The SBA financing process is severely misunderstood.

I’m going to clear it all up for you today, step-by-step.

Here’s a complete checklist of how to navigate the SBA financing process from a buyer’s perspective.

We’ll cover:

• What each stage of the process looks like
• How you can be best prepared
• The most common roadblocks in securing SBA financing
• The bank’s closing checklist
• …and more

Let’s get into it!

The SBA financing process can be broken down into 3 distinct stages:

• Pre-Underwriting
• Underwriting
• Post-Approval / Loan Closing

Here's what each stage entails, with as much detail as I can fit here:

Stage 1: Pre-Underwriting

The pre-underwriting process starts with a signed Letter of Intent (LOI).

You’ve found a business you want to buy, made an offer, and the seller has tentatively accepted. This is where financing comes in, similar to how a mortgage broker’s work would start only after you’ve identified the specific house you’re going to buy.

Most SBA lenders require a signed LOI to get started working with you. There are some rare exceptions to this, but let’s just assume for now that you need the signed LOI to get a lender involved.

The pre-underwriting process is the process of securing financing proposals from one or more SBA lenders to determine which lender you as the business buyer will ultimately go into underwriting with

The goal of the pre-underwriting process is that you as a business buyer have a complete file that is (1) structured well enough for other parties to understand, (2) SBA eligible, and (3) structured in a way that a bank will finance.

Here are the items you'll need to have ready for the pre-underwriting process:

• Items for the business being purchased:
  • Last 3 years of business tax returns
  • Current year-to-date P&L statement (dated within the last 2 months)
  • Balance Sheet dated as of the same date as the current P&L statement
  • Prior year P&L statement broken out monthly for the SBA lender bank to be able to do a year-to-year financial comparison
• Items for any 20% or more owner of the business buyer group:
  • A completed SBA Personal Financial Statement
  • Last 3 years of personal tax returns
  • Resume(s)
  • Something showing the credit score / recent credit report
    • Banks like to see this when possible before issuing the financing proposal because it mitigates the risk that they issue a term sheet and find out later on that the buyer has poor credit
• Other items you’ll need:
  • A copy of the broker CIM / listing
  • A detailed breakdown of how the broker is calculating seller’s discretionary earnings with a breakdown of what is included in the add-backs for the business
  • A copy of your signed LOI as the buyer
  • Sources of funds and uses of funds model that includes the below information:
• Sources of Funds
  • How much you need for the SBA 7(a) loan amount, what is the anticipated amount of seller financing, buyer and/or investor equity
• Uses of Funds:
  • What is the purchase price of the business, the amount of working capital needed, the anticipated SBA guarantee fee, the expected amount for bank closing costs, and your estimated amount of due diligence costs as the buyer

What makes the pre-underwriting process go well? Here are a few more tips:

Have your deal structured to ensure that the debt service coverage is sufficient and SBA acceptable before you go under LOI. This is an easy item to check, but surprisingly many potential buyers don’t do it before going through the hassle of trying to secure financing!

If you’re not sure, you can always work with an SBA loan consultant or an SBA lender to double check your deal before you go under LOI.

Another tip: Having a well-organized data room that includes all of the above-mentioned items in a way that is easy to navigate for the SBA lender or SBA loan consultant. Do yourself a favor and get everything organized when you start this process!

Here are some specific obstacles that I’ve seen at at this stage of the process:

• Buyer’s deal has not been modeled before the LOI is submitted to ensure that the numbers work
• The buyer has not contemplated what their deal costs will be (M&A attorney, financial due diligence, tax due diligence)
• The buyer has not gone through the deal to do a working capital analysis to determine how much working capital the business needs to operate

Here are some other best practices for the pre-underwriting phase:

• Have a well-organized data room before reaching out to the SBA lender banks and/or SBA loan consultants (with the above-mentioned items)
• Before going under LOI, either ensure that your deal cash flows to the debt service coverage ratio that your SBA lender wants to see, or if you aren’t sure what debt service coverage ratio the deal needs to meet, run your deal by banks directly or by an SBA loan consultant
• Ensure that you know what the working capital need is of the business

If you’ve done a good job preparing and organizing your data during this stage, the second two stages of the financing process will be pretty painless. But if you haven’t, the next two stages will be difficult and your deal will likely fall apart!

