What is an SBA 7(a) loan? Definition, terms and example

This is for a first-time buyer who keeps hearing "SBA loan" and wants to know what one is. By the end you will know what an SBA 7(a) loan covers, how long you have to repay it, how much cash you need, and how a lender decides whether the business can carry the debt.

What an SBA 7(a) loan is in plain words

The SBA does not lend you the money. A bank or another approved lender does. The SBA guarantees part of that loan, so if the borrower fails to pay, the government covers a share of the lender's loss. That guarantee is what makes lenders willing to fund a business purchase that would be too risky on its own.

The SBA's 7(a) loans page lists the uses: buying a business, working capital, equipment, real estate and refinancing some debt. The same page gives the maximum loan amount, $5 million. For most buyers of a main street business, the 7(a) loan is the biggest piece of the money.

The terms that matter to a buyer

The SBA page sets out the shape of the loan.

• Maximum amount. $5 million.
• Repayment term. Up to 10 years for a business purchase or working capital, and up to 25 years where the loan funds real estate.
• Interest rate. Set by the lender within limits the SBA publishes. Rates are usually tied to a base rate plus a margin and can be fixed or variable.
• Buyer's cash. On a change of ownership, the SBA's lending rules in its Standard Operating Procedure 50 10 require the buyer to contribute equity. Commonly 10% of the total project cost, and part of it can be a seller note that sits on standby.
• Guarantee and collateral. Owners of 20% or more usually sign a personal guarantee. The lender takes the business assets and may take other collateral.

Read the current SBA pages and ask the lender; the rules are updated from time to time.

An illustrative example

Illustrative example: a $1.5M business purchase funded with an SBA 7(a) loan.

The interest rates are invented for the example; real rates follow the SBA's published limits and the lender's terms. The debt service coverage ratio, or DSCR, is the number lenders care about most. Investopedia's DSCR explainer walks through the arithmetic. Many lenders want to see at least 1.25x, and more cushion is better.

Where it shows up in a deal

The loan shapes the whole purchase. The 10% buyer's cash sets how big a business you can look at: a buyer with $100,000 can often look at businesses up to about $1 million. The term, 10 years, sets the yearly payment, which sets the DSCR, which sets the price a lender will support. A seller note that sits on standby, with no payments for a period, can count toward the buyer's equity under the SBA rules, which is why so many offers include one.

Our guide on how to buy a business walks through the loan in the order a buyer meets it. The roll-up calculator lets you test a price, loan and payment before you call a lender. Acquisitions.com is an advisory firm, not a lender; the loan comes from a third-party SBA lender.

Common mistakes

• Shopping for a business before a lender. A lender's pre-screen tells you your price range in a week.
• Counting the seller note as free. It is debt with payments, even if they start later.
• Using the broker's SDE. The lender rebuilds earnings from tax returns. If the returns show less, the loan is smaller.
• Forgetting closing costs and working capital. The SBA guarantee fee, legal and a cash cushion all need funding.
• Leaving the DSCR thin. A 1.26x ratio leaves no room for a bad quarter.