Can you use an SBA loan to buy an online business?
Yes, and if that is your goal it will help if you can show the following:
- Good personal credit
- Relevant Experience
- 5% or 10% cash Down Payment – although, it is possible to purchase an e-commerce business with no money down*
- No Recent “Character” issues
- The “right” amount of “post-closing” liquidity
If you have all of the above qualifications then most small business e-commerce lenders will seriously consider your application for an SBA loan for an online business. SBA loans can be used to purchase an existing online business with solid historical cash flow and they are also available to current owners of businesses looking to expand or purchase real estate.
*SBA 7a loans allow the seller of a business to hold the entire required 10% down payment in the form of a “full standby seller note“ in lieu of a down payment. Also, 100% financing is possible for expanding businesses purchasing another business with the same NAICS code.
Credit Score for SBA E-Commerce Business Loan
You need “good” personal credit to get an SBA loan whether you are buying an e-commerce business or not.
The SBA does not require a minimum credit score to get a loan of $350,000 or more, but ultimately it is up to the individual lender as to what score and what type of credit quality they are going to require to get a loan.
Many lenders will tell you that “SBA loans require XYZ credit score,” any many borrowers get discouraged by this, but it is falsehood.
Again, the SBA does not dictate to lenders that borrowers must have a certain credit score, so if you have good credit but your score doesn’t meet a lender’s requirements then keep looking. Do not assume that you cannot qualify even if the representative from the lender makes it sound like the minimum score is an “SBA rule” – because it isn’t.
Fact is, that many lenders actually do have minimum credit score requirements, but the SBA allows lenders to make their own decision on who is credit worthy and who isn’t and there are many lenders who are flexible regarding your credit score.
Generally speaking, the better your credit (and credit score) is, the better the terms you can expect, but it is important to understand that some lenders allow borrowers to qualify with past derogatory credit as long as it can be shown that it is in the past, isolated and unlikely to happen again.
Also, there are some lenders who will offer an SBA loan for borrowers with a bankruptcy if your explanation is satisfactory and the BK is old enough.
Do You Need Experience to Buy An Online Business?
Lenders use common sense with regard to experience.
The last thing they want to do is offer a business purchase loan for an online business to someone who is going to be in over their head.
They want to see that you have some type of experience that lines up well with what your duties will be with the business or that you have a plan or employees with specific knowlege to cover the gaps in your own knowledge.
It also helps if the seller of the business will be available to you for some period ot time. (The SBA allows sellers to “stay on” as a consultant for up to 12 months whether you are buying an online business or one that is brick and mortar).
A good exercise is to ask yourself honestly if you were an underwriter for the lender would you approve a loan for someone with your qualifications/past work/business ownership experience/job history and education (if relevant) and if not, what would it take for you to do so?
I realize this might seem like an unfair question, but it can really help you honestly assess whether or not you are on the right path.
Down Payment for E-Commerce Business Loans
The SBA program that is used to acquire most businesses is the SBA 7a loan. It requires a 10% down payment, which can come from a number of sources.
In fact, ALL of it can be in the form of a note on “full standby” from the seller. (The SBA considers loans on full standby – which means no payments to be made to the seller for 24 months – just like it is cash you are putting towards the down payment).
This is a fairly remarkable and relatively new development (2023) and while risky for lenders, there are many who are allowing it to qualified borrowers.
In addition to seller-held financing, the SBA also allows the following sources for down payment:
- Borrowed funds – as long as you (or your spouse) have another stable source of income with which to repay the borrowed funds.
- Gifts – just know you typically need enough of your own “skin in the game” as well.
- Investors – family or friends whom you give a small percentage of ownership in the business.
- 401k rollover – you can rollover the amount of your 401k funds that came from a former employer and other types of retirement accounts (tax and penalty free).
100% Financing for Online Business Purchase
Aside from getting the seller to hold a full standby note for 24 months, there is another way it is possible to buy an online business with no down payment, although again, this is also something that many lenders will tell you is not possible.
Well, it is.
The key is that the business you are buying must be just like one you currently own – right down to the NAICS code. i.e. you must be expanding an existing business of the same type by acquiring another.
For instance, let’s say you have owned an online business for a few years and you have good credit and good cash flow and you have found another very similar business for sale. There are a (very) few lenders who will offer 100% financing to purchase the other online business.
