Complete Guide to SBA Financing to Buy a Business
Buy a Business with as Little as 5% Down | SBA 7(a) Loans Explained
Introduction
Buying a business is one of the most powerful ways to build wealth, but many first-time buyers assume they need millions in the bank to make it happen. The truth is, with SBA 7(a) financing, you can buy a business with as little as 5% down.This guide is for:
•Key employees who want to buy out the boss
•Companies looking to expand in the same industry
•Individuals looking to buy a business
The focus of this article is primarily on employees who want to purchase their employer. This guide breaks down how SBA financing works, what lenders look for, and how to plan to purchase a business.
Understanding the Banking Landscape
The SBA has its own loan policy, which is referred to in government speak as an SOP (Standard Operating Procedure). Each Bank has its own loan policy. The Bank's loan policy cannot be more liberal than the SBA's loan policy; however, it can be more conservative than the SBA's policy. Most banks' loan policies are far more conservative than the SBA's loan policy. A Loan Officer at a very large bank explained it this way: "We are considered too large to fail, so we cannot take the risk." Large banks typically don't want to make small loans to purchase businesses because it takes just as many resources to make a decision on a small loan as on a large loan.
Key Insight: The SBA guarantee is for the bank, not for you, the borrower. The SBA will reimburse between 70 and 90 percent of a bank's loss, yet many banks still won't provide SBA loans to higher-risk borrowers due to portfolio management concerns.
Smaller banks advertise that they provide business lending but tend to focus on commercial real estate rather than business acquisitions. From the bank's perspective, real estate provides recoverable collateral if a loan goes bad, whereas business acquisitions typically have no tangible collateral.
Important: There are only a select few banks whose loan policy mirrors the SBA loan policy. These are the banks we work with. They know who we are and like working with our clients.
What Is SBA 7(a) Financing?
The SBA 7(a) loan program is designed to help individuals buy businesses and companies expand by acquiring businesses.
Key Benefits for Businesses Seeking to Expand:
Independent Valuation Protection
An added buyer benefit is that the SBA lender will hire an independent, outside third party to value the business. This third-party entity has undergone bank scrutiny to be added to the bank's approved vendor list. This is similar to how a bank hires an appraiser before granting a mortgage on a home. The lender wants to ensure the asset supports the loan amount. This protects the buyer from overpaying and ensures the transaction is grounded in fair market value.
SBA Loan for a Partner Buyout
The SBA loan policy does not specify the down payment required to buy out a partner. Our banks will focus on the length of time the person has been a partner (minimum two years documented on the K-1). They will also consider the person's role within the company. An active manager brings credibility; an absentee owner does not.
A business can buy another business
The SBA views these as lower-risk loans because there is a proven management team with a track record of successfully operating a business and managing cash flow. The acquiring company's established banking relationships, accounting systems, and processes support the acquisition and reduce integration risk. Business expansion loans consistently show default rates 40-60% lower than loans to first-time business buyers.
Understanding
SBA Loan Structure
The Business is the Borrower
Business income repays the loan. You provide a personal guarantee and must operate profitably.
Banks Analyze Historical Performance
Three years of tax returns required. Banks focus on proven cash flow, not projections.
Documentation Proves Viability
Significant financial changes require explanation and supporting documentation for approval.
Critical Point: The business is the borrower. Income generated from the business is used to repay the bank. As the owner, it is your responsibility to operate the business profitably. As such, you, the buyer/owner, will provide the bank with a personal guarantee.
The bank will study and analyze the business's HISTORICAL cash flow. Banks do not rely on projections. The bank will use three years of the business's tax returns and other information to make a decision. From the bank's perspective, the tax returns are signed under penalty of perjury. At the same time, business owners often present their businesses in the worst possible light to minimize their tax liability. The banks look at three years of tax returns. If there is a significant change from one year to the next, the bank will request an explanation and documentation to justify the substantial increase in profit.
Real World Example: Engineering & Land Surveying Business
Issue One: An increase in sales and net income just before the company is being sold.
Issue Two: Helping the junior partner who owns 5% of the business purchase the remaining 95% from the senior partner.
Background: In September 2024, the business acquired seven employees from a company that had closed. As a result of this happening late in the year, net income decreased. The company incurred higher payroll and employee benefits, as well as expenses for computers, trucks, and land surveying equipment. Although the employees worked in September, there was only a minor revenue increase on the tax return due to billing and collection timing.
Solution: The company provided monthly financial statements for 2023, 2024, and the year-to-date period through June 2025, which clearly showed an increase in sales, expenses, and net income. As a result, the bank agreed to consider this when determining the business's value.
