Getting an SBA Loan: The 5 C’s

In order to get an SBA-backed loan to purchase an existing business, there are many pieces of the puzzle that need to fit just right. The business needs to qualify. The lender will want to see strong provable financials, and they will need to verify that the business has enough cashflow to cover the debt, as well as pay the owner a salary. Once the business gets the thumbs up, then the buyer will also need to qualify for the loan. There are many aspects of the buyer’s profile that are assessed, and we’ve put together a handful of the most common things lenders look for in a qualified buyer. This information has been gathered through our own transactional experiences, and also from speaking with several of the SBA lenders that we regularly work with. Every bank and lender is different, so the information presented here is intended to be just a general guideline. 

1. Cash Flow

This is the most important element when it comes to the SBA. They want to make sure that the business (or sometimes the private income of the buyer) is enough funds to not only pay the expenses, but also pay the owner a reasonable salary, with enough cash flow left over. This is why we like to get all of the businesses we are listing for sale pre-qualified by an SBA lender first. That way, the bank has already seen the business’s financials, and they can work out if they would be confident lending on it, as well as what the required down payment or equity injection from the buyer would be. 

2. Character

In qualifying the buyer for the loan, the bank will look at their character. Mainly relevant experience in the industry that the business is in, transferrable experience, such as owning a business, and their legal background will be considered. The biggest roadblock we see for buyers qualifying for SBA loans is applicable experience in the industry. We once had a very keen buyer for an HVAC company, but he had no background or experience working in the industry or any related industries, as he had been a massage therapist for the past 15 years. Unfortunately, he wouldn’t qualify for the loan, based on character, and we found him a retail shop in a tourist area, for which his background and experience was less important to the bank. 

3. Credit

The credit requirements for a buyer will vary greatly from lender to lender. Most lenders will want at least a 680+ credit score. Blemishes on their credit report such as a bankruptcy, short sale, or foreclosure will be evaluated from buyer to buyer and will depend on the circumstances of each situation. The debt to income ratio must be below 50%, and the buyer can’t have defaulted on a student loan in the past. 

4. Capacity 

The bank will need to look at the character of the buyer very closely to determine if they have the capacity to run this business. Having experience in the same industry as the business they are attempting to purchase is the ideal situation. Have they owned a business before? What does their business plan look like? Do they present a strong case for being able to successfully run this business and hopefully do well over the next 10 years? Does the buyer carry the required state and/or county license required to operate the business? Those are all questions that an underwriter needs to make a judgment call on, in order to get the loan approved, so they buyer should do everything they can to impress the bank.  

5. Collateral

Collateral is security for the loan as a secondary source of repayment. In most cases, collateral is personal (like a home) or business assets (like equipment). A lien will be placed on the assets for security, in the case of default on the loan. Collateral is most important in a commercial real estate purchase, but it is also required when purchasing a business. Buyers and investors are often surprised when the lender wants them to personally guarantee the loan, so just be aware that this is definitely a component of borrowing money to acquire a business.