The transaction has to be a true expansion of your existing business, so basically, if it is obvious that your current business is solid and the business you are looking to buy is in the same industry and has the same NAICS code (and also solid) then it is possible to get an SBA loan for an online business with no down payment.
More and more lenders are open to this.
Please keep in mind that at Green Commercial Capital we specialize in loans for $350K and up. We can sometimes help with smaller transactions but in any case, the info in this post should be helpful for anyone contemplating purchasing an online business.
Cash Flow Requirements for SBA E-Commerce Business Loan
Ideally, the cash flow of a business needs to be “1.15 or better” based on the Net Operating Income (NOI) of the business for the most recent tax year or in some cases – depending on the time of year you are closing – a year to date Profit and Loss.
1.15 is the required Debt Service Coverage Ratio for a business purchase with an SBA loan, which means that the annual net operating income for the business needs to be 1.15 times the amount of the loan payments for the year.
Another way of stating this is to say that the NOI needs to be 115% of the total of the annual loan payments.
Some lenders prefer to see the ratio at 1.25 but 1.15 can be enough if there are enough strengths to the transaction (borrower credit, borrower experience, good trends, etc.).
Net Operating Income is typically calculated as follows:
Bottom line Net Profit plus:
- Salary and Wage income for current owner or employees that new buyer will not have or need
- One time expenses that are not likely to recur
- Any unusual expenses (or bogus expenses) that Seller has been taking. (“Bogus” expenses are technically not addressed in the SBA underwriting manual, but I think you know one when you see one).
It is not unusual for a business to appear as if it is not profitable enough at first glance, but many business do have enough debt service coverage once you account for the above “addbacks.”
Purchasing an UnderPerforming Business
Also, it is not completely out of the question that if you have a particular expertise in a specific industry and you have a solid, cash-flowing business and you find the same type of business that is struggling under it’s current ownership, it might be possible that a lender would allow you to purchase the struggling business if they clearly understand how you plan to turn it around and/or if you can cash flow the full amount of the new loan from the cash flow of your existing business.
SBA 7a Loan Terms for Online Businesses
SBA loans used to finance a business that does not include real estate or heavy duty/long life equipment are limited to a 10 year term.
SBA loans used to finance a business AND real estate can be up to a 25 year term IF more than 50% of the loan proceeds go towards the real estate. The key term is “loan proceeds” as there are situations where the real estate and the goodwill, working capital, equipment & inventory are close in value.
When you have a situation like this, there are a few ways you can structure the transaction in order to take advantage of the longer term and amortization.
How To Get A 25 Year Loan
The first is to assign as much value in the contract to the real estate as possible and hope that it appraises at or close to that.
“Hope” is generally not a great strategy, but appraisers are human and when they see a contract written for a certain price, they will research the comps with that value in mind and if they feel like they can justify it, many of them will make it work. Again, not a guarantee it will come in at the contract price, but maybe it comes in high enough to get you the longer terms.
The second thing you can do is to structure the contract with some seller held financing – either on “full standy” or with terms (or both) – but assign as much of the goodwill/non-real estate to the seller-held funds as possible which allows you to put more of the loan proceeds towards the real estate which can help you get the real estate percentage above 50%. Which, in turn, allows for the 25 year term and amortization.
Rates are the big wild card in all of this as lenders can price their loans however they want.
Most lenders prefer to give borrowers a “Prime Plus” loan that will adjust (or float) with the Prime Rate.
The interest rate on the loan is set at Prime plus a margin – usually somewhere between Prime + 1% and Prime + 2.75%, but there are certainly those that will fix the rate for the entire term of the loan and others who will fix it for 3 or 5 years.
Many borrowers purchasing an e-commerce business end up with a rate at the top of the scale at Prime + 2.75%. This could be because the lender is opportunistic since the higher the rate they sell you, the more money they make or it could be justified for the risk they are taking.
SBA 7a loans can be very profitable for lenders and the combination of high profitability and the SBA Guaranty are what make high risk loans like those for an online business possible. Lenders and bankers are in business to make money. They take a risk with every loan they make and how much they stand to make on a loan influences how much risk they are willing to take – basically, pure capitalism.
So some lenders will offer you the highest rate they think they can get away with since they realize you may not have as many options as say, an uber successful dentist buying a building, but some are also very fair and logical.
