Buying a Restaurant with an SBA Loan: What Lenders Check

The honest picture

Restaurants and bars are financed with SBA loans all the time, and many buyers do well with them. They also fail more often than many other small businesses, and lenders know it. Expect a closer look at the numbers, the location and you. The good news is that the issues are predictable, and most of them can be tested before you sign a letter of intent.

For how an acquisition loan fits together generally, see buying a business with an SBA loan. If the restaurant is a franchise, read buying an existing franchise too.

The lease: the deal behind the deal

Most restaurants don’t own their building, so the lease is what you’re really buying alongside the recipes and the staff. Lenders look at:

• Assignability. The landlord usually has to consent to the lease being assigned to you, sometimes with conditions such as a personal guaranty or a higher deposit. Start this conversation early; landlord timing is one of the most common reasons restaurant closings slip.
• Remaining term. The lease, including renewal options you control, needs to run long enough to support the loan. A business with a few years left on its lease and no renewal right is a very different credit from one with a long runway.
• Rent and escalations. Rent is a fixed cost in a thin-margin business. Look at where rent will be in three and five years, not only today.
• Who pays for what. Repairs to kitchen systems, grease traps, HVAC and roofs can be expensive. Know what the lease puts on the tenant.

If the seller owns the building and will sell it to you, the real estate changes the financing; see buying your building.

The liquor license

Where a liquor license is part of the business, it can be one of its most valuable assets, and in some states licenses are limited in number and costly to replace. Transfers need state (and sometimes local) approval, which takes time and is normally a condition of closing. Under the current SBA rulebook, a transferable license conveyed in the purchase must be properly secured as collateral by the lender. In Pennsylvania, see the notes in our Pennsylvania guide.

Also check health permits, food-service licenses and any outdoor-seating or entertainment permits. Some transfer; some must be reissued to you.

Cash sales and the tax returns

Restaurants handle a lot of cash, and some sellers describe income that never reached the tax return. Lenders can’t use it. For a change of ownership, the lender bases its analysis on the business’s recent year-end financial information and verifies the seller’s tax returns against IRS transcripts. If the asking price depends on unreported income, the price is the problem, not the lender.

Useful cross-checks you can do yourself: compare point-of-sale reports, bank deposits, sales tax filings and the tax return. They should tell the same story.

What lenders look at in the numbers

• Food and beverage cost as a share of sales, and how stable it has been.
• Labor cost, including whether the seller (or the seller’s family) works unpaid shifts that you’ll have to pay someone to cover. That’s a deduction, not an add-back.
• Rent and occupancy cost relative to sales.
• Trend. Is the business growing, flat or fading? A restaurant past its peak can show good historical numbers and a weaker year to date. Lenders compare the current interim period with the same period last year.
• Capital needs. Kitchen equipment, a dated dining room, or a point-of-sale system at end of life. Unfunded replacement spending is deducted from cash flow.

The how lenders calculate cash flow guide shows how these flow into the coverage ratio.

Your experience

Lenders must document the buyer’s industry experience and how the business will be managed day to day. In restaurants that carries extra weight. If you’ve run a kitchen or a front of house, lead with it. If you haven’t, a strong general manager or chef who is staying, and a written plan for the first year, can help. A seller transition period helps too, within the SBA’s limits; see the seller transition period.

Working capital

Restaurants need cash on day one: inventory, payroll before the first busy weekend, deposits, and repairs that turn up after closing. Building a reserve into the project costs more up front but protects the business in its weakest months. See working capital in a business acquisition.

Before you sign

1. Will the landlord assign the lease, on what terms, and how much term is left including options?
2. Is there a liquor license, and what does the transfer involve and how long does it take where you are?
3. Do the point-of-sale reports, bank deposits, sales tax filings and tax returns agree?
4. Who works in the business unpaid today, and what will it cost to replace them?
5. What equipment needs replacing in the next few years?
6. What’s your experience, or who is the experienced operator staying with the business?

Test your price in the acquisition calculator with a stress case, and see how business acquisition financing is structured. If you’re looking at a restaurant now, tell us about it. We’ll tell you plainly what a lender is likely to focus on, including when a smaller deal or a different structure would serve you better.