Buying a Business With an SBA Loan: Down Payment Rules

The equity injection is a percentage of total project cost, not of the price on the letter of intent. Project cost typically includes the purchase price, closing and legal costs, any working capital you're financing and sometimes fees rolled into the loan.

For example, say you're buying a business for 1,000,000, with 30,000 of closing costs and 70,000 of working capital in the loan. Project cost is 1,100,000, and a ten percent injection is 110,000, not the 100,000 you'd get from the price alone. Lenders can also ask for more when the business is thinly capitalized, the industry is volatile or the buyer has no experience in the field.

Budget for cash beyond the injection as well. Post-closing reserves, your own living expenses during the first months and any third-party costs the lender doesn't finance all come from somewhere else. A buyer who spends every dollar on the injection has no runway if the first quarter is slow.

The rules on this are specific, and they change. Ask your lender to list what it accepts, using questions like these:

• Cash from your own savings, documented with statements.
• Proceeds from selling personal assets, such as a home or investments, with closing documents.
• Gift funds, if the donor provides a signed gift letter and the lender accepts the source.
• A seller note on full standby, which means no payments on the note for the life of the SBA loan, and which the SBA generally limits to part of the required injection.
• Borrowed money for the injection, which gets extra scrutiny, and lenders often want repayment from income outside the business.

What doesn't count is just as important. A seller note that pays you monthly reduces the business's cash flow and generally can't be counted as your equity. Money you move in from the business you're buying doesn't count either.

A standby note lets the seller finance part of your injection, which shrinks the cash you need on closing day. The trade-off is that the seller waits, potentially for the full loan term, to see that money.

Say the required injection is 110,000 and your lender allows a standby note to cover up to half of it. You'd put in 55,000 in cash, and the seller would carry a 55,000 note that receives no payments while the SBA loan is outstanding. That works only if the seller trusts the business to survive, so expect the conversation to turn on transition support, price and security.

Two cautions. First, because the note doesn't pay during the standby period, sellers often ask for a higher price to compensate, and that can push your DSCR down. Check the coverage math with the SBA 7(a) loan payment calculator before agreeing. Second, put the standby terms in the letter of intent, so the seller isn't surprised when the lender's counsel drafts the subordination agreement.

Lenders trace the source of every dollar, so start early:

1. Gather two to three months of statements for every account holding funds you'll use.
2. Write a one-line explanation for any deposit that isn't payroll or a normal transfer between your own accounts.
3. Keep the documents for asset sales, gifts, or withdrawals from retirement accounts, including tax consequences if you'll owe tax on the withdrawal.
4. Don't move large sums between accounts in the weeks before closing without a paper trail.
5. Hold the earnest money receipt and confirm the lender will credit it toward the injection.

The SBA 7(a) requirements checklist lists the other documents the lender will expect alongside these.

These are the ones that cost buyers time or the deal itself:

• Treating the injection as the only cash you need, then running out of money on closing costs or the first payroll.
• Agreeing to a price the business's cash flow can't support once the SBA loan payment is counted.
• Counting a seller note as equity before the lender confirms it qualifies.
• Overlooking that owners of a significant share of the business are typically asked to sign a personal guarantee; read SBA personal guarantee explained first.
• Waiting until after signing the letter of intent to talk to a lender.

If you're still looking for a target, a marketplace for online and small businesses can widen the search, but the lender's rules on equity, guarantees and valuation apply to any target you find. Check with your lender and an attorney on both the structure and the current SBA requirements.