How to Purchase an eCommerce Store With an SBA Loan
It's never been easier to purchase an already-existing, profitable online business. Especially with interest rates being as low as they currently are, using an SBA 7(a) loan to fund the purchase of an online business is an extremely attractive option.
On most acquisitions, the monthly loan payments are easily covered by the monthly profits of the business, with quite a bit of profit left over to put into your pocket each month (see this example below). And you don't need a lot of cash for a down payment either; you can usually buy an online business for just 10% down (15% for larger 7-figure acquisitions).
This article provides an overview of SBA 7(a) loans and how you can use them to acquire an online business, as well as answering the most common questions potential buyers (and sellers) have about SBA-loan-financed business sales.
I've Heard That SBA Loans Are Tricky for eCommerce Acquisitions... Is That True?
For far too many years, SBA lenders were not very well equipped to deal with web-based businesses and had a hard time getting SBA loans for "digital" businesses approved. Happily, that era is over and safely in the rear-view mirror.
Most mainstream SBA lenders (i.e. Chase, Wells Fargo, Bank of America, etc.) now have loan officers who are quite experienced processing loans for digital / online businesses, and more importantly, there are also several SBA lenders who 100% specialize in online / eCommerce SBA loans. These specialized SBA lenders do eCommerce loans all day every day and have become very proficient at getting eCommerce SBA loans processed and approved.
What is an SBA 7(a) Loan?
An SBA 7(a) loan is a government-backed loan available to small businesses -- including new start-up businesses -- in the United States.
SBA stands for Small Business Administration, which is an agency of the United States government. The SBA is not a lender itself; it doesn't issue loans or serve as a bank. Rather, the SBA 1) helps "connect" small businesses and lenders, and 2) guarantees loans to small businesses so that the lenders have less risk. Lower risk for lenders means lower interest rates for you (the borrower), and more importantly, it makes lenders much more likely to approve the loan in the first place.
SBA 7(a) loans can be for up to $5 million. While there is no set minimum, most SBA lenders don't find it worth their time to process loans for less than $300,000 to $400,000 (it varies from lender to lender).
Are Sellers Okay with Buyers Using an SBA Loan?
The vast majority of sellers are completely fine with the buyer funding their purchase through an SBA loan. From the seller's point of view, it doesn't really matter where the money comes from... a dollar is a dollar, regardless of the source.
The only real downside for the seller is that SBA loans typically take 45-60 days to close, which is a bit longer of a closing period than most sellers prefer. But this slight negative is more than offset by the fact that, with an SBA loan, the seller will typically walk away with 85-100% of the purchase price at closing. This is very appealing for large ($300k+) business acquisitions, where other offers may only provide 50-80% cash at closing (with the remainder of the purchase price paid through a seller note over 2-3 or even 4-5 years).
What Are the Qualifications for an SBA Loan?
In short, 1) you (the borrower) need to qualify for the loan, and 2) the business you are acquiring needs to qualify. Let's talk a bit more about each.
First, YOU need to qualify for the SBA loan. The key criteria are:
- You need to be operating for profit (meaning you can't be a non-profit or other not-for-profit type of entity)
- You need to do business in the United States
- You need to have reasonable "owner equity" to invest (i.e. 10-15% down)
- You need to have exhausted other financial resources before seeking an SBA loan
In addition to these requirements, lenders will also consider your credit score and credit history, your business experience and resume, any criminal history, and your personal history and assets. While having personal or business asset(s) to pledge as collateral will of course strengthen your loan application, it is very possible (and actually quite common) for SBA 7(a) loans to NOT have any personal assets pledged as collateral since the business and its assets essentially serve as collateral.
It's possible (and advisable) for you to get pre-qualified for an SBA 7(a) loan. This way, when you find an online business you want to buy, you can attach your pre-qualification letter to your offer (i.e. Letter of Intent, or LOI). This will give the seller the assurance that you're eligible to acquire the business and won't be wasting their time.
Secondly, the BUSINESS being acquired needs to qualify for the SBA loan. For the business, the key criteria are:
- The business must be a "small business" (i.e. less than 500 employees)
- The business must be 2+ years old
- The business must have filed at least 2 US tax returns (Schedule C tax returns are okay)
- The business must have a solid revenue and profit trend (i.e. stable or trending upward)
Many of the businesses we sell in the Store Coach Marketplace have already obtained a pre-qualification letter from an eCommerce SBA lender.
What Are the Typical Terms, Fees and Interest Rate for an SBA Loan?
Most SBA 7(a) loans for an online business acquisition have a 10-year term, meaning the purchase price (plus interest and any up-front fees rolled into the loan) are paid through 120 monthly payments. This long pay-back period results in a pretty low monthly payment, making it very feasible to pay the loan payments out of the monthly profits of the business with a decent chunk left over each month to put into your pocket.
- Underwriting fee (varies from bank to bank)
- Guaranty fee (charged on the government-guaranteed portion of the loan only, which is typically 75% of the loan amount - for loans up to $700,000: 3.00%; for loans over $700,000: 3.50% up to $1 million plus 3.75% on the guaranteed portion over $1 million)
- Annual service fee (0.55% annual fee based on the outstanding principal balance when the annual fee is assessed each year)
The underwriting fee and guaranty fee can usually be rolled into the loan so you don't have to pay them up front.