So what comes next?

Stage 2: Underwriting

Once you (the business buyer) have obtained financing proposals from the SBA lender banks and decided which one you want to engage on, the next step of the process is underwriting.

Banks will require that you have an acquisition business plan and a 3-year financial projection with detailed assumptions (in addition to the items described in the pre-underwriting section) before you start the underwriting process.

The underwriting process will primarily be you working closely with the underwriter to answer questions about (1) your business plan; (2) why you are the right person to run the business and what transferable skills you as the buyer bring to the deal and (3) the financials of the business, and any other questions they may have.

During the underwriting process, you as the business buyer will also be asked questions about business licensing, how you plan to qualify the business licensing (for example, if you’re buying an HVAC business, is there a master technician that can be the qualifier of the business license)

The best outcome of the underwriting process is that the loan is approved and a commitment letter is issued by the SBA lender bank

Again, if you’ve done your work during the pre-underwriting process, the underwriting process should be fairly straightforward. But if you haven’t, the underwriter will have a million questions (all the info you should have prepared before underwriting) and will likely reject your application!

Stage 3: Post-Approval / Loan Closing

The last step of the SBA loan process is the post-approval/loan closing process. If you’ve made it to this phase of the process, you have come a long way and I congratulate you on making it to this stage

The post-approval closing process is you, the business buyer, working with your team, M&A attorney, business insurance agent, life insurance agent, SBA loan consultant, and anyone else on your deal team to complete the bank’s loan closing checklist

What is on the bank’s loan closing checklist?

The loan closing checklist from the bank is a detailed list of items that is prepared which identifies everything that you as the buyer needs to provide the bank before you can close on your deal. These usually include:

• Purchase Agreement
• Business Insurance Documentation
• Life Insurance Documentation
• Lease Agreement Documentation
• A copy of the lease agreement that will be in place
• Landlord Subordination Agreement
• Down Payment Documentation
• Business Licenses
• Corporate Documentation
• Copies of identification from the buyer and/or investors for the SBA lending institution to be able to complete KYC/CIP

Some of my best practices for buyers to help avoid hiccups during this process:

• When you receive the initial loan closing checklist, determine which items on the list you as the buyer need to complete personally, and which items on the list can be delegated to others (your business insurance agent, life insurance agent, M&A attorney, and otherwise)
• Stay on top of the purchase agreement negotiations: This is one of the workstreams that typically takes the longest. While your attorney and the seller’s attorneys are the ones involved in the purchase agreement documentation, it is your responsibility to ensure that the deal negotiations are moving in a timely manner, and to be the ultimate decision maker when there is an impasse in negotiations
• Stay on top of the landlords and the lease agreement documentation: If you are buying a business that operates out of a leased location, you are going to need to work with the landlord to have a lease drafted that includes a base term with options to renew through the term of the SBA loan. In addition to the lease agreement, there is also a document called a landlord subordination agreement which provides the SBA lender with permission to access the property to liquidate collateral if there is a default
• Tax Clearance Letter / Documentation: Ensure that as early in the process as possible your seller and the seller’s accountant are involved in requesting a tax clearance certificate from the state tax authority (department of revenue or similar) to show that there are not any tax liabilities due to the state tax authorities. This form can typically be found with a quick Google search by typing in “State name + tax clearance letter” if your seller needs help locating it

The SBA financing process can be lengthy and riddled with various aspects that take a lot of time, but being prepared for each step of the process will set you apart from most buyers that come to the acquisition financing process either disorganized or confused.

If you stay on top of all the items I mentioned, and prepare them before someone asks for them, you’ll be ready to secure financing for your business acquisition!

As always, if you have any questions on content in this newsletter, please feel free to reach out to me via email at matthias@pioneercap.com