September 17

How to Get SBA Financing to Buy Your First Business

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If you're dreaming of owning your first business, one of the biggest hurdles is often securing financing. Fortunately, SBA (Small Business Administration) loans are an excellent option for entrepreneurs looking to buy or start a business. SBA loans are flexible, covering everything from startups to franchises and existing businesses. This guide will walk you through the basics of SBA financing, the available loan programs, and tips for securing funding.

What Is SBA Financing?

SBA financing refers to loans partially guaranteed by the U.S. Small Business Administration. While the SBA does not directly provide the loans, it helps small businesses by backing a portion of the loan, making it easier for borrowers to get approved by traditional banks. This guarantee reduces the risk for lenders and opens doors for entrepreneurs who might not qualify for conventional business loans.

Types of SBA Loan Programs

The two most common SBA loan programs are the SBA 7A and the SBA 504 loans. Each is designed for different types of financing needs:

  • SBA 7A Loan: Ideal for business acquisitions, working capital, or expansion, the SBA 7A is one of the most flexible loan programs. It offers loan amounts up to $5 million, and the loan terms can extend up to 25 years if real estate is involved. Without real estate, the term is generally 10 years.
  • SBA 504 Loan: This loan is primarily designed for real estate or heavy equipment purchases. A 504 loan consists of two parts: a first loan from a traditional lender and a second loan from a Certified Development Company (CDC). This setup can offer up to 90% financing with long-term, fixed-rate options.

Other options include government-backed programs like the USDA Business & Industry (B&I) loan, which supports businesses in rural areas with populations of less than 50,000.

Key Requirements for SBA Loans

Equity Injection and Seller Carryback

One of the main requirements for SBA financing is a 10% equity injection from the buyer. However, in some cases, a portion of this equity can come from a seller “carryback.” This arrangement means the seller agrees to finance part of the business purchase, effectively reducing the upfront cash requirement for the buyer.

Loan Collateral

Collateral is another crucial consideration. If the loan amount exceeds $500,000, banks often require additional collateral, typically in the form of real estate. Even though the SBA guarantees up to 85% of the loan, having collateral strengthens your application and increases the likelihood of approval. That said, a lack of collateral doesn’t necessarily disqualify you, especially if your business has strong financials.

Debt Service Coverage Ratio (DSCR)

Banks use a measure called the Debt Service Coverage Ratio (DSCR) to determine whether a business can support the loan payments. This ratio compares a business's cash flow to its debt obligations. For example, if you're purchasing a business, lenders will review three years of business tax returns to assess the DSCR and make sure the business can cover the loan payments.

Examples of SBA-Backed Deals

To illustrate the flexibility of SBA loans, here are two real-world examples:

  1. Marina and Restaurant Acquisition: In one case, a buyer acquired a marina and restaurant for $2.1 million. The seller agreed to carry back 5% of the financing, and a family member contributed $40,000. The SBA loan covered 90% of the total project cost, and the buyer had no out-of-pocket expenses.
  2. Franchise Purchase – Mr. Handyman: Another example involves purchasing a handyman franchise, Mr. Handyman. The startup cost for this business was $150,000, including the franchise fee, marketing costs, employee salaries, and working capital. Despite the low liquidity, the buyer secured financing with a 10% equity injection.

How to Increase Your Chances of Approval

Good Credit and Financials

Most SBA lenders require a minimum credit score of 680, although scores as low as 660 may be acceptable. Additionally, you'll need to provide proof of steady income or sufficient capital to cover your personal expenses while the business grows. Banks also look at liquidity post-closing, typically requiring 10% or more of the loan amount in reserve.

Realistic Expectations and Strong Financials

Before approaching lenders, it's crucial to have a realistic understanding of the financials for the business you're purchasing. Having accurate tax returns and a clear cash flow analysis is essential. Lenders will want to see three years of business tax returns and a year-to-date interim balance sheet to assess whether the business can support loan payments.

Final Thoughts: Leveraging SBA Financing for Your First Business

SBA loans are a powerful tool for entrepreneurs looking to purchase or start a business. With loan guarantees, flexible repayment terms, and the ability to finance up to 90% of your project, SBA financing can make the dream of owning a business a reality. Whether you're looking to buy an existing business, invest in a franchise, or start from scratch, the SBA has a loan program that can meet your needs.

If you’re serious about securing SBA financing to buy a business, consulting with experts in SBA loans can greatly improve your chances of approval. These professionals can help guide you through the application process, find the right lender, and structure the deal to meet SBA requirements.

By preparing well and understanding the ins and outs of SBA financing, you'll be better positioned to take the next step toward becoming a successful business owner.


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