Celtic Bank Blog

SBA Loans: What They Are, How They Work, and Why They're Perfect for Buying Your Business

So you’re thinking about buying a business. There are a lot of different options for making that purchase. How do you know which to choose?

We’re here to show you the ins and outs of one of the most accessible, affordable, and all-around best financing options for buying a business—the SBA loan. You’ll learn what it is, why it’s a great option, and what you need to do to get one. There’s a lot to cover, so let’s get started!

Why SBA?

There’s a million options out there for buying a business. Bank loans, short term loans, SBA loans—not to mention seller financing, and private investing. When you consider all the choices, it may seem like a buyer’s market. But is it?

Some loans come with steep and costly repayment packages which ultimately may hurt, not help, the growth of your business. Even if the business you purchase is healthy and thriving, if you get it at a cost you can’t actually afford you won’t stay in business long. So you could get the money from just about anywhere. But do you really want to?

We’re going to look at SBA loans, and why they leave their competitors--the traditional bank and short term loans—in the dust.

SBA basics

Some small business funding options charge you fees and interest that take your APR up to 99% of the original loan amount, leaving you drowning in high monthly payments. Other, more traditional, bank loans have high qualification standards that make it near-impossible to get any funding for your purchase. But SBA loans work differently. Let’s take a look at the things that set your SBA loan apart from the competition:

Terms

Many short term lending solutions have short repayment terms which create uncomfortably high monthly payments. Just imagine:

You’ve gotten a loan for $500,000 to help cover the costs of buying the landscaping company you’ve been managing. It’s a short-term loan, so your repayment terms are for three years. Your credit is great, so you lucked out and found a low interest rate at 5%. But even so, your monthly payments on the loan are coming in at just over $15K. Yikes! Can you really afford to pay that each month—especially during the first months of transition from old ownership to new?

With an SBA loan, the average loan term is 10 years—keeping your payments low and your cash flow high. And depending on your loan size and lender, you may not be subject to a prepayment penalty. This means if you find the money to pay off your loan early, you can do so without facing any additional fees. If you were to go with a traditional bank loan, you’d be subject to steep prepayment penalties that offset the money you should have saved by paying down your debts early.

Interest rates

The SBA sets caps and guidelines for loan interest rates, preventing your loans from spiraling out of control. The interest rate on your SBA loan is comprised of two parts—a base rate (published in the Wall Street Journal) and margin. The margin on your interest will be specific to your loan amount and is set at the discretion of the lender within the parameters set by the SBA. Let’s compare this to other alternative, short-term lenders.

Some alternative lenders—especially for borrowers with lower credit—start your interest at a steep 30% annually and climb upwards from there. Others offer you a seemingly affordable monthly rate, like 5%, which ends up being astronomical once it’s annualized over 60%.

To put this into perspective, if you were to purchase a convenience store at $175K with 5 year terms and the average 30% interest rate, your $175K loan would cost you just under $165K in interest alone. That’s 94% of your original loan amount—without factoring in any maintenance fees or other charges associated with the loan! Now, imagine the cost if you had one of those 60% annualized loans! Catastrophe!

When you look at the numbers, SBA loans really are the clear-cut affordable loan choice, even for those with less-than-perfect credit.

Approval rates

Speaking of less than perfect credit, let’s look at the SBA approval rates. In 2016, only slightly more than 20% of traditional bank loan applications were actually approved. Why is this? Because most traditional lenders are looking for borrowers with near-perfect credit, high net worth, and lots of years in business. Which excludes most small business owners. Those who are approved can expect a long, tedious approval and application process before receiving that funding. The short term loans are fast with high approval rates, but we just saw how expensive those can be.

Unlike the traditional bank loans, SBA loan approvals have been steadily climbing—doubling in number since the start of the millennium. This is great news for small businesses owners—or future owners. Because SBA loans are guaranteed up to a certain percentage by the federal government, your lender’s risk is minimized. So they’re more likely to approve your loan—imperfect credit and all. And with up to $5 million available, you’ll be able to get all the funding you need to buy and grow your business. Pretty great, right?

Applying for your business acquisition SBA loan

Buying a business is a big deal. So the process of funding it is kind of a big deal, too. To help you get started, we’ll walk you through the process of getting your SBA business acquisition loan so that it goes as smoothly as possible.

Choose your lender

When it comes to getting an SBA loan, you have two basic types of SBA lenders to choose from: standard, and preferred. Preferred lenders have the ability to perform the underwriting process in-house; standard lenders go through a regional SBA office. We recommend using a preferred lender.

