What goes into getting an SBA term sheet for an acquisition?

After an entrepreneur has reviewed the CIM and had the first pass of questions answered, the next step is often submitting an Letter of Intent (LOI, or “offer”) to the seller of the business. Once an owner receives one, they may counter it and negotiate the key points before deciding whether to accept or reject.

If an offer has been accepted, the listing is considered “under contract.” At this point, normally there are two next steps: 1) begin due diligence and 2) receive a term sheet for any debt financing needed.

Most entrepreneurs we work with at Mainshares use Small Business Administration (SBA) loans as the debt financing on their transactions. In order to get a term sheet for an SBA loan, a buyer will need to work with an SBA 7(a) lender or a loan broker like Heather at Viso.

A term sheet is an important next step for two reasons:

1. It shows the owner and her broker that you are capable of financing the deal and have a path towards receiving 70-90% of the funds.

2. It helps you avoid going down a rabbit hole of time and costs only to find the SBA lenders will not underwrite the deal because of a specific issue (e.g., customer concentration, license issues, etc).

What Is Needed to Get a Term Sheet for an SBA Loan?

First and foremost, a buyer needs to be acquiring a business that meets SBA requirements. For example, the business needs to operate in the US, be able to cash flow enough to pay down the loan with profits from the business, and be creditworthy.

More importantly, the business can’t be a business that the SBA deems ineligible. Examples of ineligible businesses include:

• Non-profit businesses

• Gas stations and car dealerships

• Speculative businesses (such as oil wildcatting)

For an extensive list of ineligible businesses, please visit the Code of Federal Regulation.

Aside from those quick knockout criteria, there are specific needs from the buyer, acquisition target, and deal itself.

From the Buyer:

The buyer needs to provide SBA Form 413 to the SBA lender. Theis is the buyer’s personal financial statement. In addition, the buyer needs to provide the past 3 years of federal income tax returns.

Additionally, the buyer needs to provide SBA Form 1919. The form is the borrower information form and details the structure of the acquiring business, the purpose of the loan, key personnel, etc. 

For an exhaustive list of all forms that a typical SBA lender may require, please review the most up-to-date checklist the SBA created for potential borrowers.

From the Acquisition Target:

The target (the business that the buyer is wanting to purchase), must provide year-to-date financial statements and the past 3 years of tax returns, including M-1 and M-2 schedules.

The M-1 schedule is meant to bridge the gap between the businesses accounting records and the businesses tax return that was filed with the IRS. The gap is created due to differences in financial accounting and tax accounting.

The M-2 schedule reconciles the beginning balance of retained earnings to the end of year balance of retained earnings. The reconciliation is done to show the lender what profits are retained in the business. Moreover, the reconciliation helps bridge the gap between taxable and non-taxable income.

From the Deal:

The deal should be “under contract” at this point, which will allow the buyer to provide the countersigned Letter of Intent to the bank.

For a buyer to increase its chance of getting an SBA Term sheet, the buyer should provide a business plan. After countless interactions with bank executives and bank lenders, a business plan is crucial to securing financing, in this case a term sheet, because it provides the bank a reason to lend to the buyer.

If applicable, it would be beneficial for the buyer to provide documentation related to seller financing and any planned equity financing from investors.

How long does it take to get an SBA Term Sheet?

The length of time to get an SBA term sheet is dependent on the buyer’s situation and the lender’s underwriting time. For example, a buyer could get an SBA term sheet in as little as ten days; however, it is completely probable that it could take 1-2 weeks to get an SBA term sheet.

What are the Common Terms in a Balance Sheet?

Highlighted below are the most common sections in an SBA 7(a) term sheet for entrepreneurs looking to acquire a business.

Rates and Fees

• Interest Rate: The lender often defaults to a floating interest rate, which is based on prime. Some may given the buyer an option to have a fixed interest rate. In either case, there are maximums to the interest rate that an SBA Lender can charge. 

• SBA Guarantee Fee: The fee is used to cover the government’s cost when a borrower fails to repay its loan. The buyer ends up paying the SBA Guarantee fee. From an economic perspective, this makes sense since the buyer is the one benefiting from the SBA’s program. Below is how the SBA Guarantee fee is calculated:

  • For loans with a maturity that exceeds 12 months:

    • Loans of $1,000,000 or less: 0.00%. 

    • Loans of $1,000,001 to $2,000,000: 1.45% of the guaranteed portion of the loan up to and including $1,000,000, plus 1.70% of the guaranteed portion of the loan over $1,000,000. 

    • Loans of $2,000,001 and greater: 3.50% of the guaranteed portion of the loan up to and including $1,000,000, plus 3.75% of the guaranteed portion of the loan over $1,000,000. 

  • For loans with a maturity of 12 months or less: 

    • Loans of $1,000,000 or less: 0.00%. 

    • Loans $1,000,001 and greater: 0.25% of the guaranteed portion.

• Closing cost estimate: These costs are servicing costs and any other small fee that the buyer may have to pay. Again, these fees are highly dependent on the buyer’s specific circumstance. For example, if a buyer is purchasing a business with no land or real property than a buyer will not be expected to pay a real estate appraisal fee 

In most deals with SMB investors, the guarantee and closing costs will be rolled into total uses of the deal, meaning the buyer will get credit for paying these as a form of equity.

Payment Terms

• Repayment terms: As a buyer, SBA financing will more than likely be used for the purchase of business; therefore, the repayment term a buyer will typically see is 10 years. Depending on the purpose of the SBA 7(a) loan, the repayment term could be as long as 25 years. It’s common for business acquisitions including real estate to include a longer term.

• Prepayment: If an SBA 7(a) loan has a maturity less than 15 years, then the buyer does not have to worry about a prepayment penalty. However, if the loan matures in 15 or more years, there is a prepayment penalty if the borrower pays more than 25 percent or more of the outstanding loan balance. The prepayment penalty is only applicable for the first 3 years of the loan. The size of the prepayment penalty is dependent on when the prepayment occurs. The prepayment penalty ranges from 5 percent to 1 percent of the amount that was prepaid.

• Earnest money / packaging fee: The packaging fee is paid to the lender because the lender gathers all the loan documents and makes sure the borrower (buyer) has the best chance of loan approval. Earnest money is common with SBA term sheets because it is a financial incentive for the buyer to use that lender when buying the target firm. After all, the lender put in quite a bit of time for the buyer to get the approved SBA term sheet.

Below is an example of the applicable fees in a SBA Term Sheet:

What Comes After a Term Sheet?

Once a term sheet has been signed by the buyer of a business, the bank will begin underwriting the transaction. This involves increasing levels of diligence and will ultimately end in a commitment letter from the bank to fund the loan.

Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.