SBA loans involving real estate and business purchase?
May 02, 2024
by a searcher from The University of Chicago - Booth School of Business in Chicago, IL, USA
Anyone completed an acquisition using the longer-term SBA loans available if you couple in the real estate with the purchase want to share how that's worked out for them? Besides the basics of extending the amortization table, have there been any hidden advantages or risks of going this model? Perhaps a deal where the real estate did better than the business or where unexpected real estate issues were more negatively consequential than the business?
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
1) Typically speaking if you can get all of the debt on a 25-year amortization, unless the business acquisition is really small compared to the real estate purchase, you will typically see a reasonable cash flow savings doing all of the debt in the SBA 7A loan product versus using an SBA 504 loan for the real estate. If you can do a blended amortization, depending on the amount of debt associated with the real estate with more debt associated with the real estate the better, you will typically see a cash flow savings of 5 to 20% versus doing a separate SBA 7A loan for the business purchase and the real estate.
2) The SBA 504 option is a good option for the real estate, but it can be very hard to get a lender to do the real estate in the SBA 504 option and also fund the business in the SBA 7A option unless they need to do it that way due to SBA limits (which I will discuss in my next point). Often times the SBA 7A lender wants to lend on the real estate as well because is strengthens their collateral position on the transaction, so it can be hard to separate the deals out unless there is a good reason to do so. Many SBA 7A lenders only do SBA 7A and do not do SBA 504 lending, so that will limit your lender options as well.
3) Every dollar you borrow on an SBA 7A loan counts against your $5 million SBA guarantee limit. However, when you do an SBA 504 loan the Bank funds up to 90% of the total cost up front and then the SBA 504 takes out up to 40% of the loan with the SBA 504 loan. Only that 40% piece the SBA takes out goes against your SBA limit. So if you have a total deal size that goes above $5 million, you could potentially stay at or below the $5 million SBA guarantee limit by splitting the deal up between SBA 7A and SBA 504.
4) When you do an SBA 504 loan at the same time you do a business acquisition, the SBA 504 lender cannot advance more than 85% of the purchase price. The SBA 504 portion of the loan under a change of ownership is a maximum of 35%. So you need 5% more equity on the transaction when doing a change of ownership if you are purchasing the business at the same time you are purchasing the real estate, and that can go up to 10% more equity if the property is deemed special-use, because then the SBA 504 will only fund 30% of the cost. However, if you buy the business and sign a lease for the real estate with an option to purchase it, and then you look to acquire the real estate at a later date (usually a minimum of six months out), the 90% financing will be available to you again.
5) You can do a SBA 504 loan for a guarantee amount less than 40%. Let's say you have eaten up most of your SBA guarantee limit on the business purchase and the real estate is more expensive. So long as you can get a Bank lender comfortable using a lower SBA 504 loan, you could have the SBA 504 guarantee a smaller percentage of the loan than 40%. Typically most SBA 504 lenders want to do at least a $100,000 loan, but if you can get a bank lender comfortable with the end LTV they will be at on their first mortgage (usually 75% or less), you could have the SBA 504 fund a lessor percentage under their guarantee.
6) If you are doing a stock purchase of the business or a partial business acquisition, which requires you to buy the stock or membership interest of the business, then the SBA requires the debt related to the business purchase to be amortized out over 10 years. So if you have real estate involved you will almost always want to do it in a separate SBA 7A loan or possibly an SBA 504 loan to secure the 25-year amortization on that piece of the transaction. This was a change that came up with the updated SBA SOP and lenders are hoping the SBA will eventually fix this and allow the blended amortization on stock purchases, but right now it is not allowed.
7) When you do an SBA 7A loan you can use a seller note as part of your required equity in the transaction. That seller note can also count as part of your required equity for the real estate portion of the purchase. However, when you do an SBA 504 loan there are different rules for any seller debt being used as part of your equity requiring that debt to largely match the terms of the SBA 504 loan. In addition, the Bank that is providing that SBA 504 loan needs to be comfortable with using seller debt. So it is much harder to use seller debt when buying real estate in an SBA 504 transaction.
8) The prepayment penalties on SBA 7A loans that are over 10 years are 3% of the loan in Year 1, 2% of the loan in Year 2, and 1% of the Loan in Year 3 if you prepay 20% or more of the loan in any given year. After Year 3 there is no longer a prepayment penalty. On a SBA 504 loan the Bank can do whatever type of penalty (within reason) on the Bank portion of the SBA 504 loan. Typically we see a declining prepayment penalty or refinance penalty of 5%, 4%, 3%, 2%, or 1% over the first five years of the loan term. The prepayment penalty on the SBA 504 portion of the loan is the interest rate in Year 1, 90% of the interest rate in Year 2, 80% in Year 3, and so on until after Year 10 you have no more prepayment penalty. This penalty kicks in on any prepayment of the loan, even extra principal payments. So you do not want to do an SBA 504 if you are not sure you will hold the real estate long term. If you want to make any extra principal payments, you want to make them to the first mortgage. You can refinance the first mortgage in the future and the SBA will re-subordinate the SBA 504 piece to the new Bank lender who will be in the first position on the loan. You will just have to pay for the documentation to make that happen, which is not that expensive.
9) Lastly, I think the biggest risk of combining the real estate and the business into an SBA 7A loan is the slower amortization you get on the business portion of the debt. That can make it harder to refinance the debt at a later debt into something more conventional. However, you can now do both SBA 504 and SBA 7A refinances. So some lenders will do an SBA 7A refinance into a better product once you have proved performance and the transaction risk is gone. But if you are hoping to get to more conventional financing you will likely either need to pay down debt over time or build additional value in the business and additional assets in the business because conventional lenders typically like to be fully collateralized by business assets (real estate, A/R, inventory, equipment, etc. at normalized bank advance rates) and do not like to lend on goodwill value.
I hope this information is of help. If you have any additional questions please do not hesitate to reach out to me at any time here or directly at redacted
from University of Baltimore in Timonium, MD 21093, USA
Otherwise banks were very interested and term sheets issued.