What are the Requirements of a Business Acquisition Loan?

business acquisition loan requirementsIn my previous article about financing a business acquisition, I discussed six ways that you could finance a business purchase. In the article, I mentioned that a common way to finance the purchase of a business is to get an acquisition loan through the Small Business Administration (SBA). SBA-guaranteed loans are offered by banks in partnership with the SBA and are designed to help entrepreneurs who need funding.

Although SBA-guaranteed loans are easier to get than conventional bank loans, banks still undertake a thorough underwriting process. As a rule, banks only provide a loan to buy a business that has the assets and cash flow to repay it. Furthermore, banks lend money to only those individuals who have experience in the industry and who have assets. In this article, we discuss the requirements to get an SBA business acquisition loan.

1. Executed letter of intent

You should start researching banks while you are looking for acquisition targets. However, a lender provides you with a term sheet only if you have a signed letter of intent (LOI). Some people see this scenario as a catch-22. They don’t want to look for businesses without a term sheet in place. However, banks don’t want to provide terms unless an LOI is in place. How do you solve this dilemma?

The answer is simple. A well-crafted LOI contains a section advising the seller that the offer is contingent on the buyer finding adequate financing. If they can’t find financing by a certain date, the offer just falls through. This is a common practice.

2. Your credit score

Your credit score is an important part of qualifying for an SBA loan. Solid credit is critical because most lenders (fairly or not) see your personal credit as a proxy for your financial behavior. Guidelines require a minimum score of 650. Obviously, higher is better.

3. Form 413 – Personal financial statement

You can find Form 413 here. This form contains personal financial information about yourself, your partners, and anyone with a minimum of 20% equity ownership of the company. Form 413 is used to determine your creditworthiness and your ability to repay the loan. Remember that the SBA acts as a last-resort guarantee. If things go sideways, banks will first try to collect from you and the business.

This form can look intimidating. Don’t let it intimidate you. The purpose of the SBA is to help individuals get the funds they need.

4. Form 1919 – Borrower information form

You can find Form 1919 here. This form is used to collect information about you and other key individuals/partners who are interested in purchasing the business.

5. Three years of business financial statements

Your application must include three years of business statements for the business you plan to acquire. These statements include Balance Sheets, Profit and Loss statements, and cash flow statements.

6. Three years of corporate and personal tax returns

Your application must include three years of corporate tax returns on the business that you plan to acquire. Additionally, you must also include your personal tax returns and the tax returns of all your partners.

7. Debt schedule

A debt schedule must be submitted with the application. This document lists the seller’s business debts/liabilities.

8. Debt service coverage ratio (DSCR)

To qualify for a business acquisition loan, you must be targeting a business with a DSCR of 1.15. The higher the ratio, the easier it is to get a loan because this ratio reflects the amount of cash that can be used to pay debts, interest, and leases.

9. Management experience

To qualify for a business acquisition loan, either you or (all/some of) your partners must have substantial experience in the industry of the business that you intend to acquire. This requirement is important. Demonstrating your expertise to the lender is key in helping them perceive you as a safer risk.

10. Down payment

Generally, most SBA loans require a 20% down payment. This means that 20% of the purchase price of the business you plan to acquire must come from your assets, your partner assets, or minority investors. The down payment shows the lender that you are committed to the business and that you have “skin in the game.” The down payment can often be reduced to 10% if you can get some seller financing to cover the difference and if the seller is willing to take a two-year standstill on the note.

Conclusion

Find detailed information about business acquisition loan requirements. If you are looking for funding, read this article about getting an acquisition loan.