SBA loans provide an excellent alternative to conventional bank financing when purchasing a business or small business real estate. Small business borrowers can use SBA loans to accomplish lower down payments, longer repayment terms, and easier qualifying criteria than conventional bank loans. Sometimes, however, a small business may be marginally qualified for SBA financing, and a little bit of seller second lien financing can make the transaction happen.
Many business lenders do not allow second liens behind their primary loan, but SBA lenders do allow it. The most common form of second lien financing is found where a business is being acquired, or where business real estate is being acquired, from a seller who wants to help the buyer qualify for primary financing. Small business borrowers usually want to preserve cash for business operations, and they are reluctant to part with down payments sufficient to satisfy their business lender. In these cases, if the seller agrees to subordinate their second lien to the SBA lender, and if the seller agrees not to take payments until the SBA loan is satisfied, SBA allows that second lien financing to be treated as part of the buyer’s qualifying equity. In general, seller second lien financing is used to supplement the buyer’s qualifying equity in cases where the buyer is providing at least a 10% down payment.
Why would a seller of a business, or a seller of business real estate, agree to carry some second lien financing on a standby basis? In many instances, the seller is anxious to sell the business or business real estate as soon as possible. Since the seller is receiving a large amount of cash from the buyer’s down payment, plus the buyer’s loan proceeds, they are willing to carry a small amount of second lien financing. This action allows the seller to delay some of their income tax liability and provide them an interest-earning asset. If the seller believes the buyer will continue to be successful with their business, they know they will be repaid on the seller financing when the primary loan is satisfied. For a business acquisition scenario, the buyer and the lender like to see seller second lien financing, because the seller still has some “skin in the game” to make sure the ownership transition is smooth and successful. Also, the seller often enjoys offering seller second lien financing, so they don’t have to negotiate further with price reductions.