Buying a Business With an SBA 7(a) Loan? Here’s What Lenders Look For

Buying an established business lets you acquire something a startup doesn’t have: customers, operating history and cash flow. But financing the purchase presents its own challenges, especially when much of the company’s value is tied to goodwill rather than physical assets. Conventional financing isn’t always available or the right fit. That’s where a Small Business Administration (SBA) 7(a) loan — commonly used to finance ownership changes — can help. 

The time is ripe: Baby boomers are retiring, and many are looking to transition ownership of their businesses. McKinsey estimates that 6 million small and medium-size businesses will come to market by 2035 — and more than 1 million are viable acquisition targets.

If you’re ready to take the leap, here’s what you need to know to prepare a strong SBA 7(a) loan application.

Why an SBA 7(a) Loan Can Help When Buying a Business

A key consideration in any acquisition is goodwill: the intangible value of a business, such as its reputation, brand and customer relationships. Particularly for firms without many physical assets, goodwill can make up much of a business’s value.  

Because these deals carry less traditional collateral, conventional term loans often aren’t the right fit. SBA 7(a) loans offer longer repayment terms, and SBA’s guaranty can give participating lenders greater flexibility to finance acquisitions that may be difficult to structure conventionally. However, the buyer and acquired business still need to demonstrate creditworthiness and a reasonable ability to repay.

What SBA 7(a) Lenders Look for in a Buyer

Because repayment of an SBA 7(a) loan depends on the business’s continued success under new ownership, lenders look closely at the buyer. Be prepared to show:

• Your financial commitment. Show how you’ll contribute cash or other equity toward the purchase. For an acquisition, that generally means at least 10% of the total cost, though the exact amount depends on the transaction, current SBA rules and lender requirements.
• Relevant experience. Direct industry experience or closely translatable skills will signal that you can run the business. Additionally, highlight prior ownership or management experience.
• A transition plan. Show how you’ll take over operations, retain customers and employees, and keep the business running smoothly.
• A history of meeting obligations. Character and credit matter. Lenders review the personal credit histories of any buyers who guarantee the loan.

How SBA Lenders Evaluate Post-Sale Performance Projections for a 7(a) Loan

Lenders also need confidence that the post-sale business can carry the new debt. The SBA requires detailed financial projections built on reasonable assumptions. Lenders use these projections to gauge post-close liquidity — how much cash the business will have after closing.

A few measures matter here:

• Cash flow that comfortably covers the new payments. For standard SBA 7(a) loans, you should demonstrate that your business will have enough cash to cover upcoming expenses as well as the new loan. Your banker can provide a number specific to your business. You’ll likely need solid historical information from the seller, including several years of the business’s monthly cash flow and revenue.
• A healthy ratio of current assets to current liabilities. If the post-close business’s current liabilities exceed its current assets, there’s a risk it can’t cover the coming year’s obligations.
• A working-capital cushion. Lenders want to see that the post-sale business has sufficient cash or accessible funds for fixed operating expenses — usually one to six months’ worth.

How to Structure the Deal to Protect Working Capital

Even a well-qualified buyer can run short on working capital right after closing, when prior revenue may belong to the seller and new customer payments haven’t arrived. Several options can bridge the first 30 to 90 days: 

• SBA Express revolving line of credit: Can provide a cushion for working capital needs, including seasonal fluctuations.
• Seller participation: A seller who stays on as a partial owner or advisor can smooth the handoff and signal confidence in the business’s future.
• Seller-carry note: A seller may also finance part of the purchase price, reducing the loan amount needed. A seller note may be able to count toward your required equity injection if it’s kept on full standby for the loan’s duration and covers no more than 50% of the injection. Standby notes require no payments during the term, keeping more cash in the business after closing.

Ready to Buy a Business? Why Lender Choice Matters

The right lender can help you move quickly once you decide to buy a business. For SBA 7(a) loans, the process may move faster with an SBA Preferred Lender like Western Alliance Bank. SBA Preferred Lenders have authority to make certain approval decisions directly, rather than routing each one through the SBA first, which can help streamline the process. 

Western Alliance pairs personal attention and customized deal structures with the local expertise of a banker who knows your industry, backed by the strength of a national bank.

If you’re considering buying a business, connect with our SBA lending team to talk through how an SBA 7(a) loan can help you get the deal done.