Choosing a preferred lender speeds up your loan processing time by eliminating the external third party review. It also allows you to maintain contact throughout the application process so that questions or concerns can be resolved quickly and easily. Finally, preferred lenders typically have years of experience with SBA loans, so you know your loan is in good hands.

Prequalification

Getting your business loan starts with prequalifying. Fill out a short online application. Once you’ve submitted your application, lenders will be able to access a liquid credit score and make an initial prequalification decision.

If your credit isn’t stellar, or you need a really large loan, your application will go through an additional step before reaching a prequalification decision. This is pretty normal for business acquisition loans.

Depending on the exceptions that would be made in your case, your loan application will be reviewed by individual loan experts, or an entire committee, to decide whether you’ll have the ability to successfully handle the loan. If this sounds stressful, don’t worry. For most large or more complicated loans, you’re assigned a loan expert from day one to help you through the process.

Underwriting

Remember when you were looking into buying that business, and you had to do your “due diligence” to make sure that investing your money in it was a good idea? Well, banks have to do the same thing when investing money in you. This due diligence process for the lender is called “underwriting.”

Since a lot of underwriting happens behind-the-scenes, we thought we’d give you a short run-down of what happens during the process. This way, you know what factors went into your SBA loan getting approved.

Much of the underwriting process today is automated. The specifics of your financial information are entered into a computer program, which looks at the data and calculates potential risk and other factors for the lender to consider. For smaller loans, it might also generate one of three responses for your loan: recommended, review further, or rejected. But for larger loans, a certified loan expert will review each case individually and/or with a council to decide whether to approve your loan request and how to structure it.

Talking with your loan officer frequently can help clear up any questions they may have and help them determine your loan eligibility. On this note, let’s talk about eligibility and what determines it.

Each SBA lender will weigh qualifications differently. But generally, they tend to look at a few different things:

Do you have the income to successfully pay back the loan?

  • What is the value of your offered collateral?
  • How is your personal credit?
  • How much equity have you personally invested in your business?
  • Are there any other sources available to repay the debt?
  • Are there any personal guarantees or liens attached to this loan?
  • Do you have the direct or transferable management experience necessary to successfully run this business?

How long the underwriting process will take depends on your lender and your paperwork. Expedite your process by finding an SBA Preferred Lender, as their in-house process can save you two to three weeks of time. Then, make sure you have all your documents ready. Having the needed documentation enables underwriters to see what they need to make a decision quickly, getting you your funds faster.

Collateral

Most large SBA loans (over $25,000) require collateral as insurance against loss—especially when those loans are used for business acquisition. For you, this collateral could be personal assets (such as a house) or business assets like equipment or accounts receivable. If the business you’re purchasing includes real estate in the purchase, the acquired property will also be taken as collateral.

 

A note about personal assets:

Some borrowers are concerned about using their personal assets (like a home) as collateral for business loans. But you may not need to even worry about that. Generally, home and personal assets are only taken when:

  • The lender requires your residence as collateral
  • Your residence equity is stronger and more substantial than that from your credit factors or other sources of collateral
  • The lender wants to solidify your commitment to the business for which you are receiving the loan
  • You use your residence as a place of business, or your have your business located on the same land as your home 

 

SBA lenders will hire a third party appraisal company to come and survey your property. In addition to looking at the land itself, they’ll evaluate your building and any equipment you have on the premises. Depending on the appraisal company—and the location of your house or business being appraised—this process can take two weeks or more. While the SBA generally requires collateral on all large loans, they will not automatically decline a loan if sufficient collateral is not available.

Conclusion

SBA loans provide buyers with the opportunity to get the business they’ve been dreaming of, at a cost they can afford. And with the right lender, you won’t just have someone to help you get the money; you’ll have someone to help you get the business. Consider these recent success stories from a few of our clients:

Assisted Living Facility:

Our buyer was looking to purchase an assisted living facility in southern California… while working in Asia. Communication was difficult, and the seller was uncooperative and unsure about getting the loan pushed through. Thankfully, our Business Development Officer was able to work with the buyer and seller—adjusting the application process to accommodate the challenges of the current geographical logistics. The SBA loan approved, and the buyer was able to get funding to purchase his business by the close-of-escrow deadline.

Second-business Carwash Purchase:

Our customer was in the process of constructing a new business when she decided to purchase the express carwash she’s been managing for years. Since she already had some significant loans from the construction project, many lenders were hesitant to fund her business acquisition as well. Celtic examined the finances and success of the carwash, and the experience of the borrower, and decided to approve her for the loan with a 13% down payment. The loan closed quickly, and within months both businesses were up and running.

The business opportunity you’ve been waiting for is closer than you think. Contact a trusted lending adviser today to see what options are available for you.

 

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