How much down payment do I need for an SBA 7(a) loan to buy a business?

Ten percent, and on a straight acquisition you cannot negotiate it down. SBA's current rules, in Appendix 15 of SOP 50 10 8.1, set the minimum equity injection for a change of ownership by transaction type.

For an initial acquisition, where you are buying a business you do not already own a part of, the requirement is 10% and SBA states plainly that it cannot be reduced or eliminated.

For a business expansion, an owner buyout, or an ESOP or cooperative transaction, the requirement is also 10%, but the lender may reduce or eliminate it if it determines the borrower has enough liquidity and working capital to sustain operations after the deal. To qualify for that reduction the applicant's balance sheet must not show a negative net worth as of the last fiscal year end.

Ten percent of what

Of total project cost, not the purchase price. SBA defines total project cost as every cost required to become operational, whatever the source of funds, excluding lines of credit and 504 loans. Closing costs and working capital needed to open the doors sit inside that number, so the cash required is usually more than ten percent of the headline price. Owner buyouts are the exception and are measured against the purchase price in the agreement.

Real estate bought alongside the business carries the same equity requirement. Where the deal is split into two loans, the lender allocates the contribution pro rata.

Where the money can come from

SBA splits acceptable sources into two groups.

Unlimited sources can fund the whole injection. These are cash that is not borrowed, whether from the business's balance sheet or elsewhere including a gift; cash from a personal loan to a guarantor where repayment demonstrably comes from somewhere other than the business's cash flow, and a salary the business pays the owner does not count; grants with no clawback or conditional repayment during the term of the loan; and eligible prepaid expenses the lender has verified against paid invoices, canceled checks or bank statements. Money spent on education, advisory services or fees paid to an agent is not an eligible prepaid expense and is not equity.

Limited sources can supply no more than half the required injection, individually or combined.

Can a seller note count?

Yes, on one condition that buyers routinely underestimate. Seller debt counts as equity only if it is subordinated to the lender and on full standby, meaning no payments of principal or interest for the entire term of the 7(a) loan. Not a deferral for a year, not interest-only. Nothing, for the life of the loan.

The same rule covers other standby debt: full standby, documented on SBA Form 155 or the lender's equivalent, with the note attached and the standby creditor subordinating its lien rights. A provider of standby debt may not take an equity stake in the business. Interest may accrue and be paid after the 7(a) loan is retired.

Seller debt put in place with the acquisition becomes eligible to be refinanced once it has been in place and current for 36 months.

Because a standby seller note is a limited source, it cannot cover more than half the injection on its own. On a 10% requirement, that means at least half the equity has to be real money from an unlimited source.

Considering a business purchase? BankableDeal can help review the earnings, add backs, and working capital behind the deal.