The interest rate varies a bit from lender to lender, but the SBA has set the maximum interest rate lenders can charge for an SBA 7(a) loan at Prime + 2.75%. So, for example, if the Prime rate is 3.75%, the maximum interest rate on an SBA loan would be 6.50% (3.75% + 2.75%).
How Much of a Down Payment is Required?
Most SBA lenders only require a 10% down payment on 6-figure loans and a 15% down payment on loans of $1 million or more. It's also worth noting that, in some cases, the SBA lender is willing to treat a seller note as part of the down payment. For example, if you're buying a business for $500,000 and the seller is willing to accept $450,000 (90%) cash at closing and let you pay the remaining $50,000 (10%) over a 3-year period through a seller note, the SBA lender may be willing to accept a 5% down payment (instead of 10%) and use the $50,000 seller note to satisfy the rest of the down payment.
The key takeaways here are: 1) SBA loans typically only require a 10-15% down payment; and 2) the down payment can, in some instances, be a combination of cash and a seller note.
What is the Maximum "Earnings Multiplier" I Can Offer and Have the SBA Loan Get Approved?
The short answer is really high... probably quite a bit higher than you're even willing to pay for the business, meaning that you don't really need to worry about this when making your offer.
Here's the long answer...
The asking price for most online businesses is usually based on an annual earnings multiplier (i.e. 2.25x, 3.00x or 3.50x the net profit over the last 12 months). So, for example, a business that generated $100,000 of net profit over the past 12 months might be listed for $225,000 (2.25 x $100,000) or $300,000 (3.00 x $100,000) or $350,000 (3.50 x $100,000). Most online businesses sell for 1.7 to 5.0x their annual net profit, as discussed here.
But banks (lenders) don't really look at (or care about) the earnings multiplier. The lender is primarily concerned with cash flow and, more specifically, whether the monthly cash flow from the business will be sufficient to cover your monthly loan payment (with a decent amount of cushion in case profitability wanes or unexpected expenses arise).
This is measured by the Debt Service Coverage Ratio (DSCR), which is the primary metric SBA lenders use. The DSCR is simply the average monthly net profit (cash flow) of the business divided by the monthly loan payment.
Most SBA lenders like to see a DSCR of at least 1.25 (the higher, the better). So, using the above example of a business netting $100,000 per year (which is $8,333 per month), SBA lenders would want to see the monthly loan payment be no higher than $6,666 (which is the monthly net profit of $8,333 divided by the minimum DSCR of 1.25).
What does this mean in terms of an annual earnings multiplier (since that's how online businesses are usually bought and sold)? Well, it depends on several things, including a) the term of the loan, b) the interest rate at the time the loan is issued, c) how much of a down payment is paid and/or seller note is carried, d) whether any additional amount is borrowed to purchase the business' existing inventory/equipment or for post-acquisition working capital, and e) whether loan fees are rolled into the loan.
For illustration purposes, let's make the following assumptions about this hypothetical acquisition of a business netting $100,000 per year...
- The SBA 7(a) loan has a 10-year term
- The interest rate is 6.50% (Prime of 3.75% + 2.75%)
- The buyer pays 10% down
- The purchase price includes an additional $50,000 for inventory / equipment being acquired from the seller
- The buyer wants to borrow an additional $20,000 for post-acquisition working capital
- The buyer rolls 100% of the underwriting fee (which we'll assume is 2% of the loan amount) and the guaranty fee into the loan
The following table shows what the purchase price, monthly loan payment, monthly cash flow after the loan payment, and Debt Service Coverage Ratio (DSCR) would be at various annual earnings multipliers using the above assumptions...
|Annual Earnings Multiplier||Purchase Price (Including Inventory)||Monthly Loan Payment||Monthly Cash Flow After Loan Payment||Debt Service Coverage Ratio (DSCR)|
As you can see, even if you paid a 5.0x multiple for the business (very high), and even with the assumptions that a) you paid an extra $50,000 for inventory, b) borrowed an extra $20,000 for post-acquisition working capital, and c) rolled all of the loan fees into the loan, the DSCR is still above the 1.25 minimum ratio most SBA lenders look for.
The earnings multiplier will more commonly be around 2.5 to 4.0, and many online business acquisitions won't have any inventory or equipment or require any working capital. Thus, you can see that the DSCR for a web-based business acquisition is typically well above the required 1.25 minimum.
We've created a handy DSCR calculator (which you're free to make a copy of) so you can run various "what-if" scenarios and see what your loan payment, cash flow after loan payment and DSCR would be based on your inputs.
How Do I Get Pre-Qualified For an SBA Loan?
We have several SBA lenders (most of whom specialize in eCommerce / digital businesses) we've worked with in the past and who we highly recommend. These lenders have asked us to gather a few pieces of information from potential buyers before giving you their contact information. Please complete the simple no-obligation form below to tell us a little bit about yourself and what type of business you're interested in acquiring, and we'll be happy to connect you with one or more SBA lenders.
Disclaimer: While deemed to be accurate as of the date this article was published, the information on this page is not intended to be used as legal or tax advice. Use this information at your own risk. We advise you to consult your attorney and accountant regarding the legal and tax implications of financing the purchase of a business with an SBA 7(a) loan.