By Corrie Thrasher, Founder of Thrasher Law
If you are thinking about buying a business, expanding an existing company, or funding a major growth initiative, chances are you have heard about U.S. Small Business Administration (SBA) 7(a) loans. You also likely have heard that obtaining one requires supplying enough documents to deforest a small country and answering questions about your finances that may seem far too intimate.
Despite their reputation, SBA loans are not quite as mysterious or intimidating as they seem. They are one of the most common financing tools used in business acquisitions, yet many buyers and business owners still are unsure how they work, why lenders ask for so much information, and what it takes to get approved.
As an attorney who regularly works on business transactions, I hear many of the same questions from clients navigating the process for the first time. Here are straightforward answers to some of the most common ones.
What exactly is an SBA loan?
An SBA loan is a business loan that is partially guaranteed by the U.S. Small Business Administration. That guarantee reduces a lender’s risk and encourages banks to make loans that they might otherwise decline. The most common program used for business acquisitions is the SBA 7(a) loan. These loans can be used to purchase an existing business, acquire business assets, provide working capital, refinance certain debt, or fund expansion. Although the SBA provides a guarantee, it is important to understand that the borrower is still responsible for repaying the entire loan.
Do I get the loan from the SBA or a bank?
The loan comes from a lender, typically a bank or specialized small-business lender. The SBA does not write the check for the loan but instead provides a guarantee to approved lenders who make the actual loan. This distinction matters, because each lender has its own underwriting standards, processes, and preferences. Two lenders may review the same transaction under the SBA 7(a) program guidelines and reach completely different conclusions. As a result, choosing the right lending partner is often just as important as preparing a strong loan application.
Why do buyers use SBA financing to acquire businesses?
SBA financing is one of the most popular tools for business acquisitions because it allows buyers to purchase a company without contributing the full purchase price up front. For example, instead of bringing several million dollars to closing, a qualified buyer may only need to contribute a percentage of the purchase price, with the balance financed through the SBA loan program. The repayment terms are often longer than conventional commercial loans, which can result in lower monthly payments and improved cash flow during the critical transition period after closing. For many entrepreneurs, SBA financing makes business ownership possible when it would otherwise be financially out of reach.
How much money do I need to contribute?
The answer depends on the transaction, but buyers often are expected to make an equity contribution of approximately 10 percent of the total project cost. In some situations, a portion of that contribution may come from a seller note if it meets SBA requirements. In other cases, lenders may require additional cash from the borrower. The key takeaway is that lenders generally want to see that the buyer has meaningful financial commitment to the transaction. A borrower who has invested personal funds demonstrates confidence in the business and shares risk with the lender.
Why does the SBA lender need so much information?
This is perhaps the most common frustration among borrowers. Lenders are not simply evaluating the business. They are evaluating the buyer, the management team, the industry, the historical financial performance of the company, projected future performance, and numerous legal and operational issues. Expect requests for tax returns, bank statements, financial statements, résumés, personal financial information, business projections, organizational documents, leases, licenses, and copies of transaction documents. Starting off with a business attorney experienced in SBA rules and regulations can help you feel more comfortable with the process and help structure the deal so it remains SBA-compliant.
What are personal guarantees on SBA loans and why do they matter?
Most SBA loans require personal guarantees from owners with significant ownership interests. A personal guarantee means that if the business cannot repay the loan, the lender may pursue the individual guarantor’s personal assets to satisfy the debt. Many first-time buyers are surprised by this requirement, but lenders view personal guarantees as evidence that the owners are fully committed to the success of the business. Before signing, you should carefully review the guarantee obligations with your attorney, so you can understand the associated risks.
What collateral does the lender care about?
Contrary to popular belief, SBA business acquisition loans are primarily cash-flow loans. Lenders care deeply about whether the business generates enough income to make loan payments. That said, collateral still matters. The lender may take a security interest in business assets, including equipment, inventory, accounts receivable, and other company property. Depending on the circumstances, the lender may also evaluate available personal assets. Collateral may not be the primary factor driving approval, but it remains an important part of the lender’s overall risk analysis.
What makes a lender nervous?
Several issues routinely raise concerns during underwriting:
- Declining revenue or profits
- Dependence on a single customer
- Poor bookkeeping or incomplete financial records
- Significant pending litigation
- High employee turnover
- Unrealistic financial projections
- A buyer with limited industry or management experience
Lenders are looking for warning signs that could affect the company’s ability to repay the loan. The more uncertainty involved, the more difficult the approval process may become.
What makes an SBA lender comfortable?
The strongest applications typically share several characteristics:
- Consistent historical earnings
- Reliable financial records
- Diversified customer relationships
- Experienced management
- Reasonable growth projections
- Adequate working capital
- Buyers who understand the industry and can explain their business plan
A lender wants to feel confident that the business can continue operating successfully after the transition in ownership.
What should I do before I apply?
Preparation can make a tremendous difference. Before beginning the loan process, gather financial records, review your personal credit profile, organize corporate documents, and work with experienced advisors. Your attorney, accountant, lender, and transaction team should be communicating early in the process to avoid costly delays. Most importantly, be prepared to answer difficult questions about the business, your experience, and your future plans. The more organized and transparent you are, the smoother the process is likely to be.
SBA loans are powerful tools that help entrepreneurs buy and grow businesses every day. Understanding how lenders evaluate opportunities (and preparing accordingly) can significantly improve your chances of obtaining financing and reaching the closing table successfully.
Legal disclaimer: This article is for general informational purposes only and does not constitute legal advice. Readers should consult with a qualified attorney regarding their specific circumstances.
CORRIE THRASHER is the founder of Thrasher Law and provides ongoing legal counsel to business owners and executive teams who value consistent, senior-level judgment in business operations, growth, and complex transactions. Visit thrasherlegal.com.
