Get accustomed to the lingo of the Small Business Administration (SBA) with the following definitions regarding financing for business acquisition.
The Small Business Administration is a US government agency that supports and protects the interests of small businesses. The SBA acts as a guarantor on bank loans. The SBA does not loan money directly to small business owners but plays an important role for people who want to finance or grow their business. SBA-backed loans are funded by local banks or credit unions and are 75% guaranteed by the SBA.
The SBA 7(a) Loan Guarantee Program is designed to help entrepreneurs start or expand their businesses. The program makes capital available to small businesses through bank and non-bank lending institutions. The Small Business Jobs Act of 2010 increased the maximum size of these loans from $2 million to $5 million. 7(a) loans do not require real estate as collateral, and are uniquely set up to allow asset-light entities to obtain credit.
The SBA defines a small business in a variety of ways. For each industry, the SBA has created a size standard to define “small”. These standards are measure either in revenue or number of employees. To see the size standard for you industry click here.
The Prime Interest Rate is the interest rate charged by banks to their most creditworthy customers. The rate is almost the same among all major banks. The Prime Rate is adjusted at the same time and in correlation to the adjustments of the Federal Funds Rate. The Prime Interest Rate is currently at 4%. SBA 7(a) loan interest rates are capped at 2.75% over Prime.
A loan covenant is a condition in a commercial loan that requires the borrower fulfill certain conditions or that forbids the borrower from undertaking certain actions. The violation of a covenant may result in a default on the loan being declared, penalties being applied, or the loan being called. SBA 7(a) loans are set up so that the bank does not need to apply significant covenants and monitoring to the note, thereby allowing the company to operate with minimal interference.
A personal guaranty is a guaranty requiring the borrower to promise to make good on the loan, even if the business cannot repay. The debt is secured by all personal assets including home equity, savings and investments.
The Debt to Equity Ratio (D/E) is a financial ratio indicating the relative proportion of shareholders’ equity and debt used to finance a company’s assets. The ratio is considered a measurement of risk. The two components are taken from the firm’s balance sheet. The Debt to Equity ratio can be much higher in a 7(a) loan than most conventional loans would allow.
The origination fee is an up-front fee charged by a lender for processing a new loan application, used as compensation for putting the loan in place. Origination fees are quoted as a percentage of the total loan. While lenders may not charge a separate origination fee for 7(a) loans, the SBA covers its losses by charging a 3% origination fee due at closing. This fee may often be financed.
The term of a loan is the length of time permitted for the loan to be repaid. 7(a) loans are generally repaid over 7 to 10 years at the discretion of the lender. There are no prepayment penalties for 7(a) loans.
Over half of our deals have included SBA financing. Throughout our fourteen years, we’ve learned how to navigate the SBA process well. We welcome your questions about the SBA and it’s business acquisition financing. Please contact us here.