Here are some tips to use when applying for an SBA loan. Obtaining finance to buy a business is particularly challenging. One of the advantages of buying a business in the United States that very few other countries have to assist with this process is the Small Business Administration or the SBA as it is commonly called. If you have retirement money in a 401(k) plan, this money can be used to move into a corporation and fund the purchase or down payment to buy a business. This option can be combined with an SBA loan. Both of these processes are very formal and deliberate and therefore take time, but if applying for an SBA loan is part of your business acquisition plan, consider the following 5 tips.
1. SBA lenders make their decision to approve a loan from a risk model not an opportunity model. That is, you can have the next best new small business idea in the world but SBA lenders approve loans against cash flow. That is, if the business exists and it has positive cash flow, that’s the first thing a lender wants to see.
2. If you want to use the loan to buy an existing business with a positive cash flow, the banks will understand that the current owner of the business will most likely have non-business expenses sitting on the business profit and loss statement so it reduces the amount of tax the business owner pays. These non-core non-business expenses are called add-backs and to get at the net operating cash flow of the business, they will accept a reasonable number and amount of add backs through a recasting of the financial statements. These add backs must be legal and easy to identify.
3. A recent requirement to the SBA loan application process is that the banks need to obtain an independent third party valuation of the business to support their loan decision process. The valuation must be realistic and defensible, that is, the appraiser needs to explain in their valuation report how they arrived at the final value of the business.
4. If a lender approves an SBA loan and the borrower defaults, the SBA has auditors who look at the loan application and approval process used by the bank. The auditor’s ultimate responsibility is to understand the loan application process and why it was approved and then understands why the borrower defaulted.
5. If the SBA loan auditors are not satisfied the loan application was handled correctly, they can withdraw the ability of the bank to approve SBA loans and be covered by the risk mitigation the SBA provides. If the bank does not have preferred lender status, the bank can be prohibited from applying for presenting loans for approval.
The bottom line is, banks have a lot at stake including not getting it wrong; so be patient with their process as ultimately the person at the bank who approves the loan is responsible. The SBA loan process provides great help to business buyers (and indirectly, business sellers) as it provides a source of funds for entrepreneurs. Over recent years those rules became much more difficult and therefore saw a large drop in the number of loans approved. This is now starting to change but a business must present itself in the best light possible to have any chance of obtaining an SBA loan.
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