SBA Loan Basics with Shannon Hay

I’m not a betting person, but if I were, I’d bet that you qualify for a business buying loan backed by the US government. The Small Business Administration, SBA, has loads of great programs for entrepreneurs, including both funding programs and educational programs. Generally speaking, you can qualify for one of these loans with a high 600 credit score. Plus, you don’t qualify based on your current income. You qualify based on the income of the business you’re buying! No other country that I’m aware of offers this type of funding for business buying. Certainly not Canada and not the UK.

I’ve never had an SBA loan, yet, but it is how I plan to fund my next acquisition. My buddy Shannon is an SBA wizard and we recently had a little chat. Okay, it was a lengthy chat because he’s so easy to talk to and it will take a multi part series to share all his incredible insights. You can find Shannon on LinkedIn or I can connect you directly.

Meet Shannon Hay of UMSB

Della: Hey Shannon! Do you want to introduce yourself here briefly and we'll do this kind of officially?

Shannon: Yeah, yeah, of course. Well, thank you. Thank you, Della. So, Shannon Hay, United Midwest Savings Bank. I'm an SBA lender primarily. The title says commercial lender, but I'm really focused on the SBA 7(a) funding program, which is a wonderful program for acquisition debt, right? It's the best way to use bank financing out there.

Della: So how long have you been doing this? I know it's been quite a while.

Shannon: Well, I've been in banking for quite a long time. I started my career in collections. I came from the other side of the tracks where I was collecting debt for a long time and then converted to lending. I've been in SBA lending for a decade.

Della: So you were that mean person that called me and told me…I shouldn’t be having another baby if I was going to be late on my credit card payment?

Shannon: I always, I always got accused of being too nice. I’ve always been a big believer of “You get more bees with honey,” and that communication is the key. So that's where I think I got my sales side, right? Or I was always somewhat salesy in that role. And, and so it transferred really well into serving customers and being a front end guy.

Della: Can you work in all 50 states or do you have a certain territory?

Shannon: I lend in all 50 states. Yep, not restricted in any way, shape or form. We do debt refinances. We'll do commercial real estate as well. But acquisition financing is really what I specialize in.

Della: All right. Tell us all about that because I've actually never had an SBA loan myself. I've been lucky enough to have seller financing deals on the way in and a lot on the way out as well.

SBA Loan Basics

Shannon: Yeah. So, where do we start with an SBA loan? My goodness. Well, the road to an SBA loan is not as complex and complicated as people make it out to be. First and foremost, the greatest benefit of an SBA loan is the term. It's a 10 year term. So when you're making an acquisition of a business, it allows you to take what could be compressed in a seller note or short term loan, and it's extended to a much longer period of time, which then allows you to have an immediate cash flow benefit as the new owner. Hopefully, this allows you to then invest some of that cash flow, and grow that business. Otherwise, shorter terms can be constraining from a cashflow perspective. Rates aren't the most attractive right now with the Fed and where it's at, but they're right around 11%. And they've been there for several months now. Yeah, we got really used to the 6% rates for a really long period of time. But as Fed rates shift, they do, too.

Della: Well, that's what I tell people. We've been spoiled the last few years, until recently, but before that we were like super spoiled with such low rates. I have a couple of mortgages out just because it's practically free money. I'm getting more on my savings account now, than what some of my older mortgages are.

Shannon: Same here. It's like my current mortgage is 3%. I'm getting a high percent interest yield on a savings account at four. So it's like, how do you take that money and pay off that debt? You're making 1% by not paying off that low interest debt.

Della: Exactly. I have a rental property and even that mortgage is a 4.25, I think. So yeah, I'll do that all day because I'm not making that payment, of course. No, the tenants are making the payment.

Prepay, Working Capital, Project Costs

Shannon: But the good news about the SBA is there's no prepayment penalty right? So even with the higher rates, you get down the road and you're able to manage that effectively. You can refinance it or you can just chop it down as quickly as cashflow allows you to. But it does give you the power to have that decision making capacity on when and how quickly the loan is paid off. One thing too that's included in the acquisition costs with every SBA 7(a) is working capital, right? We will think about what your cash burn is going to look like post-acquisition, because a lot of times you're not buying accounts receivable or work in progress. The seller tends to keep that. You're going to need something to bridge that gap in the first 45 to 90 days of ownership.

Della: And that's all rolled into that acquisition price?

