From Application to Approval: The 3 Must-Have Components for a Winning Business Loan Structure
In the world of business sales, brokers play a crucial role in guiding buyers through the process of acquiring a new business. At Playbook Advisory, we have been brokering business sales for the past 9 years and have seen a common trend among our buyers – almost 100% of them have purchased at least one real estate property, usually their primary residence. This experience proves to be helpful as these buyers move on to the financing stage of buying a business.
As a former mortgage broker, I understand the importance of educating buyers on their options for structuring a business loan. In my experience, financing a business is similar to purchasing a home and buyers need to be made aware of this. By instilling confidence in them, we make the process smoother and increase the chances of a successful transaction with their business acquisition lender.
The majority of businesses sold at Playbook Advisory are financed using a combination of three key components – a bank loan, the buyer's down-payment or equity injection, and a secondary loan from the seller, also known as a "Seller Note." This combination provides a flexible and well-rounded approach to financing a business purchase.
Let's delve deeper into these three components of structuring a business sale.
Bank Loan A bank loan is typically the primary source of financing for a business purchase and is usually an SBA 7A loan from a local banker. The lender will underwrite the purchase and assess the cash flow generated by the underlying business being purchased to determine if it is sufficient to cover the loan payments. The loan amount will typically be around 75-80% of the purchase price, similar to a home purchase.
For the loan to be approved, the cash flow, or Seller's Discretionary Earnings (SDE), must be greater than $150,000. If the SDE is less than $150,000, there are alternative options, which we will explore in a separate article.
It is important to note that terms for SBA 7A loans are competitive, so it pays to shop around and compare offers from 2-3 lenders before making a decision. Obtaining term sheets from each lender will give you a better understanding of the terms and conditions of each loan offer.
2. Buyer's Down-Payment: The buyer is expected to come to the table with a minimum of 10% of the purchase price but ideally, they should have 20% available in savings, retirement plans, IRAs, or real estate equity. Having a working spouse can also be beneficial as their secondary income can support household bills and monthly obligations, such as mortgage payments, school tuition, car payments, and other expenses.
3. Seller Notes: At Playbook Advisory, we encourage buyers to consider using seller financing as part of their business purchase financing strategy. Seller financing, in the form of a "Seller Note," is similar to a home equity line of credit (HELOC) that homeowners commonly use when they put less than 20% down on a home. The banks loan is ahead of the Seller Note which can cause issues with Sellers concerned about getting paid. Finally, there may be standby provision that does not allow the Buyer to make payments on their note until the first loan is paid down substantially or paid off entirely.
When a buyer sends us an initial letter of intent, one of the first things we look for is the amount of seller financing they are requesting. All of our business brokers are used to advising clients that they should be prepared to finance a portion of the deal, as seller financing provides numerous benefits. However, it is not uncommon for sellers to be hesitant about providing financing, as there is a risk of not being paid back. With lenders increasingly requiring full standby (no payments) for up to 5-7 years, sellers may feel nervous about this aspect of the deal.
In conclusion, prospective buyers should start talking with lenders and their business brokers as early as possible regarding their financing plans. By doing so it ensures a smoother process and leads to a successful closing.