SBA loans – the kings for small business acquisition

Growth and Exit | Financing

TL;DR

SBA loans (Small Business Administration loans) are a better option for acquiring small and medium-sized businesses (SMBs) compared to conventional debt.

https://x.com/Sam_Rosati/status/1867585155126194329

Here's the explanation of Sam's thread with simplified language and insights:

What’s the problem?

When someone wants to buy an SMB, they usually don’t have all the money upfront. They rely on loans to cover most of the cost. The challenge is finding a loan that allows the buyer to keep the majority ownership of the business.

How does an SBA loan work?

SBA loans fund a large percentage of the deal, leaving the buyer (searcher) to contribute only a small equity amount. This setup helps the buyer get a much bigger share of the business as "sweat equity" for managing and running it.

Example with SBA Loan:

• Purchase Price: $3.7M
• Total Cost: $4M (includes extra fees and cash reserves)
• Buyer needs to contribute 15% equity ($600k).
• The remaining 85% is funded by loans:

Here, the buyer (searcher) only puts in $600k but gets 70% ownership of the business because investors receive just 30% of the equity in return for their cash. This is a dream deal for a self-funded buyer.

How does conventional debt compare?

If you go to a regular bank for a loan (conventional debt), they won’t lend as much money as the SBA. Instead of getting 3x the business's earnings (EBITDA), they might lend only 1.5x EBITDA.

Example with Conventional Loan:

• Same Purchase Price: $3.7M
• Total Cost: $4M
• Bank Loan: $1.4M (1.5x EBITDA).
• Now, the buyer must come up with the difference:

Here’s the problem: If the buyer needs to raise more equity, they’ll end up giving away more of the business to investors. The buyer might only keep 30% ownership instead of 70%. That’s because the smaller loan forces them to bring in more investors.

Why is this a big deal?

The SBA loan's higher leverage (loan amount) allows buyers to keep more ownership, even if they don’t have much money upfront. Without the SBA loan:

• The buyer has to give up more ownership to investors.
• They lose control of the business and their potential profit.

Can you work around this?

If a conventional loan is your only option, you could:

• Negotiate a bigger seller note (the seller finances part of the deal).
• Use an earn-out, where part of the payment is tied to future performance.

But these strategies still don’t match the flexibility and leverage of SBA loans.

The Key Takeaway:

• SBA Loans: Ideal for SMB buyers who want maximum ownership and control. They allow buyers to borrow more (up to 3x EBITDA) with a smaller equity check.
• Conventional Loans Require more equity upfront, leading to less ownership and control for the buyer.

In short, SBA loans are a secret weapon for small business buyers who want to stay in the driver’s seat.

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