How to Finance a Small Business Acquisition

September 22, 2022

Adam Hoeksema

According to BizBuySell there are roughly 2,000 to 3,000 small businesses acquired each quarter in the United States.  

number of small businesses sold each quarter

In Q2 of 2022 the median sales price was $315,000.  Most searchers looking to acquire a small business probably don’t have $315,000 in cash laying around to pay cash for an acquisition, and even if they did, it might still make sense to finance at least a portion of the purchase price of the business.  In this article I am going to walk through how to finance a small business acquisition and answer some key questions related to financing options. 

In order to answer some of these questions I am going to be using our Acquisition Financial Projection Template to demonstrate.  With that, let’s dive in! 

Using an SBA Loan for an Acquisition

For most small business acquisitions an SBA - Small Business Administration - loan is a great option to finance an acquisition.  The SBA 7a program is probably the most popular program to finance an acquisition.  For very small acquisitions you might check out the SBA Microloan program which would be even faster and easier for you.   Here are some key things you need to know about using an SBA 7a loan for an acquisition:

  • Maximum SBA 7a Loan Size = $5 million
  • You can finance up to 90% of an acquisition with an SBA loan
  • Minimum equity injection for an SBA loan acquisition is 5%
  • You can use a seller’s note for 5% of the purchase price which means you could finance 95% of the purchase price between SBA and a seller’s note. 
  • The seller’s note would need to be on full standby to the SBA loan
  • The maximum SBA 7a loan term = 25 years
  • You will need to sign a personal guarantee for an SBA 7a loan
  • Your SBA 7a loan will need to be fully collateralized or SBA will require that you pledge all collateral that is available which could include your personal residence. 

Of course you can reach out to your local bank to talk more details, but these are some of the key highlights. 

The SBA recently updated their rules around acquisitions & seller notes. We cover those changes in detail in this video:

How to Get a Business Acquisition Loan

As mentioned above the SBA 7a program is a great way to finance a small business acquisition.  The process to secure an SBA 7a loan is to talk to a local bank that offers SBA loans, or you might want to connect with an SBA lender that specializes in acquisitions like Live Oak Bank

The SBA is not a direct lender, so you can’t reach out to the SBA for a loan directly, you will need to work through a bank that offers SBA loan products.  

You can expect that you will need to have a good credit history, a reasonable about of collateral, and projections that show your business can cash flow.  

SBA Loans for Buying a Business

We put together and analyzed SBA loan data over the last 5 and a half years (2018 - 2023) specifically surrounding SBA loans used to buy a business.  We wanted to share that loan data with you as you consider SBA for financing your acquisition. 

How Many Businesses are Acquired with an SBA Loan Each Year?

There are roughly 5,000 businesses acquired each year in the United States using an SBA loan as part of the acquisition financing.  You can see the annual trends below. 

Top SBA Lenders for Buying a Business

Live Oak Bank is the top SBA Lender for business acquisitions.  Over the last 6 years Live Oak Bank has closed 2,524 SBA 7a loans for acquisitions which is over three times the number of loans of the second ranked SBA lender.

Rank Lender # of Loans Approved Average Loan Amount
1 Live Oak Banking Company 2524 $1,506,710
2 The Huntington National Bank 745 $722,485
3 Celtic Bank Corporation 533 $1,485,950
4 Hanmi Bank 490 $808,823
5 Byline Bank 458 $1,421,590
6 Stearns Bank National Association 442 $450,969
7 Wells Fargo Bank, National Association 425 $736,715
8 Bank of Hope 382 $666,630
9 Umpqua Bank 355 $870,077
10 United Midwest Savings Bank, National Association 354 $1,283,279

Average SBA Loan Amount for Buying a Business

The average SBA loan amount for buying a business has been $1,045,193 over the past 6 years (2018 - 2023).  Although you can borrow up to $5 million through the SBA 7a program, the average loan amount is just over $1 million for business acquisitions. 

Top SBA Lenders by Industry  

Although Live Oak Bank and Huntington Bank top the list in SBA lending with a specific focus on business acquisitions, you will find that some banks specialize in certain industries.  So depending on what industry you are looking to buy a business in, you might want to approach a different lender.  For example, if you are looking to buy a car wash business, Live Oak Bank does not even appear in the top 10 SBA lenders for car wash acquisition loans.  Metro City Bank is the top SBA Lender for car wash acquisitions over the past 6 years.  You can see the top 10 car wash acquisition lenders below:

Rank Lender # of Loans Approved Average Loan Amount
1 Metro City Bank 32 $3,436,578
2 Celtic Bank Corporation 19 $1,586,574
3 Open Bank 12 $2,259,500
4 The Huntington National Bank 11 $707,091
5 Paradise Bank 10 $2,840,200
6 New Millennium Bank 10 $2,387,000
7 Hanmi Bank 8 $2,905,250
8 VelocitySBA, LLC 6 $1,281,500
9 Midwest Regional Bank 6 $768,167
10 Bank of Hope 5 $1,838,000

Does My Business Cash Flow? 

