Navigating SBA Loans in 2024: Understanding the Latest Changes

Whether you’re planning on buying or selling a business, SBA loans can be a great option for financing the deal. Recently, the SBA announced several impactful changes to their loan criteria. Spend the time now to learn about these changes, understand your options, and increase your chances of closing a successful deal. 

In this article, we discuss:

• What is an SBA loan?
• The partial-buyout SBA loan update
• The seller-financing SBA loan update
• Key things to keep in mind when using an SBA loan

Related Article: Six Proven Strategies for Raising Business Capital

What Is an SBA Loan?

There are several different kinds of SBA loan programs. In this article, we will focus on SBA 7a loans. One of the main uses of an SBA 7a loan is to help individuals buy existing small businesses. Below, we will discuss how SBA 7a loans can work, SBA business loan benefits, and general SBA loan requirements.

How SBA loans work

SBA (Small Business Administration) loans provide entrepreneurs access to capital to buy and run a small business. SBA loans are disbursed by an SBA-approved lender, like a bank or credit union, not the SBA. In this way, they are similar to other business loans. The difference is that the SBA guarantees the loan, backed by the federal government.

For example, let’s say you’re interested in purchasing a business but you don’t have the necessary funding. One option available to you would be to go to an SBA lender and apply for an SBA loan. SBA lenders vet you against their own requirements. If they approve your loan application, they then send it to the SBA for approval.

If you default on the loan down the road, the SBA covers the unpaid loan amount. This mitigates the lender’s risk and encourages lending.

“SBA (Small Business Administration) loans provide entrepreneurs access to capital to buy and run a small business.”

Buyer SBA loan benefits

The SBA loan program expands access to financing and incentivizes lending for small businesses. This helps small businesses and entrepreneurs to access capital and fosters economic growth.

As a buyer, SBA business loans can help buy a business if you don’t yet have the resources for the acquisition. With an SBA loan, you can put down as little as 10 percent of the value of the business and have the rest covered by the loan.

Even if you do have the required cash to buy a business outright, SBA loans also enable you to make a purchase with less up-front investment. This allows you to hold on to more cash. You can then use this cash to grow the business or pursue other investment opportunities.

Since you have invested a smaller amount of cash in the business, it is possible to achieve a higher ROI (return on investment) in a shorter amount of time. This can be true even when accounting for debt service payments.

For example, let’s say you want to purchase a business for $1,000,000, but you only have $200,000 in cash available. You apply for an SBA loan and win approval for a $900,000 loan. You put $100,000 of your own money toward the purchase, along with the $900,000 loan.

In this scenario, the SBA loan allows you to invest in a business far beyond your capability without the loan. This is leverage. At the same time, you still have $100,000 of your own money to invest in improving the business after acquisition.

Further, let’s say the business produces $300,000 in profit each year. If you put $100,000 toward the business, you would recoup your personal investment in only four months. Note, this doesn’t account for debt service payments or investments in growth activities. Even once accounting for interest rates and debt service payments, your ROI is still very high. Compare this to a timeline of three years and four months without a loan.

“By providing buyers with more financing options, SBA loans increase the pool of potential buyers.”

Seller SBA loan benefits

Buyers are not the only ones to benefit from SBA loans. When selling their company, many small business owners prefer to receive the full sale price in cash at the time of closing. In other words, they want a clean break. Depending on the available offers, this may not always be possible. SBA-financed deals are often all cash for the full sale price at closing.

By providing buyers with more financing options, SBA loans increase the pool of potential buyers. As a seller, this increases your chances of finding a qualified buyer with acceptable deal terms.

General SBA loan requirements

As with traditional bank loans, applicants must meet certain requirements to gain SBA loan approval. This is to help ensure that the borrower is able to repay the loan.

There are many individual requirements, but they can be grouped into several larger categories. To win approval for an SBA loan, you must:

• Show that the business you want to buy has enough cash flow to repay the loan.
• Prove that you’re qualified to run the business.
• Ensure the deal structure adheres to SBA deal term requirements.

The SBA will assess whether the borrower and business have enough cash flow to repay the monthly loan installments. They will collect and analyze information about the debt-to-income ratio of the business. They may also take into account any personal debt or income that you have. Generally, they’ll look at the previous three years of tax returns to make this determination.

Secondly, you must show that you are capable of running the business you plan to buy. The SBA will assess whether you have relevant previous experience. You may also be assessed on your current income and expenses, credit score, and assets and debts.

The planned deal structure must meet SBA loan requirements to win approval. This could include full vs partial buyouts, consulting agreements, seller financing, and more. The recent SBA loan criteria update impacts deal structure requirements. We take a look at these updates in the next few sections.

Partial-Buyout SBA Loan Update

One of the main restrictive criteria with SBA loans has been about partial buyouts.

