Getting an SBA loan is like trying to get into the hottest club in town. You spend ages getting ready, even longer queuing, only for the burly guy on the door to close the velvet rope. Everyone wants an SBA loan. With crazy low interest rates and friendly repayment terms, they beat almost every form of financing.
Why are SBA loans so desirable? The SBA underwrites every loan. That means banks, credit unions, and other institutions can take bigger risks on businesses they might never have offered credit. The goal of the SBA is to foster entrepreneurship. Along with lower interest rates and longer repayment terms, you often get advice and support from SBA lenders to help you succeed.
But with strict lending criteria, 100,000s of applicants, and rejection rates of up to 90 percent, you might find you don’t qualify for an SBA loan before putting pen to application. Don’t worry. There are plenty of SBA loan alternatives to obtain the financing you need to acquire a company. Some are easier to get than others, of course, but by the end of this blog, you’ll know which SBA alternative is right for you.
Before we dive into SBA loan alternatives, let me just restate that SBA loans are awesome! If you can apply with a good chance of approval – in other words, you satisfy the SBA’s lending criteria and can prove the business you’re acquiring can repay the loan – go for it. Don’t be put off by the application process. Ask us for help, even. But if your chances look slim, explore the following options.
1. Traditional Bank Loans
Small business banks haven’t always understood the appeal of online businesses. Rapid growth, intangible assets, and diverse business models were risky attributes that frightened them away. They used to prefer brick-and-mortar businesses with long histories, predictable revenue metrics, and tangible assets like property and stock you could collateralize. But an early-stage SaaS business?
Thankfully, the winds of change are blowing. Chase has begun alternative credit assessment by evaluating digital metrics like social media engagement, customer loyalty, and subscription revenue. Likewise, Wells Fargo has begun offering credit products for online businesses with subscription revenue models. Could it be that a traditional bank loan is now a viable alternative to an SBA loan?
In some ways, yes. Applications are typically processed faster and with higher acceptance rates of around 27-50 percent depending on the bank. But bear in mind the SBA doesn’t back these loans, so you’ll need a good credit score and maybe some collateral or a personal guarantee to secure the loan. Interest rates and repayment terms may not be as friendly either. Still, it’s worth considering.
2. Seller Financing
Seller financing is one of the best alternatives to an SBA loan. Instead of borrowing money from a lender, you negotiate a closing payment and then repay the balance, with interest, over time – usually three to five years. In effect, the seller becomes the lender, with the agreement formalized in a promissory note that outlines the repayment schedule and a security agreement giving the seller the right to reclaim the assets if you default on payments.
The biggest advantage of seller financing is time. You needn’t involve institutional lenders and their laborious application processes, nor must you meet their stringent acceptance criteria. The repayment terms can be more flexible too, and the premium you pay for seller financing might even be cheaper than an SBA loan. It all comes down to your relationship with the seller – have you built enough goodwill? Protections like the security agreement can be tricky, time-consuming, or expensive to enforce, especially across borders, so earn the seller’s trust and confidence before asking for financing.
Understandably, sellers worry about getting paid – and on time. You’ll need to demonstrate a strong business plan, a proven track record of success, and in many cases, that you’re creditworthy (which could mean credit scoring). However, every seller is different. Many Acquire.com exits involve a seller financing component, so you stand a good chance of being accepted.
3. Earnouts
If you can’t get an SBA loan, an earnout is another way to bridge the gap between what you can pay now and what the seller wants for the business. Similar to seller financing, you don’t need an institutional lender to finance the deal, so no application process or lending criteria apply. Instead, you agree with the seller to pay a portion of the seller price conditional on the business meeting certain performance goals.
Say a seller wants $2 million for their business. You pay a closing amount of $1.2 million with the remaining $800,000 payable only if the business hits a specific profit or revenue goal. By agreeing to an earnout, the seller puts “skin in the game”, which incentivizes them to stay on for a longer transition to thoroughly prepare you for success. If the business fails to hit that profit goal, the seller doesn’t get paid.
Earnouts are on the rise in M&A, but the seller is unlikely to bet on your success unless they’re confident the business can meet the targets you’ve set it. Be clear and fair around the earnout’s targets and timelines to make it easy for the seller to say yes. To get the seller on board, think of the earnout as a tool for bridging the valuation gap rather than an easy way to score alternative financing.
4. Rollover Equity
Please note: Acquire.com doesn’t natively support partial acquisitions. For help structuring this type of deal, please reach out to our expert M&A team at support@acquire.com.
If you like the seller and want them to have a vested interest in the business post-sale, you could also consider rollover equity instead of an SBA loan. Although not financing as such, it reduces the amount of upfront cash you need to pay. You either acquire a percentage of the company or you pay some portion of the consideration in shares of your company.
In this scenario, you use your available funds to buy a majority stake in the business and the seller retains a minority position in the selling entity, or you grant the seller a position in the new entity or holding company, depending on the corporate structure. In either situation, the seller is afforded the possibility of a windfall via a second exit at some point in the future. You need less upfront cash and the seller benefits from the business’s future success. It’s a win-win, right?
Not always. Rollover deal structures are complex and need additional time for negotiating valuations and equity splits. While it reduces your upfront commitment, you also get less in return. You must split the rewards of your leadership with the former owner. And while you might be the majority stakeholder, disagreements with the seller on the company direction may cause you headaches down the line. That said, when structured properly, this can be a great way to retain the seller’s motivation in the company post-closing and align everyone’s interest in service of a future liquidation event.
Most sellers are looking to sell 100 percent of their company, too. They may be reluctant to postpone their exit and post-acquisition plans for a share of their company’s future profits. Tax complications can also occur. That said, if you and the seller like each other, share visions for the business, and want to work together, a rollover equity deal could be the right alternative to an SBA loan.
5. Alternative Financing (Revenue-Based)
If you’re acquiring a business with recurring revenue, another alternative to an SBA loan is revenue-based financing. Companies like Boopos allow you to borrow cash against future recurring revenue, either for growing a business or acquiring one. Many alternative financing companies that offer revenue-based financing don’t take equity or personal guarantees in return, taking the pressure off you.
The downside? Revenue-based financing is expensive and the application process, while swift and relatively easy, usually has strict acceptance criteria. If you’re acquiring a proven SaaS business with predictable recurring revenues and strong cohorts, you stand a good chance of being approved, but there are no guarantees. Likewise, fintech brands like these can cease lending or change their lending criteria at any time, limiting your options.
Shifting the repayment onus from you to the company you’re acquiring might sound like a smart move. But expect to sacrifice a chunk of future earnings for the privilege. That might be okay if you’re acquiring a business with strong financials, but if margins are slim, you might be better off choosing another SBA loan alternative on this list. For more help, speak to our M&A team.
How to Choose the Right SBA Loan Alternative
You’ve seen the options, now which do you choose? None of these options is perfect and perhaps a mix of seller financing, earnouts, and a bank loan might be your answer. If you’re serious about acquiring a startup and have been denied an SBA loan or don’t qualify for one, sign up and speak to the M&A team. You might find we don’t just pair you with the right financing, but the best startup, too.
The content on this site is not intended to provide legal, financial or M&A advice. It is for information purposes only, and any links provided are for your convenience. Please seek the services of an M&A professional before entering into any M&A transaction. It is not Acquire’s intention to solicit or interfere with any established relationship you may have with any M&A professional.
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