I've got a small manufacturing business I'm trying to sell and every buyer that comes along gets sticker shock when I tell them they need 10% cash down for an SBA loan. They act like I'm making it up. Can someone explain the actual reason behind the SBA's 10% rule? Is it just bank paranoia or is there something more?
SBA
Why SBA rules require the buyer to put at least 10% cash down
It's not just bank paranoia, though banks definitely like it. The SBA guarantees a big chunk of the loan, so they want the buyer to have real skin in the game. If someone puts down zero, they can walk away from a bad deal with nothing lost.
Yep. It's about aligning incentives. The SBA's logic is that a buyer who's already dropped 10% cash is way less likely to bail or default. Banks also want to see that the buyer can actually save money, not just talk a good game.
Short answer: the SBA doesn't want to be on the hook for 90% of a loan to somebody with nothing invested. The 10% equity requirement is written into the SOP. It's not negotiable, so your buyers just have to deal with it.
I've sold two businesses and honestly the 10% thing filters out tire kickers fast. The buyers who can't come up with 10% cash are usually the ones who'd run the business into the ground anyway. It's a feature, not a bug.
That's fair. I hadn't thought about it as a filter but it does seem to separate the serious people from the dreamers. Still, I've had buyers with plenty of assets but no liquid cash. They could put up a home equity line or something, right?
Sometimes, but it gets tricky. SBA wants the 10% to be cash or a cash-equivalent, and they scrutinize borrowed funds. If the down payment itself is borrowed, that's a red flag. They watn to see that the buyer can actually save.
It's also about the loan-to-value ratio. If the business is valued at $1M and the buyer puts down $100k, the SBA loan is $900k. That 90% LTV is already high. If they put down less, the risk profile gets worse and the bank might not even approve it.
Exactly. And remember the SBA guarantee is only 75-85% of the loan depending on the program. So the bank is still holding a chunk. They want the buyer to have some real equity so the bank isn't the only one with exposure.
One more thing: the 10% rule also helps prevent over-leverage. If a buyer puts down 10%, they have a cusshion if the business hits a rough patch. If they put down nothing, a small dip in revenue can sink them.
I had a buyer try to use a seller note for the down payment. My broker shut that down immediately. SBA rules say the 10% can't come from the seller. It has to be from the buyer's own funds.
Good to know. So basically, no seller financing for the down payment, no borrowed funds, and it has to be cash. That's a tough pill for some buyers, but I get the logic now.
It's not just SBA either. Most conventional lenders want 10-20% down for an acquisition. The SBA is actually more lenient in some ways because they'll guarantee a higher LTV, but they still want that 10% equity.
If your buyers are struggling, maybe suggest they look at a smaller business or partner with someone. Or they can save longer. The 10% rule isn't going away, so they need to plan for it.
Also, don't forget that the 10% can include closing costs and other fees in some cases? No wait, that's not right. The 10% is strictly equity. Closing costs are on top of that. I've seen buyers get confused about that.