Succeeding in Your Business: How you can use SBA financing to buy a business or franchise

Cliff Ennico

“I have been thinking about buying a franchise. I was going to roll over some money from a 401(k) I have with a former employer, but my spouse isn’t keen on the idea as it’s our only retirement money.

“I visited a local bank recently and was surprised — actually, shocked — to find they were willing to consider an SBA loan to finance my purchase of the franchise. It looks like a good deal, but I’m sure there’s lots of ‘fine print.’ What are the main things I should look out for?”

An SBA loan (sometimes called a “Section 7” loan) is a bank loan to your business, of which most or all of the principal is guaranteed by the U.S. Small Business Administration. Because of the government guarantee, SBA loans usually bear a lower rate of interest than conventional commercial loans.

If you can get an SBA loan to buy a business or franchise, that’s the way you should go. While you will be tying up some of your assets, it’s a lot less risky than tapping into your retirement funds. Also, the IRS will never hassle you over an SBA loan, though they might challenge a 401(k) rollover.

Having said that, SBA loans can be a pain in the you-know-what. Banks are still somewhat nervous about making these loans unless everything is perfect. Accordingly, the rules for these loans are fairly strict, and you will have to generate a ton of paperwork.

Here’s a quick and dirty checklist of things you will need to do:

Get a good accountant and a good lawyer.

There are lots of things you can do without an accountant or lawyer but buying a business (franchised or not) is not one of them. Your accountant will need to:

• Prepare (and possibly certify) your personal financial statements and tax returns for the bank.

• Review the seller’s financial statements and tax returns.

Your accountant will also need to allocate the purchase price to specific asset categories for tax purposes and prepare IRS Form 8594 for the closing.

Your attorney will need to prepare a purchase and sale agreement with the seller and review all of your lender’s SBA loan documents. Your attorney will also need to deliver an “opinion of borrower’s counsel” to your lender at the closing of your loan, in a form prescribed by the SBA. Your lender won’t close without that opinion.

Ask if the lender participates in the SBA’s “pre-approved” program.

At some banks, getting a commitment letter for an SBA loan does not mean the SBA has agreed to guarantee the principal amount. If your bank participates in the SBA’s “pre-approved lender” program, however, that won’t be a problem: The SBA guarantee will be automatic upon the bank issuing your commitment letter. If your bank does not participate in this program, you should either work with one that does or wait until the SBA issues a separate commitment letter for its guarantee.

Make sure the seller and the franchise will cooperate.

As part of its due diligence, your bank will need information from both your seller and the franchise. Make sure they both are aware you are relying on an SBA loan to finance your purchase of the franchised business. Some SBA lenders will require the seller to postpone payment of a portion of the purchase price (usually 10 percent to 20 percent) for up to 10 years, and the seller won’t like that. If your franchise has never before dealt with SBA financing, be sure to introduce your bank loan officer to someone at the franchise so that they can discuss the process directly.

Do a title search on your house.

While your bank will take a lien on the assets of the franchised business, they will also require a second (or third or fourth) mortgage on your home. Make sure your attorney knows how to obtain title searches and deal with title insurance companies. A defective title, or a lack of sufficient equity in your home, can destroy your chances of getting SBA financing even if the business’ track record is solid.

Get the SBA “third-party” documents upfront.

When you buy the franchised business, both the franchise and other third parties (such as the landlord of the premises where the business is located) will need to consent to the transfer. The SBA has mandated forms for these consents, and these may not be acceptable to the franchise or the landlord. You should get copies of these third-party documents as soon as the bank issues its commitment letter and give your bank loan officer contact information for the franchise’s and landlord’s legal counsel so they can communicate directly and work out any issues.

Give yourself lots of time.

It takes anywhere from four to six weeks to close a business purchase financed by an SBA loan because you are closing three transactions at once:

• The purchase of the business assets.

• The negotiation of your franchise agreement.

• The SBA financing documents.

Either you or your attorney will need to act as an orchestra conductor to make sure all three transactions close smoothly, and at the same time.

Cliff Ennico (crennico@gmail.com) is a syndicated columnist, author and former host of the PBS television series “Money Hunt."

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