Cannabis is a Special Case
Because of its status as a controlled substance, any cannabis enterprises that touch the cannabis plant are not eligible for typical loan programs, and are certainly not eligible for SBA loans. If this describes the business you wish to buy, you must either have cash or a private loan in place. Sometimes, creative solutions to this problem are possible. For example, a buyer can hold real estate and equipment and lease those assets back to a separate operating company. This provides a way for the buyer to extract (a reasonable amount of) cash from the operating company without touching the cannabis itself. Your state’s regulatory agency (in Colorado, the Marijuana Enforcement Division) will decide if such a solution counts as ownership or not. They are usually not unreasonable, but they will not tolerate schemes designed to circumvent the law.
Oftentimes the company you wish to buy merely services the cannabis industry (RFID tags, software, equipment, etc.) and therefore is able to qualify for a loan just as any other business would. Information about the SBA is provided below.
SBA Financing Information and Overview
There are several financing options available for buyers.
Conventional financing (non-SBA) varies on the type and size of business, the value and type of assets, the buyer’s background and financial position, and other specifics (customer concentration, management, etc.) of the business. There is no rule of thumb on conventional financing. Smaller businesses will require much higher collateral coverage than larger businesses. Loans based on cash flow typically only apply to businesses with very high EBITDA (in the millions). A Personal Guarantee (PG) will be required on all but very large companies. It is best to have an extended conversation with business bankers from at least three lenders as each lender has their own sweet spots.
For smaller companies with a transaction size generally under $3 million, there are loan programs with the US Small Business Administration (SBA). The SBA enables private lenders to make loans for the purchase of a business that they ordinarily would not make by guaranteeing a portion of the loan proceeds in the event of a default by the borrower. SBA financing is the primary vehicle through which small business acquisitions are financed. The two loan types that are most commonly used are the 7(a) and 504 loans.
The 7(a) loan is the most commonly used type of SBA loan for small business acquistions. Proceeds from a 7(a) loan can be used for nearly any legitimate business purpose including purchasing a business, real estate, debt refinance, business expansions, equipment and working capital. The term of a 7(a) loan is dictated by the use of proceeds but typically runs from seven to ten years. Interest rates are typically variable and are based on a spread (2% to 2 ¾%) over the Prime Rate.
The 504 loan program is intended for real estate and fixed assets. 504 loans are unique in that they provide for lower down payments (as low as 10%) with favorable terms including maturities up to 25 years and attractive interest rates which can be fixed for the life of the loan.
The SBA Process
It can be advantageous to work with a SBA lender that is a “Preferred Lender,” who has the ability to originate, process, and close SBA loans much quicker than their non-Preferred Lenders who do not maintain a PLP designation. Qualifying for a SBA loan is easier than most people expect. The information that your lender will need to review a situation varies from transaction to transaction; however, the typical information needed for a submission are:
- Business Tax Returns for last 3 years (and financial statements if available)
- Year-to-Date Income Statement and Current Balance Sheet
- Schedule of Existing Debt related to the business
- Borrower’s Personal Financial Statement (SBA Form 413)
- Credit Check on the guarantors of the loan
- Borrower’s Resume
- Business Plan, including summary of business and projections
- Asset Listing
You’ll typically get a response from the lender in about a week. If you received a financing proposal, it will outline all of the additional documents required to secure the loan. A summary of the steps for a closing is:
- Review Business
- Negotiate and Execute a Letter of Intent
- Submit Request for Financing
- Due Diligence
- Contract Negotiations, Detailed Documents for Lender
Feel free to call us anytime to talk in greater detail about SBA loans.
A few key items lenders look for on SBA loans:
- Cash Flow means Everything: Business acquisition loans are evaluated based on historical cash flow reported in the business’s financial statements and tax returns. The lender will also evaluate your personal financial situation to determine your personal debt obligations and how much money you need from the business to meet those obligations.
- Experience is Important: The lender is loaning you money, not the business. Your perceived ability to run and grow the business will be assessed. Don’t take this item too lightly.
- Create a Business Plan: A business plan will be required. View this as a healthy process. This will force you to learn the business, determine what needs done differently in the future, and what financial impact those changes you intend to make will have. You may be going back to the owner to ask a lot of questions but once you own the business you may not have time to step back and think through what you want to do differently. A well-written business plan will prove to the lender and owner (and yourself) that you understand the business, competitive environment, employees, products, etc. and are well positioned to take over as the leader of the business.
How much money do I need to buy a business?
There is no exact number. The amount of money you will need as a down payment will depend on the assets of the business, your personal financial situation, and the specifics in your business plan (if you plan on expansion). At a minimum, be prepared to be able to put down at least twenty-percent of the total cost of buying the business but, in many cases, the amount can be thirty-percent or higher.