Just know that if you end up with a rate that is not worth bragging about that there is an exit strategy because you will typically not have a prepayment penalty.
SBA Prepayment Penalty
Prepayment penalties are a means of discouraging a borrower from paying off a loan early.
The SBA 7a program has no prepayment penalty for loans of 15 years or less and a very reasonable and short penalty for longer term loans.
So, if there is something about the transaction that causes you to end up with a higher interest rate that is not fixed you can take some comfort in knowing you may have the option to refinance at any time.
In either case, you are allowed to pay as much extra principal as you’d like, or pay off or refinance a shorter term loan at any time and even loans longer than 15 years allow you to pay up to 25% of the principal balance in each of the first 3 years.
Also, it should be noted that as of late 2020 the Federal Reserve has said they are not going to touch the Fed Funds Rate until at least 2023 which means that the Prime Rate is unlikely to go up for a while – possibly quite a while – so any new borrowers should also take comfort in the fact that a “floating rate” is unlikely to float (up) for a few years giving you time to refinance the loan, pay it down, etc.
Post Closing Liquidity
Post closing liquidity is basically how much cash you have “post closing.”
You would think there is some type of uniform metric like the “6 months PITI” used in residential mortgage lending but there isn’t, so this is completely a judgement call for a lender and is completely case by case.
In fact, it is safe to say that every application for an SBA loan for an online business is evaluated on a case by case basis, because no two transactions are the same. Sure there are similarities for many transactions of the same type, but no two businesses and no two borrowers are exactly alike, so there is a lot of nuance in underwriting e-commerce businesses.
Some businesses are sold where there is a lot of AR outstanding and some lenders will give you lots of working capital in the loan to make sure you have enough cash to do what you need to do – it really just depends on the transaction.
All things being equal, a lender would prefer that a borrower have a fair amount of cash on hand or at least access to some, but again there is no SBA requirement for this.
FYI: the program being discussed in this post is the SBA 7a loan as that is the SBA loan that can be used to acquire a business. For a full rundown on all SBA 7a loan requirements click here.
Maximum Loan Size for SBA Business Acquisition Loans
You can actually get up to $10 million in “SBA financing” for a business acquisition, but for 99.9% of lenders the maximum SBA 7a loan size and therefore the maximum amount of loan is actually $5 million.
So how do you get to $10 million?
Let me ‘splain.
There are few (again, a very few) SBA lenders who will give you a second loan of up to $5 million behind a $5 million SBA 7a “first” mortgage, BUT they will only do this for the strongest of transactions and they will most likely require some amount of additonal collateral and term life insurance on the borrower.
How do they define “strong?”
Well, it depends.
Obviously, a loan for an online business with excellent cash flow for a borrower with great credit, very relevant experience, no character issues and a good amount of post closing liquidity could very well qualify, but you don’t necessarily need to check all of those boxes.
SBA 7a loans are first and foremost “cash flow” loans, meaning the lender’s foremost concern is the business’s historical cash flow – specifically how strong and stable it is. Ideally, they will want to see at least a few years of revenue and profit with a nice upward trajectory and they will want to fully vet all of the business’s SWOT: strengths, weaknesses, opportunities and threats.
Secondarily, they need to have a level of comfort with the borrower on multiple fronts.
If the online business you are buying has strong, stable cash flow and you as the buyer come up slightly short on some of the other requirements, then you should still have a shot at approval – whether you are buying a business of $500,000, $5 million or north or $10 million.
I do not want to set improper expectations, because the lenders that offer these outsized loans have to be cautious since any loan they put behind an $5 million first will NOT be guaranteed by the SBA, so the lender is taking a lot more risk in spite of the fact that the second is likely to be backstopped by additional collateral provided by the borrower(s), but the fact is – it is possible for the right deal.
A Note About Collateral
Keep in mind that because there is typically less collateral (real estate, long-life equipment) changing hands in an e-commerce business purchase the SBA lender could potentially require liens on property that you own due to the personal guarantee that is required for all 20% or more owners.
There are, however, situations where a lender will not put a lien on a primary residence, for instance, if you have less than 25% equity in your home due to the loan to value of your first mortgage and/or your first mortgage plus any secondary financing you might have. In fact, if you only own a primary residence and you have a home equity line of credit with available credit above 75% of the value of the property then the lender will not put a lien on your property.
