Top 5 Things to Know About Terms and Conditions for SBA Loans

Recently, we shared our top 5 tips for navigating SBA financing for acquisitions, including picking the right bank and what to expect during the process.

In this article, we’ll share five things anyone considering acquiring a business should know about terms and conditions for SBA loans. There are certain things the SBA requires and others that they don’t allow. Being realistic about the terms and conditions is a good first step to increase your chances of success with SBA financing.

As always, seek out professionals — financial advisors, attorneys, bankers, and/or M&A advisors — who have expertise in this area when seeking a loan. They can help you work through the kinks and oddities of structuring an SBA deal.

1. Expected Rates and Terms

SBA loans offer interest rates at a maximum of 2.75% over prime. The rate floats for most loans and adjusts quarterly. You can get up to 10 year terms (amortization) for growth capital and/or business acquisitions. Terms are longer for real estate and certain kinds of equipment. Your loan officer should explain how to adjust and/or blend amortization to get the best loan for your situation.

2. Coverage Ratio

Calculate coverage ratio as the sum of debt payments and estimated taxes due, divided by the EBITDA of the business. Banks are generally satisfied with a debt service coverage ratio of 150%. You could go lower in certain circumstances, e.g., if the bank is hungry, you have a lot of collateral, etc. But plan to hit 150% to make life easier.

3. Collateralization

You don’t need to have 100% collateralization of the loan using your business and personal assets. A coverage ratio over 150% can and should make up for your lack of assets to pledge against the loan. We’ve done deals with service businesses with fewer than $500K of assets on the balance sheet that were able to borrow several million dollars of term debt because of the experience of the borrower and their cash flow coverage. That said, every bank is a bit different in what they can do, and collateral matters more to some than others.

4. Buydowns

Buydowns aren’t an option with SBA loans. The SBA wants you to take it all right away or not at all. A one-hundred percent buyout of the owner is required. Whatever amount is owned, you have to buy all of it. An owner can’t go from 50% ownership down to 5% ownership.

5. Balloons and Earnouts

These creative options would be nice, but neither are allowed in SBA lending. The standard operating procedures can be found here (they’re hefty, so find your bifocals). Here’s a secret: inventive ways around these limitations are found all the time. For example, you can use an escalating interest rate on seller financing to incentivize repayment on or prior to a significant increase in rate; this can substitute for a balloon or bullet requirement that is otherwise not allowed.