Using an SBA Loan to Acquire A Business During COVID
Thanks to a provision of the CARES Act, borrowers who use Small Business Administration 7(a) loans to acquire a business prior to September 27 2020 may borrow up to $5 million in a low-cost loan to fund an acquisition AND have the government cover (not defer) the first six months of principal AND interest on the loan. This program is driving increased interest in M&A activity in the smaller side of the market. But like anything that sounds too good to be true, this program will likely only work in a limited set of circumstances.
Here are some details:
- What type of business can be acquired with a 7(a) loan under this program? SBA 7(a) loans are cash flow loans, that are issued by a participating SBA lender, and guaranteed up to 75% by the SBA. The business to acquired must be profitable, must have a debt-service ratio acceptable to the lender, must have less than 500 employees, and cannot generally have annual revenues over $25 million. In addition, most SBA lenders will want to see either no impact to the business from COVID, or demonstrated strong post-COVID recovery.
- Can a corporate acquirer obtain a 7(a) loan to acquire a smaller company? Yes. An individual or a corporate acquirer can obtain a 7(a) loan. However every 7(a) loan requires a personal guarantee, which may be unappealing for some corporate borrowers.
- What is the term on a 7(a) loan? SBA 7(a) loans typically have ten year terms, but they can be shorter. Assuming the debt service levels can be met, the term can be shortened (thereby maximizing the principal payments in the first six months.) There is no prepayment penalty on the loan.
- Which banks issue 7(a) loans? Any bank that is an SBA lender can issue a 7(a) loan, but given the timing involved, it likely makes sense to use a preferred SBA lender. Preferred SBA lenders have more experience and autonomy, and do not need to obtain direct approval from the SBA for each loan.
- What is the typical interest rate on an SBA 7(a) loan? Rates vary depending on the size, term, and borrower; and may be negotiable. An SBA 7(a) loan over $50K with a term of less than seven years starts at 2.25% plus prime annual interest rate.
- How long does it take to obtain an SBA 7(a) loan? This is where things get tricky. Only loans closed by September 27 2020 qualify for six months of principal and interest covered by the government. Plan for at least 45-60 days to get a loan closed. Most banks require a signed LOI to begin the loan closing process. This makes the program a likely option for transactions that are currently underway, or that are very simple and easy to navigate and where an LOI can be signed by end of July.
Our takeaway – the ability to get six months of principal and interest covered could be a great opportunity in a limited set of circumstances, benefiting both buyers and sellers in a transaction. But even without that feature, SBA 7(a) loans are still the best and one of the cheapest ways to finance a lower middle-market acquisition, assuming you’re open a personal guarantee.
Email us at firstname.lastname@example.org with questions on this program, or any aspect of buying or selling a business.
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