At the end of 2019, Baby Boomer business owners were already beginning to retire in record numbers. As with most trends, the COVID-19 pandemic accelerated the number of Baby Boomers exiting the workforce, opening the door for many small businesses to change hands.
However, data shows more than half of business owners do not have a succession plan for transitioning their business. And, most of those in the market to purchase a small business don’t have the cash-on-hand for an outright purchase – or even for a 20% down payment on an established business with a healthy value. Small Business Administration (SBA) loans can form a bridge between business buyers and sellers with an attractive financing solution for both parties.
For Business Sellers: SBA Loans vs. Seller Financing
Some business owners are willing to personally finance some or all of the purchase price of their business. This is referred to seller financing. The business buyer then makes regular payments to the seller with interest.
Though seller financing can be an appealing option, there are also drawbacks that should be considered. With seller financing, a business owner looking to exit will continue to be tied to the business for the term of the financing. If during this time, the new business owner is not successful, there is a risk the seller’s loan will not be repaid. The process of collecting on the debt will fall to the seller, who may then incur additional costs and stress.
A business owner may consider seller financing when the business has intangible assets that make the value higher than the physical assets alone. These intangible assets, referred to as “blue sky” value, are difficult to finance with a traditional loan because they are not considered collateral.
An SBA loan makes it possible to obtain a loan that isn’t fully secured by collateral because the SBA guarantee reduces the lender’s risk. This makes it possible for the seller to receive their full purchase price and transition the business to new ownership immediately.
For Business Buyers: SBA Loans for Aspiring Business Owners
Starting a business from the ground up is not an easy feat, which is why many aspiring entrepreneurs look at purchasing an existing business. The challenge becomes financing the purchase.
Funding options tend to fall into two main categories: Equity financing and debt financing. With equity financing, an investor provides funds in exchange for some ownership in the company. This means they will likely have a say in business decision-making.
Business owners that want to retain full control of their business often turn to debt financing such as a bank loan. Conventional business loans have certain requirements that may pose challenges for a business buyer, such as needing a 20% down payment or to be fully secured with collateral.
In these situations, future business owners find SBA loans to be advantageous for a few important reasons.
- The ability to finance non-tangible assets. An SBA loan doesn’t need to be fully secured with collateral because the lender receives additional protection from an SBA guarantee. This opens the door to finance the value of things like intellectual property, technology, an established customer base, and specialized equipment.
- A lower equity injection. Though the down payment requirements vary by SBA program, a borrower may not need to come to the table with a 20% down payment. The average is around 10%.
- The terms are longer. SBA loans have longer repayment terms than conventional loans, which can lower the monthly payment. This can be particularly helpful during the transition period, when a lower payment can improve cash flow.
- The ability to finance working capital. As the business transitions to new ownership, it can be helpful to have funds available to support business operations in case there are any interruptions in revenue or unplanned expenses. SBA loans allow businesses to finance working capital expenditures.
Whether you are considering the prospect of buying or selling a business, it’s always wise to understand your options. Reach out to the knowledgeable small business lending team at LSB to learn more about whether an SBA loan is the right option for you!