Outcome: As a result of the junior partner having ownership and being actively involved in the business, our banking partner was willing to provide financing with no additional money down.
Documents Required for aLoan
Important Note: If your projections are more than 10% over historical performance, you, as a buyer, lose credibility unless there is something unusual to justify the increase. The most common example is when a business buys a business that provides different services, and projections are higher due to cross-sale opportunities.
If the buyer is another business, the acquiring business will also need to provide the above information for their company.
Eligibility Requirements
Before applying for an SBA loan, the buyer must be:
*Past defaults on government loans can disqualify a buyer.
When banks evaluate a commercial loan application, they don't just look at the numbers. Their decision hinges on five key factors known as the Five Cs of lending. These principles help lenders assess the risk and viability of lending to a business.
How Much Down Payment Do I Need?
The SBA requires a minimum down payment of 10% of the project cost. The project represents the total amount of money required to acquire the business, encompassing the purchase price of the business, working capital, and closing costs. This down payment can come entirely from the buyer or be split between the buyer and the seller.
Example Structure
•Base purchase price: $1,000,000
• Working capital: $200,000
• Closing costs: $20,000
• Total project cost: $1,220,000
• Buyer down payment: $61,000 (5%)
• Seller standby note: $61,000 (5%)
• SBA loan: $1,098,000 (90%)
• Amount paid at closing to the Seller: $1,098,000 (90%)
Working capital is the amount of money required to operate a business. It ensures the new owner has enough capital for immediate operational needs.
Packaging Your Loan Application
To improve your chances of success, prepare your loan application carefully:
- Credit Report: Review your credit report for errors and understand how your score reflects repayment history
- Financial Statements: Include profit and loss statements, balance sheets, and business tax returns
- Debt Service Coverage: Ensure the business generates enough profit to cover loan payments
- Documentation: Gather articles of incorporation, leases, business licenses, insurance policies, and other essential documents
- Use of Proceeds Statement: Provide a detailed breakdown of how the loan funds will be spent (e.g., acquisition, working capital, equipment)
Your Salary
During the bank's underwriting process, the bank will factor in your salary as a business expense. You will be required to provide a month-by-month projection of the business's anticipated performance, including your salary.
Critical Recommendation: It's highly recommended that you stick close to that projected salary amount during the initial 24 months following the closing. Once you have surpassed the initial 24 months, your chances of success increase dramatically. At that point, you will have a better understanding of the business and its cash flow, allowing you to determine if the business can afford a higher expense.
No Money Down When Expanding in the Same Industry
During the bank's underwriting process, the bank will factor in your salary as a business expense. You will be required to provide a month-by-month projection of the business's anticipated performance, including your salary.If a buyer already owns a business and is acquiring another company within the same focus based on the NAICS (industry) code, the SBA considers it an expansion. No down payment may be required in these cases.
Key Benefits for Businesses Seeking to Expand:
Independent Valuation Protection
An added buyer benefit is that the SBA lender will hire an independent, outside third party to value the business. This third-party entity has undergone bank scrutiny to be added to the bank's approved vendor list. This is similar to how a bank hires an appraiser before granting a mortgage on a home. The lender wants to ensure the asset supports the loan amount. This protects the buyer from overpaying and ensures the transaction is grounded in fair market value.
Your Salary
During the bank's underwriting process, the bank will factor in your salary as a business expense. You will be required to provide a month-by-month projection of the business's anticipated performance, including your salary.
Critical Recommendation: It's highly recommended that you stick close to that projected salary amount during the initial 24 months following the closing. Once you have surpassed the initial 24 months, your chances of success increase dramatically. At that point, you will have a better understanding of the business and its cash flow, allowing you to determine if the business can afford a higher expense.
A business can buy another business
The SBA views these as lower-risk loans because there is a proven management team with a track record of successfully operating a business and managing cash flow. The acquiring company's established banking relationships, accounting systems, and processes support the acquisition and reduce integration risk. Business expansion loans consistently show default rates 40-60% lower than loans to first-time business buyers.
Common Questions
Typically 3-6 months from start to closing.
Usually 5-10% of purchase price, often $100K-$500K depending on firm size.
Our banking relationships and expertise help present the strongest loan applications. We pre-qualify scenarios first.
Ready to Explore Your Options?
The Step-Up Legacy Plan™ isn't right for every situation, but when it fits, it solves the employee ownership challenge elegantly.
Schedule a confidential consultation to discuss your specific situation and determine if this approach can achieve your goals.