Shannon: That's correct. It's all rolled into what we call project costs, which would be the actual acquisition debt, plus working capital, plus loan closing costs. There are costs in closing a loan. We can speak to that, but that's an individual project conversation. Some closing costs will be more expensive on a larger loan and they're much less on a smaller loan.

Della: Do the closing costs need to be paid upfront with cash or do they get rolled into the loan or are there options?

Shannon: Generally, we tend to roll it all into the loan, roll it into the project. Then what you need to think of is what is the buyer's responsibility or borrower's responsibility from an injection or down payment perspective, right? So you take the total project costs, minus the down payment and now you end up with what your loan would be. That requirement is the biggest hurdle for most borrowers. For SBA borrowers, there is a 10% down payment requirement or equity injection requirement.

Special Option for Internal (Employee) Buyout

Shannon: The good news is, the SBA has come up with new and creative ways to finance that. The biggest is that now sellers are able to fully participate in that 10%. That's banking lingo for the idea that the sellers can provide the entire 10%.

Della: Help me be layman though. What does this mean exactly?

Shannon: Sure! The seller can take a note for that full 10%, as long as they're willing to put that 10% on a two year standby, meaning that, no payments can be made on that particular 10% for the first 24 months. They can collect interest and that's good for the seller. A buyer could really enter into a situation with no money down.

But, I'm a banker, so I'm always going to throw an asterisk on there and say that it depends, right? The no money down scenario probably is best suited for internal buyouts. For someone that's worked in the business for a period of time and has blood, sweat and tears invested in the business. Then it makes a lot of sense for a seller to say, “I'm just going to pledge that 10% for you because you've cried and sweated with me over the last however long, and I want to do that as a favor.”

Traditional (External) Buyers

Shannon: I'd say banks right now really like what we call the 5&5; 5% buyer cash and 5% seller note on two year standby participation. So we call that the 5&5 or the 5/5 Split. It shows that the borrower or buyer has some skin in the game, right? That they've saved or prepared for this event, buying a business. And then it also gives assurance that the seller is tied into the transition of the business and success of the business going forward. Cause they want to make sure they get their 5% back.

Seller as Business Partner

Della: Since you mentioned the sellers kind of hanging around in some fashion or another here, what about continued seller ownership?

Shannon: Yeah. So that's a new rule within the SBA. Just last year, they passed a law that allows for a seller to retain ownership in the business. The negative part of that is it does require the transaction to be a stock sale. But as long as it's under 20%, right, 19% or less, the seller would not have to guarantee the portion they're retaining. So they can then cash out equity all the way up to that 81 % before they would actually have to guarantee the buyer’s loan.

If they were to keep more, they're going to have to be a co-signer on that acquisition loan. Every owner, every owner with 20% or greater equity on an SBA note must guarantee, must personally guarantee that loan. That personal guarantee now draws in a lot of other factors, right, or variables that that owner needs to consider.

For one, loans greater than a half million dollars, if an owner has more than 25% equity in their personal real estate, they will have to pledge that for the loan. That's a big factor right now because there's so much equity in our homes.

Della: Yeah, prices have jumped a lot recently.

Buyers with Home Equity

Shannon: Right. And so a lot of people have more than 25% equity in their homes, and it gets captured in those transactions of more than half a million. Loans less than a half million don't have to necessarily look at that as collateral.

Della: How small of an acquisition loan can you do since we kind of hit the bottom end here in the conversation?

Shannon: Yeah, no, of course I am limited to $150,000 individually, right? I can't do a loan less than $150K but I do have a team in Panama City, Florida that does take loans less than 150K. The hard part with small acquisitions is they tend to break in cashflow, right? Because you have to think about the individual buyer. Usually, they're buying a job, and they're leaving a job, right? And that job paid them something. And so we want this new job that they're buying to pay them something too.

A lot of times that gets compressed in those deals that are less than 250K, unless it's a really strong net operating margin type of business.

Della: Absolutely! I’m all about buying a J-O-B, a small owner operated business because I know it’s the best way into entrepreneurship. But the whole point of buying a business is to create financial freedom for yourself and your family. You have to buy at least your current salary, plus some cushion, because you don’t really want to go backwards, in most cases.

There’s loads more SBA convo coming your way in the next episode of my chat with Shannon. In the meantime, reach out to either one us or check out SBA.gov