Should I get SBA pre-qualified before I sign an LOI?

What does a pre-qualification actually tell me?

BizBuySell describes it as an early lender review of your credit, liquidity, experience and overall financial strength. It usually produces an estimated loan size and high-level terms. It is not a preapproval, which involves a deeper review and a conditional commitment, and it is not a full approval.

It looks at you. It does not look at the target. The seller's returns, the valuation and the quality of earnings report come later, and any of them can change the loan.

Why do it before the LOI?

• It shows the seller you can close. BizBuySell notes that sellers compare offers and that a letter lowers their perceived risk.
• It tells you which category your deal is in. Cantrell Law advises confirming your buyer category with the lender before signing, because the category sets coverage and whether the injection can be reduced.
• It finds lender differences. A Searchfunder author writes that lenders will implement the new SOP differently and that buyers should structure around that.
• It protects your money. The same author warns buyers not to pay for third-party diligence before the economics have been tested.

What should I run myself before the LOI?

Beancount advises recomputing coverage at 1.25x on conservatively adjusted earnings before signing. Here is a screen with assumed numbers.

1. Asking price $1,800,000. Working capital and fees $100,000. Project costs: $1,900,000.
2. Injection at 10%: $190,000. Loan: $1,710,000.
3. Annual debt service at 10% over 10 years: $1,710,000 x 0.15858 = about $271,173.
4. Listing SDE $400,000, less an assumed $80,000 replacement salary: cash flow of $320,000.
5. Coverage: $320,000 / $271,173 = 1.18x. The deal passed the old 1.15x and fails 1.25x.
6. Price the cash flow supports at 1.25x: about $1,693,687. The offer needs to be about $106,300 lower, or 5.9%.

Finding that before the LOI means the offer starts at a number the bank can fund. Finding it after means a renegotiation. See My deal cleared 1.15x DSCR. What happens now that the SBA requires 1.25x?.

What do I bring to the lender?

BizBuySell lists a personal financial statement, personal and business tax returns where they apply, a resume showing experience, recent bank statements and a schedule of debts. An SBA lender will also ask where your 10% will come from. At least half must be your own cash or other unrestricted sources, because standby notes and passive investors together cap at half. See Can a seller note count toward the SBA 10% down payment?.

What should the LOI say about financing?

A pre-qualification does not replace a financing contingency. The LOI should say that the offer depends on lender approval, the valuation and, where it applies, the quality of earnings report. See What should a letter of intent to buy a business include?. Expect the valuation and the quality of earnings report to stretch a 30 to 60 day diligence window. Ask the lender when it expects the SBA loan number, not only the closing date, because the loan number date decides which SOP applies, per SBA Information Notice 5000-880695.

One more check, from a buyer in a Searchfunder thread: confirm early that the seller has filed all tax returns. Lenders underwrite from returns, and missing years can stall a deal for months.

When can I skip it?

If you are paying cash or using non-SBA financing, a pre-qualification letter from an SBA lender does not help. If the seller will not grant exclusivity, a letter is still the best evidence you have. A short exclusivity period is a term you can ask for in the LOI before you pay for third-party work.

Where these numbers come from: Pre-qualification scope, documents, timing and cost are from BizBuySell. Rule details are from SBA SOP 50 10 8.1 as summarized by Cantrell Law, Beancount and Starfield & Smith. Lender-implementation, loan-number and tax-return points are from Searchfunder (QoE), Searchfunder (impact) and Searchfunder (readiness). Effective date: SBA Information Notice 5000-880695. Confirm current terms with an SBA lender.

Related questions

Is a pre-qualification letter binding on the lender?

No. BizBuySell describes it as an early assessment, not a guarantee, preapproval or full approval. Final terms depend on full documentation and underwriting.

Does a pre-qualification hurt my credit?

It can. BizBuySell notes some lenders run a soft credit check and others a hard pull, so ask before you apply.

Should I talk to more than one lender?

Yes. Implementation of the new SOP will vary by lender, per a Searchfunder author, so a second opinion on the same deal is cheap.

What comes next

Once the LOI is signed, the diligence clock starts: What happens after you sign a letter of intent? A buyer who plans to make several acquisitions can ask a lender how a holding company would be underwritten before the first deal, not after the third.

Related articles

• My deal cleared 1.15x DSCR. What happens now that the SBA requires 1.25x?
• What should a letter of intent to buy a business include?
• How long does an SBA acquisition loan take to close?
• Who pays for the SBA-required quality of earnings, and what does it cost on a $3M+ deal?
• How much will a bank lend to buy a business?

Meraki Dealmakers is a service of Meraki Partners, LLC, an advisory firm. It is not a broker-dealer, investment adviser, business broker, law firm or accounting firm. This article is general information, not legal, tax or investment advice.