PURCHASING A RESTAURANT WITH A SBA 7A LOAN…OR NOT.
The title of the blog might seem a bit odd. The reason I’ve added “or not” to the title is because contrary to popular belief, using an SBA loan to purchase a business is a somewhat cumbersome process that can take a lot of time and they require a lot of documentation from both the buyer and the seller.
To begin, the purchase of a restaurant (or most any small business) is the purchase of personal, not real property. Even if the sale includes the real property the sale of the business is serviced with an SBA 7a loan and the real property would be serviced with an SBA 504 loan. Today, I’m discussing SBA 7a loan used to purchase the restaurant.
By way of a quick overview, US Small Business Administration (SBA) is a federal agency that guarantees loans made by individual lenders it does not make loans. This is important to know that all SBA 7a loans are not created equal and this is because each individual lending institution that offers SBA 7a loans has different requirement that are made in addition to those mandated by the federal agency. For instance, SBA 7a loans don’t require that borrowers own real property to qualify for the loan, but many lenders that service SBA 7a loans, especially the larger, corporate banks (think Wells Fargo, Chase, Bank of America) will not loan to a borrower unless the borrower owns real property that can be used to collateralize the loan.
In a previous episode I spoke about a client of mine who I met after he was denied an SBA 7a for the purchase of a successful restaurant in San Francisco. When I found out that in addition to his robust background in the hospitality industry, he also had substantial passive monthly income through a family trust, I was surprised that he didn’t qualify for the loan. Come to find out, he had gone to large corporate bank and because he didn’t own real property, they would not approve him for the loan. Now mind you, the lending institution did not tell my client that he didn’t qualify for the SBA 7a loan service through their institution, but he would more than qualify for the same loan through another local bank or credit union. Which of course he did, but until we met, he thought that his personal financial circumstances disqualified him from accessing an SBA 7a loan which was very far from the truth.
One quick thing, if a restaurant buyer does own real property and is working with a lender that does not require real property ownership to grant the loan, the Small Business Administrations requires the real property to be collateralized. To be clear, if a borrower owns real property no matter what the lending institution requires, the SBA, at the federal level requires that the real property is collateralized.
While on the subject of collateral, if the borrower does not own real property, the loan is collateralized with the assets of the business: the furniture, fixtures and equipment. This requires landlords to sign a release that, in the event of a loan default, the lending institution has security interest in the FF&E and is allowed to the premises to seize and sell the FF&E. This can be a sticky situation if the landlord owns some of the furniture, fixtures, and equipment (this scenario would be a great topic for another blog).
Under most any circumstance a restaurant that does not have strong cashflow with sales trending up over a minimum of three years will not qualify for an SBA 7a loan. Additionally, and every lender is different, there is a minimum loan for the SBA 7a. For instance, the two local institutions I use most often for SBA lending will not service loans that are less than $300K. So if a buyer needs funding to purchase restaurant for $250K they’ll need to find private funding or request financing from the seller.
Once a lending institution issues pre-qualifications that both the buyer and the restaurant qualify for a SBA 7a loan, the real work begins. First, the borrower needs to supply a lot of verified financial information in addition to fairly comprehensive business plan that includes a 2 and sometimes 3-year proforma with the first year detailed by month. I strongly recommend to restaurant buyers that they contract a consultant to help them create the business plan because during this phase of the restaurant purchase, the buyer is also trying to secure approval with the landlord as well as a lease assignment and new lease terms. The buyer is also going through the most times arduous process of the change of ownership inspection and requirements by the county health department (see blog _____ for more on this) and the application for the transfer of the seller’s ABC alcohol license.
Once the financials of the borrower and the business, the business plan and proformas are submitted the real slog begins. And I don’t use that word lightly. Getting through the underwriter process is almost always a slog. First, there is an almost mythical aura of the underwriter; they seem to be this all-knowing being that exists outside of time and space. In actuality, the underwriter is more often than not an employee of the lending institution and they are tasked assessing how much risk the lender is taking on by servicing the loan and they can make the most absurd requests. No, really absurd.
For example, I had a client who had contracted with a consultant to help vet the business and retool the menu. The underwriter required the following: a letter from the consultant detailing the scope of work and the consulting fee; confirmation from the consultant and borrower that no more service beyond those accounted for in the consultant’s invoice would be required. The underwriter also required a screenshot from the borrower’s bank account that the fee had been paid. That’s not too unreasonable, and mind you this is one detail I’m pulling out from a very long list of question and requirements that the borrower was tasked with. The problem was, no matter what the borrower and consultant submitted to the underwriter, it wasn’t sufficient. Oh, and I’m not talking about a large fee, I’m talking about a $5,000 fee.
For funding larger purchases, the SBA 7a underwriting process might be fine. But for loans less than $500K, I really question if it is worth it. From my experience, it is generally an arduous, painstakingly long and somewhat exhausting process for the buyer and the seller. Honestly, by the time the loan funds, most of my borrowers will tell me they wish they’d found another source of funding. And there you have it.
Ryn Longmaid is a restaurant broker and consultant at Santa Rosa Business & Commercial in the San Francisco NorthBay and the host and founder of the Facebook Live Series, Deep Dish: discussions on the business of restaurants for restaurateurs, restaurant buyers and sellers and the restaurant curious.
As well as being a licensed real estate broker, Ryn is a CBB with the California Association of Business Brokers (CABB), a CBI with the IBBA and she holds an MBA in Sustainable Business Management. In addition to being a proficient business broker, Ryn has over 20 years’ experience in the restaurant, hospitality, and food industries. She has served as the executive chef for Amy’s Kitchen, personal chef to actor Don Johnson, she founded and operated a successful and longstanding restaurant. She has also held teaching posts in restaurant management at the Art Institute-San Francisco and The Culinary Institute of America-Greystone.