Selling your small business is an enormous undertaking. Plenty goes into ensuring the process goes off without a hitch, from deciding to sell, listing the business, and closing the sale with the right buyer.
The key is to find the right buyer for the company you’ve grown for many years. However, many potential buyers are on the lookout for businesses with good financing options. Full cash purchases are few and far between, with many buyers relying on various options from the seller or third-party investors.
Loans backed by the SBA (Small Business Administration) are one popular solution to financial woes. Small business owners will work to prequalify their businesses for SBA loans to facilitate sales and find more buyers.
Take a look at how a seller can prequalify their business for SBA loans and how that process can help the sale.
Why Sellers Prequalify Their Businesses for SBA Loans?
The common understanding in a purchase, whether it’s a business or home, is that the financing piece is always the buyer's sole responsibility. After all, the buyer is the one that will have to repay the amount they finance or bring cash upfront.
However, when it comes to selling a business, the owner can also get involved with the financing process. Many will ask why it’s a good idea for the business owner to have the business reviewed by the SBA for potential financing. The answer is simple: save time!
Securing an SBA-funded loan can take up to a couple of months in some cases. Getting a head start for potential buyers cuts down on some of the waiting time, helping with a quicker closing.
Aside from the timing, which is the biggest reason to go through the process, prequalifying comes with many benefits.
Benefits of Prequalifying for an SBA Loan
Since the process can take time, many sellers wonder whether it’s worth going through all that hassle. The decision is a personal one, but it can bring benefits to the selling process.
Here are a few to think about:
Understanding financial structure - Sounds simple, but in reality, it gives the seller a head start on understanding the design of the sale. If you discover the business would not qualify for an SBA loan, it will be time to explore other financing structures.
Types of buyers - A business seller will need to explore various types of buyers depending on the approval status for an SBA loan. For example, businesses that don’t qualify for the loan will likely start searching for buyers who can provide a more substantial down payment and secure outside funding.
Asking price - Businesses that qualify for an SBA loan will likely sell for a higher price. Buyers tend to feel more secure purchasing a business that has SBA loan prequalification, understanding that there is enough confidence in the growth of the business to secure such funding.
Faster sale - Sellers who undergo prequalification will attract better buyers faster. The right buyers will come to the table with more attractive offers, ending in a quicker sale.
Control - Securing certain funding ahead of finding the right buyers means you, as the seller, control the process from start to finish. Encouraging buyers to use the financing you secured, especially through the SBA, cuts down on waiting for external funding to come through, which does not always happen.
How to Prequalify the Business for SBA Loans?
Now that you have a clearer understanding of the reasons and benefits behind securing prequalification for SBA loans, it’s time to move on to the process.
You, as the seller, must complete a couple of steps to prequalify for SBA loans. Let’s review them further so you can get started right away.
The Right SBA Lender
The crucial first step is finding the right lender. Don’t be swayed by some of the promises given by all of the different SBA lenders on the market. Focus on lenders who will close a loan quickly without too much fuss.
A seller can begin the process by reviewing the SBA Preferred lender list if a broker isn’t engaged in the process. Of course, working with a broker is the seller or buyer's choice; however, sometimes, reaching out directly to a lender is the right way to go.
Keep in mind, though brokers are a great resource, they do not work with just one lender and might make promises they cannot fulfill; choose one wisely!
Submit Documentation
Applying for any type of funding requires quite a bit of paperwork. A potential lender will want to review the creditworthiness of the individual or business asking for the funds and will need some information to get started.
The same applies to the prequalification process for an SBA loan. Here is some of the documentation you’ll want to gather:
The past three years' worth of Federal Tax Returns
Year-to-date company information in the form of:
Profit and Loss Statement (P&L)
Balance Sheet
Accounts Receivable
Accounts Payable
Broker’s Offering Memorandum - This documentation will contain the asking price and what the sale includes.
The Seller’s Discretionary Earnings calculation for the last three years
Be sure this has all possible add-backs the lender should review with an explanation for anything considered nonstandard.
If possible, any customer concentration information
Lender Next Steps
Once you provide all the necessary information to the potential lender, the ball is in their court. Prequalification approval timing varies from one lender to the next, but most will respond within 48 hours.
The response from the lender comes in the form of a one-page prequalification letter, and it is identified as such. Various disclosures on the form will explain that it is not a formal approval or a commitment on their behalf and that further information and processing are required.
Once the Buyer is Secured
The prequalification has done its job, and a buyer is secured! Of course, since the buyer is taking out the loan rather than the business that worked toward a prequalification, there are certain steps to take before the closing.
Before funds exchange hands, keep in mind some changes might be necessary:
Owner’s draw that is needed for the buyer
Adjust salaries if the buyer will need to replace the owner with a new employee
Adjust the rent expense if the rent will increase after the sale is complete
With these adjustments complete, the rest of the process can proceed.
The broker or business owner will facilitate an introduction between the buyer and the lender providing the prequalification.
When a Letter of Intent (LOI) is written, the document is provided to the lender by the buyer or broker.
The LOI will prompt the lender to reach out to the buyer with clarifying questions concerning their interest in the business and to secure additional details such as experience, credit history, down payments, and others.
The buyer will provide additional documentation to the lender after the initial conversation.
The lender sends a proposal letter if they decide to offer financing. The buyer can review the form and accept it at their discretion, then continue working with the lender to submit a credit file with the loan request submitted to underwriting.
When underwriting is successful, the lender sends a commitment letter to the buyer.
With that, the bank will draft closing documents, funding the transaction within five to seven business days, allowing escrow to close. The buyer will then wire-transfer their deposit to escrow one to two days before the closing, with the bank funding after all documents and the buyer’s wire transfer are completed.
How to Make a Prequalification Successful?
Sellers often wonder the best way to make the process successful - what steps they can take proactively.
There are a few easy things to keep in mind as you start the prequalification journey:
Submit all documentation in one concise, well-labeled file. Make sure to include all information, no matter how minuscule, and ensure the lender knows why it was provided.
Answer any questions promptly to help the lender move the process along. Provide additional documentation if any is requested.
It’s best to explain any nonstandard add-backs used in the Seller’s Discretionary Earnings immediately and where the data was recorded.
Remain as transparent as possible.
Is Prequalification Worth It?
A part of successfully selling a business is timing. Deals tend to fall apart when the sale stagnates, standing still in one spot without moving forward. Buyers have time to change their minds altogether or find another business they are willing to invest in immediately.
Going through the prequalification process with an SBA lender speeds up the sale significantly, making all the difference in the long run. With a prequalification, the seller can help the buyer move forward with the deal without waiting on external funding, which might take a significant amount of time.
Couple a prequalification with the vast potential of worthy clients facilitated through Smobi, and the sale of a business is a done deal. Most small business sales are funded through an SBA-approved lender, making prequalification that much more important.
SBA loans, although common, may not be the best fit for every business acquisition. Look into other financing options in our guide about common financing methods.