SBA vs. Conventional Loans

The Small Business Administration (SBA) has been a vital funding source for small businesses and often the only source available in industries that lack tangible collateral, including independent financial advisor practices.

Fortunately, as the wealth management SBA loan pool has matured, conventional (non-SBA) lenders have cautiously entered. A conventional loan has several advantages over SBA loans:

• Reduced Time to Close
• M & A Deal Flexibility
• Partial Buyouts & Tranche Sales
• Reduced Fees & Rate Risk
• Scalable Borrowing
• Limited Default Consequences

Reduced Time to Close

SBA loans on average take three to nine months to close, which may result in a would-be seller favoring a buyer who can close more quickly. In comparison, advisors can often secure conventional financing in 30 to 45 days with a significant reduction in application documents.

M&A Deal Flexibility

SBA loans are very restrictive regarding transaction structures, providing sellers with few restructure or exit options. In contrast, conventional loans provide sellers with the options of a partial buyout or tranche succession, neither of which are possible with an SBA loan based on their maximum 12 month departure timeline.

Partial Buyouts and Tranche Sales

A partial buyout allows sellers of independent practices to sell less than one hundred percent of their business and remain in whatever capacity they desire. A tranche buyout outlines set percentages and buyout dates over several years. Both transactions are viewed favorably by conventional lenders.

Rate Risk

SBA obligations are typically structured as floating rate loans, whereas conventional lenders offer fixed-rate options, providing protection against potential payment increases in the future. Additionally, most SBA obligations are funded with floating rates between 7.5% and 8.25% compared to conventional loans which are often funded with fixed rates between 6.8% and 7.5%.

Fees

Regardless of financing type, there are additional fees that the applicant must take into consideration including a guarantee fee, origination fee, and pre-payment penalties.

For government-guaranteed loans, the SBA charges a guarantee fee before close, ranging between 3% to 3.75% and often paid by the borrower out-of-pocket. Conventional loans do not have a government guarantee or the requisite fee, instead charging an origination fee of around 2% to 3% of the loan amount but can be paid from loan proceeds, not necessarily out-of-pocket.

Scalable Borrowing

The SBA limits each borrower to a maximum indebtedness of $5M in total; as a result, an enterprising financial advisor may be quickly capped out after two to three acquisitions or one larger transaction. Conventional lenders can extend financing well above $5 million with legal lending limits for each borrower varying between $4 million to $90+ million.

Advisors often work with a correspondent lender to understand the advisor's M&A strategy to ensure they are partnering with a bank that can scale with their ambitions.

Default and Collection

The most critical loan factor for any borrower is what recourse lenders have in the event of default. Of course, no advisor envisions defaulting on a loan, but unexpected challenges in life can happen — such as new regulations, health complications, or legal entanglements.

An SBA loan requires a lien placed on the borrower’s home (assuming they have sufficient equity) but is not required for conventional financing. Therefore, in the event of default, an SBA borrower’s home is not protected from bankruptcy whereas a conventional borrower may have their loan discharged allowing them to remain in their home.

Know Your Options

There are situations when an SBA loan is appropriate for a financial advisor and other scenarios where a conventional structure is preferable. Ensure that you evaluate all of your options prior to funding. A correspondent lender can aid advisors in the selection of an appropriate bank partner.