To help California restaurant owners transact sell their restaurant businesses, Mission Peak Brokers is providing a How to Sell Your California Restaurant series of blog posts. We hope to provide restaurant sellers with information and insight on all the key elements involved in selling restaurants. Whether you are ready now or plan on selling in the future, arming yourself with essential information on the process of restaurant business sales will empower you throughout the business sale.
This is the second blog post in the series. If you missed, the first, check out Restaurant Valuation: How To Successfully Sell Your California Restaurant.
Restaurant Business Loans
As a restaurant seller, you might be asking yourself why would you have to concern yourself with restaurant business loans? The short answer is “no loan, no sale.” It’s absolutely to your advantage to work through what financing options can be made available to a prospective buyer for your restaurant.
Ideally, you want to get your restaurant business pre-approved for a restaurant business loan by the Small Business Administration (SBA)
There are several options for financing the purchase of restaurant. These restaurant business loans include:
- SBA Loan,
- Seller Financing,
- Online Business Loan,
- Retirement Rollover Loans,
- Unsecured Commercial Loans,
- Second line of credit
Restaurant Business Loans: SBA Loans
The U.S. Small Business Administration (SBA) loan is the gold standard of business loans. The SBA does not loan directly to borrowers; instead, the SBA guarantees the loans to lenders which both stimulates and encourages lenders to loan to business owners. SBA loans are guaranteed up to 85% by the SBA. This means that in the case of a borrower’s default, the lender has a lower risk. SBA loans for acquisitions,
SBA 7(a) loans, are used to fund acquisitions for a 10-year term. If real estate is included in the purchase along with the business, then the loan is known as an SBA 504 and the loan period is 25 years. Including real estate in the purchase allows for lower monthly payments since debt service is longer and permits equity to build for a future sale.
SBA also has a micro loan of up to $50,000 which is much easier to get than the 7(a) and 504. Specific terms vary by lender. The maximum term, as dictated by the SBA, is six years. Most lenders will require a personal guarantee, a specific credit rating and some form of collateral for loans under the microloan program.
The rates are usually the lowest available compared to other types of loans. Rates can be either fixed or variable rates. SBA sets the prime rate and then lenders add on an additional amount for their profit, so it pays to shop SBA lenders. Borrowers need to be creditworthy (FICO scores 680+) and have relevant experience, preferably managing or owning a similar business as the target acquisition.
Typically, buyers must inject cash in the amount of 20-25% of the purchase price on a 7(a) loan and 10-20% on a 504 loan. The application process requires buyers to be thorough, conscientious and thorough in order to qualify. The lender will qualify both the business and the buyer and require documentation for key aspects of the business and financial performance. Consequently, the business must be able to show clean books and records with consistent earnings year-over-year.
The lender will also require a valuation (if the loan amount is over $200,000), equipment inspection, and property inspection (if real estate is being purchased). If the restaurant is a franchise and on the SBA Franchise Registry, the SBA loans are pre-approved and the lending process is streamlined.
Getting the restaurant business loans can be demanding but the benefit to the buyer having an experienced lender put the business under a magnifying glass to identify misrepresentations and avoid unwelcomed surprises. The upfront costs of the loan can be drawback but some lenders will be willing to roll in the costs into the loan so that the buyer-borrower limits the cash outlay to the typical 20% which helps preserve more of the buyer’s financial assets for working capital.
For the restaurant business loan, lenders will require the borrower and spouses to also execute a personal guaranty on the note. With larger loan amount (over $300,000), the lender will additionally require the borrower collaterize any real property that they own despite the SBA’s guarantee.
Restaurant Business Loans: Seller Financing
If an SBA loan is not an option for the restaurant that you want to buy, it may be possible to negotiate seller financing. Instead of receiving the full purchase amount, the seller may be willing to finance all or part of the purchase price. In this scenario the buyer and seller negotiate the terms and interest rate of the loan. Typically sellers want to get paid out on the note within five years of the sale.
There are many benefits for sellers to carry financing. One benefit is that the seller will be more supportive of the buyer to assure repayment. The seller also makes more on the sale due to the added interest rate. Despite making more on the sale by financing the loan, since the proceeds are amortized, the seller’s tax consequences are reduced since their gain on the sale is metered out over a period of years rather than all at once.
Sellers will collaterize the assets of the business for the loan via a UCC filing. The buyer will also execute a personal guarantee on the note as well if they buy the business through a business entity. If the buyer defaults on the seller’s note, then the seller can reclaim the business if the buyer is unable to cure the default within specific timeframes.
Restaurant Business Loans: Online Business Loans
Online lenders help prospective buyers by providing competitive financing through online matching platforms. BoeFly.com is a an online business loan aggregator which connects borrowers with lenders from among its more than 5,000 participating banks and specialty finance companies. Lenders benefit by being presented with only those loan requests that fit their lending profile, dramatically lowering their time and cost of origination. Borrowers fill out an initial form indicating the amount sought, FICO score, whether the buyer has collateral, and then the information is forwarded to matching lenders who make their offers to the borrower.
Restaurant Business Loans: Retirement Rollover Loans
Some borrowers with retirement accounts can borrow against their 401k plan. This equity financing can be an excellent option to minimize debt particularly for a low-risk business investment. The funds from the retirement plan rollover are generally used in conjunction with conventional business loans or SBA loans to acquire the target business.
There is of course risk associated with investing your retirement assets into a new business. In addition, due to the technical requirements of the Internal Revenue Code, strict compliance is necessary in setting up the roll-over and administering the plan. Failure to adhere to the rules could be extremely costly, subjecting the rollover funds to immediate tax as well as a potential penalty for early withdrawal of retirement funds. For this reason, borrowers should only permit reputable financial services to handle their 401k rollover.
Restaurant Business Loans: Unsecured Commercial Loans
Unsecured credit refers to loans or lines of credit where there is no collateral to back the loan. Borrowers might have to look at this option where they have poor credit and the seller is unwilling to finance. Although this type of lending is possible for a acquiring a restaurant, it is considered risky for lenders. The borrower’s personal financial strength as well as the business cash flow needs to be strong in order to qualify for an unsecured line or loan. With out collateral, the lender will impose a much higher interest rate and a short term. These conditions make debt service more challenging. It is, therefore, important to hire an account to perform due diligence to properly verify earnings so that the buyer is assured that there are sufficient funds to cover higher than average debt service as well as derive earnings.
Restaurant Business Loans: Second Line of Credit
Another option is for a borrower with home equity to secure a Home Equity Line of Credit (HELOC) to finance the purchase of their business. This may be an easier option for a borrower with equity since these loans tend to be easier to obtain and cheaper than an SBA loan, particularly if the SBA loan will require collateralizing the buyer’s real estate anyway.
If you are interested in selling your restaurant, Mission Peak Brokers can help. We are highly experienced and knowledgeable about restaurant business sales, including bars, cafes, nightclubs, etc. We have closed numerous eatery business sales in the Bay Area. We have represented sellers and buyers.
In addition to business sales, we also provide commercial real estate sales and business/commercial financing including restaurant business loans. Contact us today for additional information.