Why Your Business Isn’t SBA Pre-Qualified

18:09

Ever wonder why some online business listings are marked “SBA Pre-Qualified” while others aren’t? In this video, Brad from Quiet Light explains how SBA 7(a) loans actually work in online business acquisitions. Learn why SBA pre-qualification isn’t an official government designation, how lenders evaluate cash flow and tax returns, and the major deal-breakers that prevent businesses (and buyers) from securing SBA financing.

CHAPTERS 

00:00 Why Isn’t Every Listing SBA Pre-Qualified?

00:45 How SBA 7(a) Loans Actually Work

01:50 SBA Loan Terms: Multiples, Down Payments & 10-Year Amortization

03:30 How a Business Qualifies for SBA

05:45 Ineligible Industries, Deal Sizes & Seller Preference

07:00 The Truth About “Buyer Pre-Qualification”

08:15 4 Key Buyer Qualities

10:00 The Dark Side of SBA: 186-Point Checklists & 130-Day Closings

12:15 Personal Guarantees & Monthly Cash Flow Reality

14:00 Why Sellers Prefer Fast Cash Buyers Over SBA Deals

16:00 When SBA Makes Sense for Your Exit

TRANSCRIPT

00:00 Why Isn’t Every Listing SBA Pre-Qualified?

We get asked this all the time. Why isn’t this listing SBA pre-qualified? It’s a fair question. [music] If you’re browsing listings and you see some marked SBA pre-qualified and others not, it’s natural to wonder what is going on. Is something wrong with the business? Is it a red flag? Usually no, but to really understand the answer, you need to understand how SBA financing [music] actually works. How the business qualifies, how the buyer qualifies, and why some deals just don’t fit the mold. That’s what we’re going to cover in this video. >> [music] >> 

00:45 How SBA 7(a) Loans Actually Work

Let’s talk about what SBA loans actually are. Most people think that SBA loans are >> [music] >> borrowing from the government directly. That’s actually not true. So, in reality, you do have a personal guarantee essentially to the government. So, if you default, they’re going [music] to come and take everything you own or everything that they need to satisfy the loan. But, when we talk about SBA loans, there are actually private underlying banks that lend the money. They go to the SBA and say, “Hey, I’ve got a loan that meets your guidelines. We’d like to get some lending on this.” If they meet the guidelines, it’ll get approved, and then they loan their own money. After they loan their money, then they have sort of an insurance policy. That insurance policy guarantees that the bank will be made whole if this loan goes into default. This is how the government gets banks to participate in the process. So, SBA loans up to about $5 million is a great way for buyers to find [music] capital that is at competitive rates, that is not impossible to get, and that has sort of a a well-known process that people understand and that they can roll through. 

01:50 SBA Loan Terms: Multiples, Down Payments,& 10-Year Amortization

In the 7(a) program, it’s [music] up to $5 million. So, there are lenders that will do deals as small as 250 or 500,000. Buyers expect, based on what we’ve seen [music] in the trends, 10 to 15% of down payment. So, that’s not a one-size-fits-all. Sometimes people come to me and they’re like, “Hey Brad, this business is so many dollars. I want to just pay you 10% down, [music] and that’s how I’m going to buy it.” That’s not really how it works. The lenders on the back end, they’re taking a 3-year average of the tax returns, and then they’re figuring out, “Well, at a three times multiple, or a three [music] and a half times multiple, how much lending can we get based on what is showing in the tax [music] returns?” And so, they’re taking that and saying, “Okay, um if we can get $1 million here, how much down payment will we need? Okay, we’re going to be at a really good spot. It’s going to be 10%.” Sometimes it’ll be 10% seller financed, 10% from the buyer. What that really means is that the [music] deal needs 20% cash injection to cover the loan. There’s lots of different ways to kind of do this, but you just [music] got to keep in mind that it’s not just, “Oh, SBA loans are 10% down.” Or, “SBA loans go up to 5 million no matter what.” That’s not how it works. Uh other parameters, they have a 10-year payback. So, that 10 years becomes really beneficial in the world we live. [music] We sell most businesses between a two times multiple and a five times multiple. So, if someone’s paying back on 10 years, then there is an inherent baked-in cash [music] flow. So, think about that for a second. 