Partial buyouts are now allowed

Before, individuals using an SBA loan to buy an existing business had to completely buy out the seller. That is, there were rules prohibiting sellers from retaining any ownership of the business for one year post-closing.

Now, partial buyouts are allowed under SBA guidelines. Instead of only being allowed to purchase 100 percent of a business or nothing at all, buyers can buy only a portion of a business. This leaves the remainder in the hands of the owner.

For example, it would be possible to purchase 80 percent of a business and leave 20 percent to the owner. Of course, the owner would need to agree to this in the first place. While many sellers prefer a clean break, some may prefer to stay involved in the business after the sale. This new rule change allows for this.

As a seller, it is important to know that any owner in the borrowing entity or the business is required to personally guarantee the loan if they own 20 percent or more of the subject business.

“By allowing sellers to stay involved in the business after the sale, the SBA is easing the transition process and decreasing the chance of business failure.”

Benefits of partial-buyout rule changes

There are several key benefits to this change of rules. For starters, it opens up SBA loans as a financing option for any situation where the seller wants to stay involved in the business after the sale. This increases the pool of potential buyers for these types of situations, which can raise competition and make it easier to find a qualified offer.

Some businesses require a high level of expertise or a specific license or certification to operate. In these scenarios, it can be difficult for a seller to find a buyer with the required expertise or license. With the new changes, the seller can sell the majority of the business while retaining an ownership stake.

This allows them to step away from much of the day-to-day operations while still providing their license or expertise so the business can continue operating. The buyer benefits by being able to operate a business they wouldn’t have been able to otherwise. The seller benefits by being able to sell much of their business, scale back involvement, and retain some equity.

In most situations, buying and running a new business requires a steep learning curve. It is often quite challenging to step into an ownership role successfully. By allowing sellers to stay involved in the business after the sale, the SBA is easing the transition process and decreasing the chance of business failure.

Seller-Financing SBA Loan Update

Seller financing refers to any situation where the seller finances some portion of the purchase to be paid back over time by the buyer. Recent SBA updates have made it easier for this type of arrangement to take place.

The SBA has loosened the rules around seller financing

Previously, if a seller helped with any portion of the 10-percent-or-greater cash injection required for an SBA loan, they needed to make certain concessions. These concessions made seller-financing any portion of an SBA loan deal unattractive to most sellers. 

Under the updated rules, sellers can provide the entirety of the required 10 percent SBA loan cash injection. It simply requires a 10-year amortized seller note and a two-year standby period. (That is, they forego repayment for two years.)

If the buyer covers 25 percent of the 10 percent cash injection, the seller can cover the rest with a 10-year amortization note. In this scenario, the remainder is subject to a two-year interest-only period, not a full standby.

Sellers can now also trade seller equity for the loan down payment. Of course, these deals are scrutinized for approval by the lending institution. This type of arrangement is popular when a key employee buys out the owner but doesn’t have enough cash saved up for the loan down payment.

Benefits of loosened seller-financing rules

As you can imagine, sellers were not likely to accept seller-financed offers under the old rules. The recent changes make seller financing much more palatable. This opens up the possibility of seller-financed deal structures, increasing the likelihood of buyers and sellers reaching mutually agreeable deal terms.

“SBA loans can be an excellent way to finance a business acquisition for the right buyer and seller.”

Key Things to Keep in Mind when Using an SBA Loan

You may have been told by associates or colleagues that SBA loans are difficult or unwieldy. For starters, don’t believe everything you hear.

SBA loans can be an excellent way to finance a business acquisition for the right buyer and seller. Nevertheless, there are several things to keep in mind as you navigate the process.

The SBA and lending institutions each have their own requirements

Both the SBA and each individual SBA lender have their own criteria for loan approval. Many people who get denied an SBA loan assume they don’t meet SBA requirements. Often, it is because they didn’t meet that specific lender’s requirements.

In reality, the SBA’s list of requirements is fairly short; lenders add requirements on top. For example, there is no official credit-check requirement from the SBA in order to be approved. Most lending institutions, however, will require one.

The takeaway here is if you are denied approval by one lender, it doesn’t mean you can’t win approval from a different lender.

Consider working with an SBA loan broker

Given the nuance of winning SBA loan approval, many individuals choose to work with an SBA loan broker throughout the process. An experienced broker will help you choose lending institutions that favor your specific situation.

At the same time, they can help you ensure you have dotted all the i’s and crossed all the t’s before submitting your application. This allows you to put your best foot forward and increases your chances of gaining approval.

Conclusion

SBA loans can be a terrific way to finance the purchase of an online business. As a seller, the availability of SBA loans widens your potential buyer pool and increases your chances of getting an all-cash offer. 

Recently, the SBA made several important rule changes, including:

• Allowing partial buyout deal structures
• Loosening rules regarding seller financing requirements

These changes open up SBA loans as a financing option to more potential buyers and sellers, facilitating deals and making it easier to buy or sell an online business.