SBA pro tips for searchers....

searcher profile

July 16, 2019

by a searcher from Northwestern University - Kellogg School of Management in Los Gatos, CA, USA

Based on the post activity, it seems like there's a lot of interest in SBA loans across a number of the posts on here. I went through the SBA process in late 2016/early 2017 and closed on a loan to acquire The Wright Gardner in early###-###-#### I find myself regularly talking to other search entrepreneurs and imparting my advice on the process, and decided to write down some of my tips and biggest learnings from going through the process..

I'll caveat this post with the fact that there are people on this site who know way more than I do about SBA loans. I've done exactly one in my life, so if you are one of those people, please correct any false, misleading, or only partly true statements made here in the comments and I'll adjust the post!

First some pros/cons of using SBA loans


Pros

-10 year term is better than you'll get anywhere. Best I've heard of anyone doing on regular commercial term loan is 7Y.

-the interest rates are quite good for a business acquisition loan given the risks. Right now we're at 7.75% with a floating rate. I know someone who just closed a fixed rate at 6.95%. I heard of someone recently closing on a fixed rate in the low 5s..

-re-amortization amidst de-levering - if you have surplus cash and want to de-lever, you can throw a pile of cash at the loan and the lender will re-amortize it, which will cut your payments, freeing up cash flow for other purposes. That's nice financial optimization flexibility to have


Cons
-They tie up any real estate to your name - I had to pledge every real estate asset to my name as collateral securing the SBA loan. This creates some nausea and ongoing maintenance work like re-submitting proof of insurance every year

-You must personally guarantee the loan, and so will anyone else holding title on the collateral (in my case, my wife)

-Eliminates or complicates many structuring possibilities. For example, sellers must exit the equity completely. It's possible to structure around this on the back-end, but it's kind of cheating. The SBA rules require a full transfer of equity to the buyer and don't allow for the seller to retain an interest. This forecloses some potentially favorable structuring mechanisms such as earn outs and other equity retainer mechanisms for the seller. Also, SBA is particularly not friendly to joint acquirers or equity structures where more than one partner owns >15% interest. You can structure around that by creating an acquisition structure )ex. 85/15) that differs from your holding structure (ex. 50/50). Again, this is kind of cheating, but can be done when the equity partners really trust each other! 


Some Suggestions for Applying for and getting an SBA loan approved and funded

-Have a clean bank account to fund from (ideally with money sitting idle and no transactions for several months before close). This will eliminate or greatly reduce last minute underwriting drama

-Set a conservative timeline, then work to beat it by a lot, and you might close on time
-Get your real estate story figured out. The requirements around real estate are tough, even for businesses where location is mostly irrelevant. You want your leases priced at market rates, even if you are leasing back property from the current owner. If they're willing to offer below market rent on a property they own, you're probably better off reworking seller note terms (balance, term, interest rate) to create cash flow equivalence to vs. under-market rent

-If SBA is central to your financing strategy and you have real estate assets that will serve as collateral, it's probably in your best interest to open a HELOC account on any assets to get each asset to a combined LTV of 80 or 90% well in advance of starting the SBA process. It's close to a no regrets move. HELOC will have better rates and terms than SBA. The financial flexibility of HELOC is very helpful to have once you operate. I've heard of people getting 10y interest-only HELOCs at prime-200 that convert to a 30Y amortizing mortgage at term with a fixed margin above prime. The only downside to this strategy is that the SBA lender will assume full draw-down on any open HELOC, even if it's actually un-drawn because SBA is junior to the HELOC, The SBA underwriter will then assume a repayment schedule on that full draw-down as part of your personal underwriting ratio calculations. In short, it makes you look more indebted than you are and will increase the amount of income SBA will assume you need, which can stress the loan's coverage ratios, potentially reducing the amount of leverage you can put on your deal. But, of course, you can use the HELOC funds to play with the SBA loan amount.

-Get someone knowledgeable about SBA to review your application before it goes in (if possible) - they'll spot potential hangups

Best of luck and happy searching!

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The best way to connect with me is to join my ETA network at operators.mn.co

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commentor profile
Reply by a lender
from Michigan State University in Newport Beach, CA, USA
Hi Nirav. Whether it's you or a partner, somebody has to have outside income to support the new HELOC payments. However, there is somewhat of a workaround, but it takes time. In concept, if you draw the funds now and put them into your account, once the funds sit there for a few months, they are now "seasoned". When the lender asks for your last few months of bank statements, some months down the road, it looks like the money is just yours and has been sitting there. This is ultimately up to the lenders due diligence, and theoretically, if they want to dig and look back on the line of credit and see when it was drawn, it could raise some additional questions, but if they don't dig that deeply, I've seen this method work where it doesn't look like you used the line for the down payment.
commentor profile
Reply by a lender
from California State University, Sacramento in Seattle, WA, USA
Nick, It's been great keeping in touch with you. Kudos to you on the majority of the overview...you're not after my 'day job' are you? : ) Speaking with SBA Lending experts that are searchfund friendly (very important) early on is key as Nick mentions. You'll want advise/ideas pre IOI/LOI. Nick points out some of the SBA PROS and some of the sticking points. SBA Lenders competent in Searchfund can give you structure ideas that other lenders aren't aware of that allow you to play within the spirit and the intent of the SBA program; discussing ways to work with/around the nuances of the searchfund 'gotchas' from the get-go. redacted ###-###-####
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