Using an SBA loan to buy a business

Most acquisitions of businesses under $5 million in the United States are financed with an SBA 7(a) loan. Most first-time buyers learn how the program works from the lender, after they have already agreed a price with the seller. That order is backwards. The rules below decide what you can pay, what you need to bring, and whether the deal funds at all — and every one of them can be checked before you make an offer.

What the 7(a) is, and why lenders use it for acquisitions

A 7(a) loan is made by a bank or non-bank lender, not by the SBA. The SBA guarantees a large share of it — typically 75% on larger loans — against default. That guarantee is what allows the lender to fund a purchase where the main asset is the business's cash flow rather than real estate or equipment they could repossess.

For a business purchase without real estate, the standard term is ten years. If the deal includes the building, the term can extend to 25 years on the real-estate portion. The maximum loan is $5 million. Rates are variable, set at prime plus a spread the lender negotiates within SBA caps; in practice, expect a few points over prime.

The lender's underwriting question is the same every time: after the buyer takes a reasonable salary, does this business produce enough cash to make the loan payments with room to spare? Everything else — your résumé, the seller's add-backs, the appraisal — is evidence for or against that one question.

The equity injection rule

For a change of ownership, the SBA requires the buyer to inject equity of at least 10% of total project cost. Two things about that sentence trip people up.

"Total project cost" is not the purchase price. It includes the price, plus working capital, plus closing costs, plus any capex the lender agrees to finance. On a $1.2M business needing $40,000 of working capital and $25,000 of closing costs, the project cost is $1.265M and the minimum injection is $126,500, not $120,000.

Ten percent is the floor, not the norm. Many lenders want 15% to 20% from a first-time buyer, or from any buyer where the business has customer concentration, thin margins, or a short track record. The 10% figure gets you a conversation; the lender's own credit policy decides the number.

Where the injection can come from

Savings, a retirement rollover (a ROBS structure, which has its own rules), a home equity line, a gift with a signed letter, or an investor taking equity. What it cannot be is borrowed money you are personally repaying — the lender will ask for the source, and they will check.

How a seller note counts

Under current SBA rules, a seller note can satisfy part of the equity injection, with two conditions. It must be on full standby for the entire term of the SBA loan — the seller receives no principal or interest until the SBA loan is paid off. And it can cover at most half of the required injection. So on a $126,500 requirement, a standby seller note could contribute up to $63,250, and you bring the rest in cash.

Most sellers will not agree to full standby, because it means waiting ten years for their money. A seller note that pays monthly from year one is still useful — it reduces the SBA loan — but it does not count as your equity. Confirm the current rule with your lender before you build an offer around it; this is the provision that changes most often.

The coverage test the lender runs first

Debt-service coverage ratio, or DSCR, is cash available for debt divided by annual debt service. Cash available for debt is the business's earnings — SDE, normalized — minus the salary you need to live on. That subtraction is the step buyers miss, and it is the whole game.

A worked example

A service business listed at $1,200,000 with $412,000 of stated SDE. You need $95,000 in salary. You put 10% down, the seller carries 10% (paying from year one, so it does not count as injection), the rate is 10.5%, and the guarantee fee is financed.

That funds. Coverage is well above 1.25x and you keep roughly $128,000 a year after salary and debt. The lender will also want to see working capital and closing costs in the project cost, which raises your cash to close to around $220,000 — nearly double the "10% down" a listing implies.

Now suppose diligence strips $100,000 of add-backs the seller overstated, and real SDE is $310,000. Cash available drops to $215,000, coverage drops to 1.14x, and the same deal no longer funds at $1.2M. The maximum price the lender will support falls to roughly $1,075,000. One earnings adjustment moved the price by more than $120,000. This is why the add-backs are reviewed before the offer, not after.

The guarantee fee

The SBA charges a one-time fee on the guaranteed portion of the loan. It scales with loan size — generally between 2% and 3.75% — and the SBA resets the schedule each fiscal year, sometimes waiving it entirely on smaller loans. It is almost always financed into the loan rather than paid at closing, which is why the worked example adds 3% to the loan balance. Ask your lender for the current table; it changes every October.

What the lender will ask for

A complete package is the single biggest determinant of how fast the loan closes. Have these ready before you apply.

• Three years of the business's tax returns and financial statements, plus year-to-date interims. Tax returns, not just the broker's recast.
• A signed letter of intent or purchase agreement with price and terms.
• Your personal financial statement and three years of personal tax returns.
• Documented source of your equity injection — bank statements showing the funds have been in your account, or the rollover or gift paperwork.
• A résumé or narrative showing why you can run this specific business. Industry experience helps; general management experience helps; a transition period with the seller staying on helps most.
• A business plan or projections for the first two years under your ownership. Lenders read this for whether the salary you have assumed is realistic.
• The seller note terms in writing, if there is one, including standby language if it is meant to count as injection.

Timeline

From a complete application to funding, expect 45 to 90 days. Three things stretch it. The seller's financials arrive piecemeal or do not reconcile to the tax returns. The lender orders a business appraisal and it comes in below the purchase price, which reopens the price negotiation. Or the buyer cannot document where the equity came from. All three are avoidable, and none of them are the lender being slow.

Preferred Lender Program (PLP) banks can approve loans in-house without waiting on the SBA, which cuts weeks. Ask any lender you talk to whether they have PLP status for 7(a).

Why deals get declined

In rough order of frequency: coverage below the lender's threshold once the add-backs are normalized; customer concentration above about 20% with a single customer; an appraisal that does not support the price; a buyer with no relevant experience and no transition plan; and equity that cannot be traced. Every one of those is visible before the application if you look. The deal analysis exists because most buyers do not look until the lender does.

Alternatives and combinations

The 7(a) with a seller note is the most common structure and the one above. SBA 504 loans apply when real estate is a large part of the deal, at a fixed rate on the property portion, often paired with a 7(a) for the business. Conventional bank loans are available for larger, asset-heavy businesses with strong collateral, usually at shorter terms. ROBS lets you use retirement funds as equity without early-withdrawal penalties, under strict IRS rules that need a specialist.

For most first acquisitions under $2 million, the 7(a) plus a seller note is where the analysis starts and usually where it ends. One exception: buyers on an E-2 visa generally cannot use SBA financing and need most of the price to be their own capital — a different calculation, covered in E-2 visa requirements when buying a business.