Summary: Business acquisition loans backed by the Small Business Administration (SBA), typically through the 7(a) program, have the simplest qualification requirements. Unfortunately, this has led to misconceptions.

Qualifying for these loans is easier than qualifying for conventional acquisition loans. However, they are not easy to get. Lenders evaluate these opportunities carefully to ensure they meet the underwriters and the SBA's qualification criteria.

This article discusses the requirements to qualify for an SBA 7(a) loan. This includes the information buyers must provide about themselves, the opportunity, and the financing structure.

A Quick Word on SBA Loans

The term "SBA Loan" is a bit of a misnomer because the SBA does not lend money directly. Rather, it provides certain guarantees to financial institutions, who, in turn, make loans. The lender itself makes the business acquisition loan and takes some of the risk.

This detail is important because each lender's requirements are likely to differ. Just because a lender declined your transaction does not necessarily mean another lender won't take.

Business Acquisition Loan Requirements

Lenders participating in the SBA loan program usually consider the following criteria when evaluating a potential borrower:

1. Reasonable personal credit

To get a business loan, the borrower (or some of the borrowers if a group is seeking a loan) must have decent personal credit. Most institutions will work with credit scores from 650 to 690.

2. Signed letter of intent

The transaction must have reached the point where you have made an offer through a signed Letter of Intent (LOI). A well-written LOI typically states the proposed acquisition and financing terms.

The letter of intent is essential to evaluate the transaction. Lenders need it to craft a term sheet and typically ask for a copy early in the application process. They can't create a term sheet without it. Consequently, there are no exceptions to this requirement.

This requirement is often viewed as a potential catch-22 by buyers. Buyers don't want to make an offer to the seller until they have qualified for funding. And, lending institutions are unable to provide terms until they examine the letter of intent.

The solution is simple. A well-crafted letter of intent should contain a clause stating that the offer is contingent on getting financing. This clause is common in business acquisitions and gives the buyer a reasonable time frame to find financing. Given the importance of the LOI, buyers should consider retaining a qualified attorney to help craft it.

Note: Lenders do not provide prequalification letters per se. Opportunities get prequalified only after the initial underwriting.

3. Borrower information form (Form 1919)

This form is used to collect information about the principal(s), key individuals in the business, and guarantors, along with information about any current or past government financing. You can find the form here.

4. Personal financial statement (Form 413)

The personal financial statement contains all relevant financial information about you, your business partners, each owner with more than 20% equity, and each guarantor. This form is used to determine your repayment ability and creditworthiness.

Filling out form 413 can be intimidating - don't let it be. Remember that the SBA provides the lender with a guarantee on your behalf specifically to help borrowers who wouldn't otherwise qualify for a loan. You can find the form here.

5. Three years of personal/corporate tax returns

As part of the application package, you need to provide three years of personal tax returns. Additionally, you must provide three years of corporate tax returns on the business that you are looking to acquire.

6. Three years of business financial statements

As part of the application package, you must provide three years of financial statements for the business you plan to acquire. Most banks ask for Profit and Loss Statements, Balance Sheets, and Cash Flow Statements.

7. Debt schedule

As part of the application package, you have to provide a debt schedule that lists all the business's debts/liabilities.

8. Management experience

To qualify for a loan, some (or all) applicants must have substantial business experience. It is better if your experience is in the same industry of the business that you are trying to purchase, but that is not always a requirement. Ultimately, you must prove to the participating lender that you can manage the business you plan to buy and that you are a safe risk.

9. Debt service coverage ratio

The debt service coverage ratio is the ratio of cash that is available to service debt, interest, and lease payments. It's calculated by dividing the Net Operating Income by the Debt Service. The higher the ratio, the easier it is to obtain a loan. At a minimum, the business you plan to buy should have a debt service coverage ratio of 1.15.

10. Down payment

As a rule, SBA lender participants prefer that buyers make a down payment of 20% of the total value of the transaction. Yes, this number is high, but it shows the lender that you are committed to the business.

You can reduce your down-payment requirement if you negotiate sufficient seller financing. However, for this strategy to work, the seller must also be willing to take a two-year standby/standstill. Even if you get seller financing with a standstill, you must be able to provide a minimum down payment of 5%. To learn more, read "What is the cost of buying the business?"

How to get a business loan

If you are looking to acquire a business in the near future, please read our guide on how to get a business acquisition loan. This guide provides all the steps required to finance an acquisition.

Want to finance a business acquisition?

The first step to work with us is to submit this form.  Once we review it, one of our associates will contact you to discuss the specific details of your acquisition.

Editor's note:

This information should not be considered legal or financial advice. Given the complexity of business acquisitions, this document is not guaranteed to be 100% accurate or cover every potential option. However, we make every effort to provide you with the best information. If you have comments, suggestions, or improvements, contact us via LinkedIn.