03:30 How a Business Qualifies for SBA

We sell you a business for a three times multiple. So, three times the yearly earnings. You’re going to pay it back, guaranteed, on a 10-year payback. So, we have created cash flow for you just because we’re spanning out those [music] payments over time. The interest rates can vary. Most banks are doing prime plus 2.75, although there are banks that will do a fixed [music] rate, it’s just not as common. Uh Uh so, I would expect if you’re getting an SBA 7(a) that you’re going [music] to be at prime plus 2.75% when you’re doing those. So, that floats. You know, when the interest rates were lower, [music] we were seeing rates as low as 7%. Uh when the rates got higher in 2022 and 2023, we started seeing rates up closer to 12%. >> [music] >> So, it depends on where the prime rate is. One point I want to call out for the buyers primarily is this [music] long repayment really is beneficial to someone buying a business. So, it’s not just the point I [music] made about, “Hey, we sold at a three-times multiple and you get 10 years and all this kind of thing.” It’s also just a sleep-at-night factor for the buyer. Okay, so when we talk about how the business qualifies for SBA, there’s a few components uh for the seller to consider. One is cash flow. The business has to have enough cash flow to justify a loan. Uh we can get into the nuance of that, the DSCR, the debt service coverage ratio. Usually needs to be 1.25 or better. This means if you have a $100,000 loan repayment, then there needs to be about $125,000 of cash available to cover that. Uh we generally like to see this be higher than 1.25, but that’s just a guideline that you kind of need to follow. Whenever we take this to a lender and say, “Hey, would you want a loan against this?” one of the main things they’re going to look at is well, what is the cash flow? That’s the first and most obvious. Does it have the cash flow to cover a potential loan? And if it doesn’t on the tax returns, then we’re going to start saying, “Hey, we can’t qualify fully. We might be able to qualify it some of the way depending [music] on whether or not we checked the other boxes.” 

05:45 Ineligible Industries, Deal Sizes, & Seller Preference

Some of those other boxes, we need clean financials that match. Let’s talk about what that means. So, I talk to sellers every day. “Hey, I have this business that makes $300,000 a year. You know what I say to them? I say, “Okay, it’s US based. All right. On that [music] 300,000, how much of that 300,000 shows on your tax returns as ordinary income?” Now, why am I asking that? Well, because I have a lot of sellers that will say, “I make 300,000, but the tax return says [music] I make 50,000.” Well, they’re using a lot of deductions, which might be benefiting them when they operate the business. But, when you go to sell the business, it can become a real detriment for these SBA loans, because the SBA is going to look at that and say, “Uh $50,000 in earnings in ordinary income, I can’t lend much against this.” Whereas, if you have a seller that says, “Hey, I’m not going to take tons of deductions. [music] I’m going to show some ordinary income on my tax return.” Those are people that can say, “Okay, I say I make 300, my tax return shows 290,000.” And so, now we’re looking at a business that probably is going to qualify really well. Next, we have US [music] based ownership. This is a tricky one. There’s an eligible industry component to this, and that’s not something that we get into a lot, but what are the potential things here that would not qualify? And I’ll just do like a basic list, like gambling, uh speculative businesses. These are things that are highly volatile. 

07:00 The Truth About “Buyer Pre-Qualification”

There’s laws and restrictions around these things, and so that’s that’s not a great category. Um maybe a non-profit, not an SBA eligible business. An MLM, not an SBA eligible business. There’s a long list of these things that don’t qualify. For most of the stuff that we see online, most of it qualifies if it has the right history and earnings and structure [music] and things like that. The last one, size and practicality. You could have a business for sale for $10 million and get $5 million worth of SBA [music] lending for it, but we’re not going to be able to exceed $5 million in SBA lending under the current guidelines. Practicality, for me, a $250,000 [music] SBA loan might be something that in theory could work. But do I really want to take my seller through a multi-month process so that he can get [music] a $250,000 sale? The answer is no. I would actually rather keep the business out to market and wait for a cash buyer that can write a check for $250,000 or in this case wire it because we don’t want to go through a long painful SBA process for $250,000. So I believe that technically the US-based ownership is a requirement, but this gets down to >> [music] >> sort of a guideline situation. 

