Do You Need to Get Prequalified for an SBA Loan?
One of the most common questions I get from searchers and aspiring ETA entrepreneurs is: “Do I need to get prequalified for an SBA loan?” The short answer is no, but the full story is a bit more nuanced. Let’s dive into what SBA prequalification entails, its role in the acquisition process, and why it might still be a valuable step for potential buyers.
Is Prequalification a Requirement?
Technically, getting prequalified for an SBA loan isn’t mandatory. You can move forward in the loan process, obtain a term sheet, and even make progress toward securing financing without a prequalification letter. However, many business brokers—and sometimes sellers—use prequalification as a way to vet serious buyers.
Brokers often handle inquiries from hundreds of interested parties for a single business listing. To streamline their efforts and protect the seller’s time, they may require a prequalification letter before sharing more detailed business information or arranging direct conversations with the seller. Essentially, this letter helps demonstrate that you’re not just browsing but are financially prepared and serious about making a deal.
What Is a Prequalification Letter?
An SBA prequalification letter is issued by a lender after reviewing a limited but important set of information about your financial and professional background. Here’s what lenders typically assess:
Personal Financial Statement: An overview of your liquidity, assets, and liabilities.
Liquidity: The cash or readily available funds you can contribute to the acquisition. There’s not a hard and fast rule here for how much liquidity you need to have on hand, but a general rule of thumb is that you’ll want to have around 10-15% of the total project in liquid cash. I would say this is the most important piece to obtaining SBA financing, and the most common road block I encounter among prospective searchers.
Retirement Accounts: The value of your retirement savings, though these aren’t always considered accessible. However, if you plan to use a ROBS 401k rollover, you can withdraw from these accounts penalty free.
Credit History: Including any foreclosures or bankruptcies, and your credit score.
Professional Experience / Resume: Your background and skills relevant to managing the target business. This is the second most important piece that lenders are assessing. They want to be confident in your ability to operate your new acquisition, and oftentimes that means an understanding of the industry. Direct industry experience is always best, but many lenders are comfortable with translatable experience - meaning that even if you don’t have direct industry experience, you can draw from a demonstrated track record of successful business development or managing teams.
Last 3 Years Personal Tax Returns: A review of your recent tax history to assess financial stability.
Based on this information, the lender issues a letter indicating you’re prequalified for a specific loan amount. However, it’s essential to understand what this letter does and doesn’t guarantee.
The Limitations of Prequalification
While a prequalification letter is a valuable tool, it’s not a silver bullet. Unlike mortgage prequalification—where the lender determines how expensive a house you can afford—SBA prequalification is less straightforward. Here’s why:
Not All Businesses Are Created Equal: Even if you’re prequalified for $1 million, not every business priced at that amount will qualify for SBA financing. The business’s financials, cash flow, and operational fit play a significant role in determining whether it’s a viable acquisition.
No Guarantee of Financing: Prequalification means you meet the basic criteria for a loan, but final approval depends on the specifics of the deal, including the business’s profitability, debt service coverage, and other financial metrics.
Suitability Is Case-Specific: Some businesses may appear attractive but fail to align with SBA underwriting standards, even if they fit within your prequalified budget.
Why Prequalification Still Matters
Despite its limitations, a prequalification letter can be a powerful asset in your acquisition journey. Here’s how it helps:
Establishing Credibility: Sellers and brokers are more likely to take you seriously when you can demonstrate financial readiness.
Getting Access to Opportunities: Brokers may require this letter before sharing detailed financials or arranging seller meetings.
Saving Time: Knowing your prequalified amount helps you focus on businesses within your financial reach. It unfortunately does happen where a buyer will get under an executed LOI, and then come to me to arrange financing for their deal, and we’re unable to help because they simply can’t meet the liquidity and experience requirements to get it done. Getting prequalified can save everybody a lot of heartache before embarking on that long process. But just as importantly, it can give you an accurate gauge of the size of acquisition you should be pursuing.
The Path Forward
While prequalification isn’t a requirement, it’s a strategic move that can open doors and streamline your acquisition process. It’s a tool to demonstrate your seriousness and gain access to the information you need to evaluate potential opportunities effectively.
If you’re considering a business acquisition and want to understand whether prequalification is the right step for you, let’s talk. I can guide you through the process. Together, we can ensure you’re well-prepared to navigate the SBA loan process and achieve your entrepreneurial goals.
If you've got an acquisition you're considering or are under LOI, feel free to email me at jason@arenacommercialcapital.com. Our firm, Arena Commercial Capital, is a full service commercial lending brokerage with over 100 lenders across the US.
We’re committed to helping motivated searchers like you navigate the complexities of SBA financing and buy your dream business.