The SBA and any bank lender is going to want to make sure that your business or the business that you propose to acquire can cash flow.  What does it mean to cash flow?  It means that the business should generate enough cash to pay all expenses as well as repay the loan.  We have a free cash flow template that you can download and use to help you determine whether your business ought to be able to cash flow the proposed acquisition loan.  Our Acquisition Financial Model will probably work even better if you have existing financials from the seller that you can use to help forecast your cash flow. You will also be able to forecast your debt service coverage ratio which is what the SBA will use to determine whether you meet the cash flow requirements of a 1.25 DSCR.

What is Goodwill in a Business Acquisition?

Goodwill is the premium that the buyer pays above the book value of the business.  For example, if the business you are acquiring has assets of $1,000,000, liabilities of $500,000 that means it has an equity value of $500,000.  If you pay $750,000 to acquire the business that technically has an equity value of $500,000, that $250,000 premium is considered goodwill.  You can see below that our acquisition financial projection template helps you calculate the goodwill for your business acquisition. 

 

how to calculate goodwill

How to Calculate Goodwill in a Business Acquisition?

As seen in the image above in order to calculate goodwill for a business acquisition you need to take the purchase price minus the net asset value of the business.  

The net asset value of the business is equal to all assets minus all liabilities that will be assumed as part of the acquisition.  As you can see in our template we calculated goodwill as follows:

Fair value of fixed assets acquired

+ Accounts Receivable

+ Inventory

= Total value of assets acquired

- Accounts Payable assumed in acquisition

- Other debts assumed in acquisition

= Value of Net Assets

Then to calculate goodwill we take the following

Purchase Price

- Value of Net Assets

= Goodwill

Can I Finance Goodwill in a Business Acquisition? 

It can be difficult to get a loan to cover the goodwill portion of a business acquisition.  Why?  Because lenders like to have collateral, so if part of the acquisition is to purchase assets that can be used as collateral for a loan it will often be easier to finance that portion of the acquisition, but the goodwill portion by its very nature does not provide the lender with collateral.  You might be able to find a lender that is willing to finance goodwill because you pledge additional personal collateral like a home, but sometimes you will need to find another solution.  One way to finance goodwill in a business acquisition is with a seller’s note. 

What is a Seller’s Note?

A seller note is when a seller agrees to receive some portion of the purchase price of the business through a series of payments.  Often this will be treated as a loan where the seller can earn interest on the portion of the purchase price that is financed with a seller note.  An example would be a $1,000,000 purchase price with an $800,000 SBA loan, a $100,000 equity injection from the new owner and a $100,000 seller note that is paid over an agreed upon term. 

One thing you need to know about SBA loans is that they require seller notes to be on full standby to the SBA loan.

What does it mean for a Seller Note to be on Full Standby?

This means that the buyer can not make any payments on the seller note until the SBA loan is repaid in full.  For example, if you have an SBA loan with a 5 year term, you can’t start to make payments on the seller note until the 5 year SBA loan is paid off.  In our acquisition template you can see how you would enter in a projected 5 year SBA loan and a seller note with payments starting after the term of the SBA loan. 

Should I Use a Seller’s Note in a Business Acquisition?

Of course the seller might want to get paid the full purchase price on the day of the acquisition, but as the buyer it can make a lot of sense to force a portion of the purchase price to be a seller’s note.  Why?  This keeps the seller motivated to help you succeed as the new owner of the business because some of their payout will come later. If you pay the seller in full on the acquisition date, you may never hear from them again even if you need some help in the transition, so keeping at least a small seller’s note can make a lot of sense. 

Learn More: How to Structure a Seller Note and SBA Loan.

How to Acquire Multiple Small Businesses

We have been assuming that you are going to acquire a single small business, but there is a growing trend in the small business world where business owners are implementing a roll up strategy when they will acquire an initial business that is often called the platform company and then roll up additional similar companies through add on acquisitions. An example of a roll up acquisition strategy would be acquiring an HVAC contractor in a major metro area that might be a market leader, and then rolling up smaller HVAC contractors in the same market through bolt on acquisitions to increase market share.

Options for Financing a Small Business Acquisition

Of course an SBA loan and seller note are not the only options for financing an acquisition.  Here are a few more options that you might consider:

As you get into the process of acquiring a business and need a set of financial projections for your lenders or investors, make sure to check out our Acquisition Projection Template which you can also see in action below.

About the Author

Adam is the Co-founder of ProjectionHub which helps entrepreneurs create financial projections for potential investors, lenders and internal business planning. Since 2012, over 50,000 entrepreneurs from around the world have used ProjectionHub to help create financial projections.

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