08:15 4 Key Buyer Qualities

We have people telling us that they’re interpreting the guidelines differently. We can see that there have [music] been some updates that have just flat out required US ownership, but I just want everyone to be aware that on a monthly basis I’m having multiple people email me to tell me, “Hey, the buyer does not have to be US-based.” So I don’t know if that’s just that these guidelines take a long time to kind of permeate through the market [music] or if the interpretation is just incorrect by these buyers, but that’s a perfect example. Okay, so just to recap, let’s talk about why a business wouldn’t qualify for an SBA loan. So if it didn’t have enough cash flow is one reason. You know, if the cash flow doesn’t support the debt, probably not going to be able to do it. If we’ve got messy financials or if we don’t [music] have 3 years of tax returns that show some earnings. You got to remember, they’re going to do a 3-year average on the tax returns. [music] Okay, so if you earn zero in year one and zero in year two and 500 in year three, that’s not a very good average. >> [music] >> US-based ownership, you know, if it’s a foreign national, we’re just going to reject it. You know, we’re just going to say, “Hey, if everybody’s not [music] in the US, we’re not going to want to do this deal.” Is it an eligible industry? That’s usually a pretty easy box to check. And then [music] is the size right? Like I have people coming to me, “Hey Brad, I saw you launched a $250,000 listing. Can I get an SBA loan for it? The other thing I want to just finally say on this is, does the seller want to sell with an SBA loan? If they don’t, it doesn’t matter if it [music] qualifies, because ultimately the seller gets to decide, do they want to pursue the SBA or do they not? 

10:00 The Dark Side of SBA: 186-Point Checklists & 130-Day Closings

Let’s talk about buyer pre-qualification for a minute. One thing I want to mention about buyer pre-qualification is it’s actually not a real thing. So, just so you know, when we have a business and then a buyer comes to us and gives us a letter from a broker lender that says, “Hey, I’m SBA pre-qualified.” Is that an official designation? No, it is not. It’s not official. It’s not a real [music] pre-qualification. So, what does it actually mean? It means that we’ve had a buyer go to a broker lender, meet with them, show them under the hood of their own personal financials and things like that, and then that lender has written a letter that says, “Hey, John Doe over here qualifies for [music] $5 million SBA coverage.” It means nothing besides that a lender has looked [music] at this person and thinks that they check the box. So, I want to just say that as an overarching thing that SBA pre-qualification is not really a [music] thing. It’s just a guideline from a lender saying, “We think this person meets the criteria, so we’re giving you a letter that gives you some confidence that they can [music] get through the process.” Let’s break down some of the points. Credit score. This is a moving target. You’ve got to have a decent credit score to get an SBA loan. I don’t want to even pin it to a certain score at this moment because I’ve seen different lenders say different things. A new one that has become really prominent since [music] 2021, relevant experience. This has become huge. I’ve had buyers that look like they check every box, and then when the lender asks them, “Hey, so do you know anything about e-commerce?” they say, “No. Uh I’ve been running a manufacturing business my [music] whole life.” That’s no relevant experience. We’ve got to have some industry [music] experience, something that makes you look like you can take over this business and you’re not going to lose your shirt. You’re going to have to have an equity injection. Which I would say in most deals I’ve done, we see 10 to 15, [music] 20% from the buyer as an equity injection into the deal. And then finally, and one that I’ve had people tell me, “Oh, this is not required. I’m not going to do that.” a personal guarantee. 

12:15 Personal Guarantees & Monthly Cash Flow Reality

What does a PG, personal guarantee, mean? It means that if you stop paying it, whatever assets that you own [music] are now available for them to pursue to get their money out of the deal. So, I list off these several things, but I want to say it instead of it being a bullet list, I would call these sort of like qualities. Qualities that need to be present to get a loan. Okay, so >> [music] >> is the credit score perfect? You’re going to need to have something that’s within the range of what they require. [music] What about relevant experience? It’s very subjective. Bank by bank might have a different, you know, feeling on that. What about that personal financial statement? Does that need to look good? How What is the criteria? Not exactly sure, depends on the bank. Don’t think you’ll get around a personal guarantee no matter what you do, but [music] I’m not saying that every single one of these has to be perfect. But I am saying these qualities need to be present. We need to have this list mostly covered, and we need to have a justification for each item on the list. All right, let’s talk about the trade-off for a second. One of the things is is just tough for me as someone who does this work all [music] the time is just seeing how addicted Americans are to leverage. But what else? What are other reasons why we might not want to go through it? >> [music] >> Uh one, it requires a lot of documentation. I have seen lists from these banks that do these deals. I had actually two going on at once last year. And one of the people said to me on a call, “Man, you cannot believe the closing checklist from this bank for this SBA deal.” 

