As you know, SBA loans can often be the best way to go in order to finance your business acquisition. Through SBA financing, you can get deals funded with limited collateral…deals that would often be rejected by banks using traditional financing. That’s the good news.
But along with SBA financing comes a rigid set of rules, including your requirement to come up with cash out of pocket to cover your “equity injection”. SBA did make some improvements to their rules which we detailed here, SBA Lending Update Improvement Equity Requirements. We also explained a strategy where you can use 401k money as your equity injection here Using A 401k As A Down Payment On A Business. But what if you just plain don’t have the money required? Should you give up? We don’t think so, and here’s another possible solution.
THE GIFT LETTER
This comes into play in a situation where you have a friend, family member, business associate, etc., who has the money available and is willing to help you out. According to SBA banking guidelines, you ARE ALLOWED to use a gift as your equity injection. In order to facilitate that, you would need to provide a “gift letter” to your banker. The gift letter needs to indicate who the “gifter” is, who they are gifting the money to, how much money it is, what the money is for, and state that they are not requiring the money to be paid back. They should also attach 2 months bank statements showing that they, in fact, have the money available to gift. They do not need to actually gift the money at that time, but would obviously need to have it available and gift it prior to closing.
Here is a sample gift letter:
I often like to close with an example for clarity, so here we go:
- Let’s say you find a business making $200,000 per year, and you negotiate a solid buying price of $500,000.
- Your required minimum out of pocket (equity injection) would be 10%, which is $50,000.
- First you would negotiate with the seller to carry half of that in the form of a seller note. This seller note can be considered part of your equity injection as long as it meets to criteria:
- It can’t be more than half of the required equity injection
- It has to be on “standby” until your SBA loan is paid off. Meaning, you can’t pay the seller on this note until you have paid off the bank. You can accrue interest, but just can’t pay it yet.
- You could then accept a gift for the other $25,000.
- The bank would then fund the remaining $450,000 in an SBA loan over either 7 or 10 years.
- If you did a 7 year, this would make your remaining payment roughly $6,600 per month.
- This leaves you with a little over $10,000 per month in extra cash, while the business is working to pay off the bank loan for you.
So, the end result is you are making $120,000 per year (plus any salary that you may be inheriting with the business), while paying the business off, and owning it free and clear in a little over 7 years (after you pay off the seller note also).
I understand that not everyone has someone who can gift them that kind of money, but it’s good to know that the option is available inside of SBA guidelines if you do.
Institute for Business Acquisitions