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New SBA Loan Rules Make It Easier for Borrowers to Acquire Businesses
On Jan. 1st, 2018, the SBA enacted a series of new rules making it easier for individuals to use SBA 7(a) loans to purchase a business. Specifically, the SBA modified its Standard Operating Procedures (SOPs), including SOP 50 10 5(J), which reduces equity requirements for business acquisitions.
On Jan. 1, 2018, the SBA enacted a series of new rules making it easier for individuals to use SBA 7(a) loans to purchase a business. Specifically, the SBA modified its Standard Operating Procedures (SOPs), including SOP 50 10 5(J), which reduces equity requirements for business acquisitions and makes it easier for for borrowers to get funding for franchises.
What were the SBA’s Previous Equity Requirements for SBA 7(a) Business Acquisitions?
The SBA’s previous rules for acquisition loans required that deals with more than $500,000 in goodwill needed 25% seller note/buyer equity. In comparison, acquisitions involving less than $500,000 in goodwill needed 20% seller note/buyer equity to be approved. Just to recap, goodwill refers to the intangible asset that arises when someone purchases a business for more than the value of its tangible assets like real estate or equipment. Goodwill typically includes brand value, customer relationships, and employee relationships, as well as any patents, trademarks, and copyrights that a business has.
A buyer note is a form of debt security issued by the buyer of a company to the seller, in exchange for partially financing the buyer’s acquisition. Buyer equity, in comparison, is the cash down payment that the buyer themselves is investing in the business.
New SBA 7(a) Acquisition Requirements Reduce Equity Requirements
As a result of its new policy, the SBA has reduced buyer equity requirements to just 10%. This means banks can provide up to 90% of the funding a borrower needs to purchase a business. Therefore, a qualified borrower would only need to provide 10% of the loan amount in the form of cash or a seller note. Of that 10%, 5% needs to come directly from the buyer (in order to make sure they have some skin in the game.) However, the other 5% can be derived from the seller note. So, by combining a seller note with an SBA 7(a) loan, buyers can now achieve up to 95% of the financing they need to purchase a business.
New Rules Make It Easier for Borrowers to Get Funding for Franchises
In many cases, SBA loans, including the SBA 7(a) loan, can be difficult to get for franchises, as the SBA often classifies franchises as affiliates instead of independent small businesses, disqualifying them from SBA eligibility. However, new changes to SBA’s loan policy means that SBA loan-eligible franchises are now listed on the SBA Franchise Directory. Each franchise on the list can now be identified with a SBA Franchise Identifier Code. This helps lenders quickly identify the status of any franchise on the list. In some cases, an addendum, an additional part of the loan agreement, is required to qualify a franchisee for an SBA loan.
Related Questions
What are the new SBA loan rules?
The new SBA loan rules make it easier for borrowers to acquire businesses and get funding for franchises. The SBA has reduced buyer equity requirements to just 10%, meaning banks can provide up to 90% of the funding a borrower needs to purchase a business. Of that 10%, 5% needs to come directly from the buyer, and the other 5% can be derived from the seller note. This means that by combining a seller note with an SBA 7(a) loan, buyers can now achieve up to 95% of the financing they need to purchase a business. Additionally, each franchise on the SBA Franchise Directory can now be identified with a SBA Franchise Identifier Code, which helps lenders quickly identify the status of any franchise on the list. In some cases, an addendum, an additional part of the loan agreement, is required to qualify a franchisee for an SBA loan.
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How do the new SBA loan rules make it easier for borrowers to acquire businesses?
The new SBA loan rules make it easier for borrowers to acquire businesses by reducing the equity requirements to just 10%. This means banks can provide up to 90% of the funding a borrower needs to purchase a business. Therefore, a qualified borrower would only need to provide 10% of the loan amount in the form of cash or a seller note. Of that 10%, 5% needs to come directly from the buyer (in order to make sure they have some skin in the game.) However, the other 5% can be derived from the seller note. So, by combining a seller note with an SBA 7(a) loan, buyers can now achieve up to 95% of the financing they need to purchase a business.
In addition, the SBA has also created a SBA Franchise Directory which lists SBA loan-eligible franchises. Each franchise on the list can now be identified with a SBA Franchise Identifier Code. This helps lenders quickly identify the status of any franchise on the list. In some cases, an addendum, an additional part of the loan agreement, is required to qualify a franchisee for an SBA loan.
What are the benefits of using an SBA loan to acquire a business?
The Small Business Administration (SBA) 7(a) loan program is a great option for business owners looking to acquire an existing business. The SBA 7(a) loan program offers attractive interest rates, repayment terms, and closing costs, and is backed by the government, making it easier for banks to offer these loan products to high-risk borrowers. Benefits of using an SBA loan to acquire a business include:
- A credit score of at least 690
- No bankruptcies in the past three years
- At least a 10% down payment
- For franchisees, a paid franchise fee before the loan funds are released
- A clean criminal history, or the ability to explain any misdemeanors on your record
- No current Federal debt
- Industry or managerial experience (to prove you’re qualified to run the business you want to buy)
The business that will benefit from the loan must also be a for-profit entity, a small business by definition, based in the United States, have invested equity, and have exhausted its other financing options.
What are the risks associated with using an SBA loan to acquire a business?
The risks associated with using an SBA loan to acquire a business include the possibility of defaulting on the loan, the need to provide collateral to secure the loan, and the prohibition of earn-outs. Defaulting on the loan could lead to the lender taking possession of the collateral, which could include real estate, equipment, vehicles, accounts receivable, or other business or personal assets. The lender may discount the value of the collateral you pledge against the loan, as many types of collateral (such as vehicles) lose value over time. Alternately, a lender might require 10–20% of the loan amount down. Earn-outs, which are not permitted under SBA loan regulations, involve the seller of a business staying with it for prearranged period, usually a few years, during which they will receive additional payments based on the financial performance of the company. In theory, this will incentivize the seller to make sure the company successfully transitions to new ownership, but in practice, it could lead to conflicts that undermine the stability of the business.
What are the requirements for obtaining an SBA loan to acquire a business?
In order to qualify for an SBA 7(a) loan to acquire a business, you must meet the following requirements:
- A credit score of at least 690
- A record free of any bankruptcies in the past three years
- At least a 10% down payment
- For franchisees, a paid franchise fee before the loan funds are released
- A clean criminal history, or the ability to explain any misdemeanors on your record
- No current Federal debt
- Industry or managerial experience (to prove you’re qualified to run the business you want to buy)
- A for-profit entity
- A small business by definition
- Based in the United States
- A business with invested equity
- A business that has exhausted its other financing options
In addition, having a good credit score (preferably above 680), a history free from recent bankruptcies, foreclosures, or tax liens, having been in business for at least two years, the ability to provide collateral for loan requests over $25,000, the ability to make a down payment of 10% if your intended use of funds is to purchase a business, commercial real estate, or business-related equipment, sufficient cash flow to meet your debt obligations, sufficient working capital (once you subtract liabilities from assets), and “good character” according to the SBA (partially decided based on your track record of managing your resources and day-to-day business affairs) can increase your likelihood of SBA 7(a) loan approval.