They will put liens on any investment properties or second homes.
SBA Loan for Online Business Startup
FYI: A loan for the startup of an online business requires 10% down and can be tougher to get approved, but if you can show all of the above qualities AND provide an extremely detailed business plan with solid projections and make-sense “assumptions” for your projections then it is possible. The more cash (or access to cash) you have over and above the required 10% down the better.
See below for potential sources of cash down payment.
If you would like more info or have any questions re: anything I did not cover re: SBA loans for online businesses, feel free to contact me at jking (at) green commercial capital (dot) com or 1-800-414-5285 or you can visit our website at Green Commercial Capital for more info about the various SBA loan programs.
SBA Cares Act Benefits
(This info is now dated since the Cares Act benefits expired, however, there is an outside chance the SBA could bring them back, so I am leaving this up for now).
If you are looking to buy an online business before September 30, 2021 there are currently some economic stimulus incentives in place that should improve your odds of approval with an SBA lender including:
- the SBA will make the first 3 months of principal and interest payments up to $9000/month (while the money lasts)*
- the SBA has temporarily waived all SBA fees on new loans
- the SBA is giving lenders a 90% guaranty on new loans vs. the typical 75% guaranty.
From a likelihood of approval standpoint, #3 above is actually the most beneficial for borrowers looking to purchase an e-commerce business, because it gives the lender a much stronger safety net for the loan.
Why a 90% SBA Guaranty Can Make a Difference:
- The Small Business Administration essentially provides a type of mortgage insurance for a bank loan.
- On an SBA 7a loan of $350,000 or more the SBA normally guarantees (“insures”) 75% of the loan amount.
- This “normal” SBA Guaranty of 75% gives a lender a level of comfort that if a borrower defaults the SBA will pay them 75% of what is owed on the loan. (Lenders really like this :))
- Due to the recent Economic Stimulus the SBA is providing lenders a 90% guaranty, so in this case, if a borrower defaults the SBA will pay a lender 90% of what is owed on the loan.If a borrower puts down 10% (either themselves or in combination with a seller 2nd/seller “carry” on Full Standby) and the SBA guarantees 90% of the loan then it becomes a very low risk transaction for the lender as long as they underwrite it correctly per SBA rules.
So what does this all mean?
If you are looking at using SBA financing to buy an online business and looking to close before the end of September of 2021 then your odds of approval are much greater now than at any time in recent memory…because this temporary 90% guaranty substantially reduces the risk for the lender making transactions more approveable – especially for a typically “under-collaterallized” transaction like an online business purchase.
*Updated: the SBA was going to pay 6 months of payments, but as of February 17th they are now only going to pay 3 months. There was $3.5 billion in the SBA budget for this as of February 2, 2021
SBA Loan Incentives for 2021: Key Takeaways
SBA lenders have different appetites for various business types and ecommerce businesses are actually not high on the list for the vast majority of SBA banks and lenders, but there are definitely those who are actively lending in the space.
The second round of economic stimulus has presented an incredible opportunity for those looking for an SBA 7a loan to buy an online business in 2021.
The following benefits are in effect until Sept 30th 2021:
- There is NO SBA Loan Guaranty Fee – Borrowers usually pay a fee for the “guaranty/insurance” (similar to a mortgage insurance premium for a home or HUD loan) but this fee is currently waived. It is normally 2.3% to 2.75%, so the fee waiver amounts to savings of anywhere from a few thousand dollars on a small loan to $138,000+ on a $5 million loan.
- The SBA will make your first 6 months of payments up to $9000/month – again while the money lasts, but it should last well into the Summer (hopefully).
- The SBA is providing a 90% guaranty to lenders – this is especially important as the SBA “guarantee” is one of the main reasons that lenders are able to make a loan in the first place. The SBA normally gives a lender a 75% guaranty on a 7a loan but the guaranty has been increased to 90% temporarily which makes the loan much more secure for the lender allowing them to be more likely to approve a loan they might normally percieve as higher risk. Think of the guaranty as an insurance policy on the loan for the lender. If a borrower defaults the SBA will pay them 90% of what is owed on the loan. When you consider that as a borrower you would be coming in with 10% whether the seller helps or not, you can see how a lenders might consider approving a loan they might not normally approve.