overall financial situation, not just the cash flow of the business. Often this is where the Coverage Ration becomes an issue.

Personal History – We often see items in buyer’s personal history that cause problems in the loan approval process. There are little problems and big problems, Some can be worked around, some can’t. Example- we once had a buyer in his early 30’s. On his record he had pleaded no contest in a bar fight incident 12 years earlier while in college. That held up his loan process for months.

For certain you need to make sure you don’t have problems with student loan repayments, child support or alimony.

Applicable Skills

This is often the most important element in a successful business acquisition loan process.

The banks and SBA want to have a borrower who has some skill or experience that can be applied to the business immediately. An example is if your only experience is as a high school history teacher it is very unlikely that you could get approved to purchase an industrial machine shop. However, you might well get approved to purchase a vocational training school.

A buyer should search their personal history so that they can identify all of their experiences and possible skills applicable to the business the wish to purchase.


You may be able to buy a business on favorable terms using a small business bank loan backed by the SBA. The requirements are lengthy and complicated but there is a great deal of help available to guide you through the process. The truth is a commercial bank would be very, very unlikely to loan money to small business buyers without the SBA guarantee loan program.

There are many, many very good businesses available to purchase which might fit your  personal goals.

What on earth is a coverage ratio in financing with an SBA Loan?

When dealing with financing of various sorts you will come across the term “coverage ratio”. It my be in the context of “Interest coverage ratio”  or “debt coverage ratio” or some other similar nomenclature.

Here’s the basic concept of a coverage ratio. The coverage ratio is designed to determine what margin for error there is in a borrower’s ability to pay back the debt.

Let’s use an example assuming you are buying a business, here are some basics:

  • Business Purchase Price $500,000
  • Seller’s Discretionary Earnings (SDE) $175,000 (Seller’s discretionary earnings is the business earnings before Interest, Depreciation, Taxes, Amortization and Owner’s Compensation).
  • Down payment Buyer has available $100,000
  • SBA Loan $400,000  financed for 10 years @ 7% =  $4,644 per month payment which = $55,750 per year.
  • Salary the Buyer needs from business to pay living expenses  $100,000.
Coverage Ration Calculation  
SDE                                       $175,000
Salary needed                         $100,000
Available for Debt Service      $75,000
Amount of Debt service          $55,750
Coverage ratio is                     1.35   Amount available for debt service divided by actual debt service.
Generally speaking when seeking an SBA Loan the coverage ratio required will be between 1.25 and 1.4.

The best business planning tool?

If you plan to be in business you’d better have a Business Plan. If you plan to start a small business this tool can be the difference between success and losing everything. If you think this Business Plan tool is expensive wait til you see how expensive it is to NOT have a well thought out and written business plan.

If you are considering starting or buying a business it’s a good idea to have the best tools. It may cost you a few bucks but it could be a cost that saves you many, many thousands of dollars.

A good business planning tool will also allow you to compare options from a consistent platform.

I think the best Business Plan Software on the market today is Business Plan Pro . (Yes, this is an affiliate link and we get a few cents if you buy it but, hey, give us a break, we did the research).

The best part about this software is it’s intuitive and you don’t need an MBA to operate it. The Standard edition is all most people ever need. It’s a product that has been around for many years and it’s very practical and efficient to learn.

As you can see the layouts are clean and easy to understand.

Let the software do the math
If you are going to get into business you need a plan that is logical, well thought out and proven. Trust me, if you go to your banker with a professional business plan your odds of getting financing improve dramatically. A plan like the one Business Plan Pro produces will be a requirement for any SBA loans that you apply for or pursue.

Here’s a few fatal mistakes a good business plan can help you avoid.

The best time to have a business plan is before someone asks you to see it! Get ahead of the curve…get your plan.