14:00 Why Sellers Prefer Fast Cash Buyers Over SBA Deals

And I was like, like what what do you mean? He was like, “It was 75 points long.” I was like, “Ooh.” 75 points? So then I was talking to the other SBA deal I was working on. And I said to the buyer there, “Well, this guy just showed me the closing checkpoint list and it was 75 checkpoints long.” [music] And she goes, “Oh, that’s great cuz I’ve got a checklist that’s 186 points long.” So, there’s some pain. There’s some pain getting through this process. There’s a lot of documentation. It takes a lot of time. You know, you’ll feel like, “Man, can’t we do this a little bit more efficiently than we’re doing it? Is there not a way that we could streamline this process? Do I really [music] have to go through this diligence over and over and over again because there are components of it that sort of feel like you are in a never-ending cycle of diligence.” One of the things that a lot of the lenders say, they’ll tell you, “Hey, we’ll close the deal in 45 to 60 days. That’s the target.” [music] Then there’ll be others that come to the table and they say, “Hey, um we’re not naive like those other banks. We close ours in 90 days.” I hate to tell you this, but I’ve done three SBA deals in the last year that in every case took over 130 days to get over the finish line. So, what’s the trade-off? The trade-off is, hey, I know you’re getting all this cheap debt and you’re getting all this it’s a long time [music] frame. It’s very favorable. It’s all these great things. It allows you to buy a larger business. Those are great attributes of taking SBA loan, but the trade-off is the time, the complexity, the diligence involved, all these things [music] are big factors that might make you want to reconsider. And then the other one that’s larger that doesn’t have to do with the the loan itself, but just do you value being able to go to bed at night and sleep? Are you worried [music] about that payment? When you go take a three, four, five million-dollar SBA loan, you’re signing up [music] for a 50, 60, 80 thousand-dollar a month payment for 10 years. Keep that in mind. Try it on. 

16:00 When SBA Makes Sense For Your Exit

Try to envision what it feels like to buy a business that makes a hundred grand and 70 of it in the month has got to go to pay the loan. That’s going to feel like the cash flow is not as good as you were thinking on the front end when you were thinking that this SBA loan was sort of like a lending lottery ticket. One other thing on the trade-offs, just keep in mind, this goes back to the point I was making about does the seller want it? Okay? A seller might just say, you know what? I’d just [music] rather stay out to market and look for the deal that closes in 30 days. If I have a cash buyer, why does [music] the deal need to take 90, 100, 130 days, even 60 days? It really doesn’t. When I do cash deals, a lot of times they close in two weeks, three weeks, four weeks, five weeks. They close much faster than the SBA deals. So, you might just have a seller that just says, “Hey, I just don’t want that complexity in my life. I don’t want to go through that process.” And so, we just choose not to do it. So, SBA can open lots of doors. Obviously, it’s a very important part of what we do at Quiet Light. We sell a lot of our businesses that are especially in the one million to five million or even six and seven million range, a lot of those have an SBA loan attached to them. So, they’re really important. But, just know that introducing an SBA loan introduces some friction. It introduces complication into the deal. And so, it’s nuanced and we’ve got to work through those things and [music] figure out, hey, does this work well in this situation? It’s got to work for everybody. It’s got to work for the buyer. It’s got to work for the seller. So, that’s the full picture on SBA [music] qualification. What it means, why some listings have it and others don’t, and what it takes to actually [music] get the loan. If you’re serious about buying an online business, like and subscribe. We’re going to keep breaking down the tactics, the process, and the mistakes to avoid. Everything you need to know to buy smart.