Too Big for SBA, Financed Another Way
Most buyers learn acquisition finance through the SBA. It is the right tool for a lot of deals.
It is the wrong tool once the price gets big enough. An SBA 7(a) loan tops out at $5 million. Past that point, a buyer needs a different lender, a different structure, and a different set of tests.
This week we take one $14 million deal and walk it through the way a lower middle market senior lender underwrites it: leverage, fixed charge coverage, the borrowing base, and the four things the credit committee spent its time on.
This is a composite deal built from transactions we have worked on. Names, locations, and figures are changed.
The Deal on the Table
Business: Industrial MRO distributor in the Midwest. Fasteners, cutting tools, safety supplies, and shop consumables sold to manufacturers and maintenance departments.
Years in business: 34
Team: 52 employees, two warehouses, and vendor-managed bins inside customer plants. The founder still signs the big supplier agreements.
Asking price: $14,000,000
Revenue (trailing twelve months): $24,000,000
Adjusted EBITDA per the seller: $2,950,000
Implied multiple: $14,000,000 ÷ $2,950,000 = 4.75x EBITDA ✓
Active accounts: 1,400. Largest customer is 16.0% of revenue.
The buyer: a former plant operations director backed by a small group of private investors.
Why the SBA Was the Wrong Tool
Start with the cap. The SBA loan can be at most $5,000,000. That is 35.7% of the price.
Add $520,000 of transaction costs (QoE, legal, and lender fees) and the project costs $14,520,000. The SBA's 10% equity injection is $1,452,000. That still leaves $8,068,000 ✓ with no lender behind it.
Say the seller agreed to carry all of it on a 10-year note at 7%. That note gets paid, so it is not on standby. It counts as debt.
SBA loan: $5,000,000 over 10 years at an illustrative 9.75% (Prime plus 2.75%), $784,621 a year ✓
Seller note: $8,068,000 over 10 years at 7%, $1,124,116 a year ✓
Total debt service: $1,908,737 ✓
Against $2,150,000 of cash flow after capex and taxes (built below), that is 1.13x ✓. Total debt would be 5.03x verified EBITDA. That fails the SBA's 1.25x floor for an acquisition, and few sellers would carry that much paper.
The fix is not a bigger SBA loan. It is a capital stack built for a business this size.
Test 1: Rebuild the EBITDA
The senior lender ordered its own Quality of Earnings report. Here is the bridge:
Adjusted EBITDA per the seller: $2,950,000
Market salary for a general manager: ($100,000). The founder took a below-market wage. His replacement will not.
Reserve for slow-moving inventory, never booked: ($90,000)
Shrink found in the physical count: ($60,000)
Warehouse rent reset to market: ($50,000). The founder owns one building and charged the company below-market rent.
"One-time" ERP support: ($50,000). It recurs every year.
QoE EBITDA: $2,600,000 ✓
At $14,000,000, the real multiple is 5.38x ✓, not 4.75x.
Then the lender takes out what never reaches debt service:
Unfinanced capex: ($150,000). Forklifts, racking, vending bins.
Cash taxes and tax distributions: ($300,000)
Cash flow available for fixed charges: $2,150,000 ✓
Test 2: How Much Senior Debt?
Senior cash flow lenders in this market typically lend roughly 2.5x to 3.5x EBITDA. This lender offered 3.0x.
The question was 3.0x of which number.
Term loan: $8,850,000 → $7,800,000
The buyer asked for 3.0x the seller's $2,950,000. The lender sized it at 3.0x the QoE figure of $2,600,000. On verified earnings, the buyer's request was really 3.40x, and the lender would not go there. With the revolver draw, senior leverage would have been 3.63x, above the 3.50x covenant on day one.
That cut $1,050,000 ✓ from the senior loan. Something else in the stack had to fill it.
Test 3: The Revolver and the Borrowing Base
A distributor lives on working capital. The lender added a $4,000,000 asset-based revolver, secured by receivables and inventory and sized by a borrowing base.
Accounts receivable: $3,400,000. Over 90 days and other ineligibles: ($300,000). Eligible: $3,100,000.
Receivables availability at 85%: $2,635,000 ✓
Inventory at cost: $4,600,000. No sale in 12 or more months: ($700,000). Eligible: $3,900,000.
Appraised net orderly liquidation value at 60% of cost: $2,340,000. Inventory availability at 85% of that: $1,989,000 ✓
Borrowing base: $4,624,000 ✓
The borrowing base is above the $4,000,000 commitment, so the full line is usable. The buyer draws $600,000 at closing and keeps $3,400,000 ✓ available for the seasonal build.
Notice the inventory math. Every dollar of eligible inventory supports only 51.0 cents of borrowing. Lenders lend against what a liquidator would pay, not what the shelf cost.
The Capital Stack
Uses:
Purchase price: $14,000,000
Transaction costs: $520,000
Total uses: $14,520,000 ✓
Sources:
Senior term loan, 3.00x QoE EBITDA: $7,800,000
Revolver draw at closing: $600,000
Seller note, subordinated: $1,750,000
Seller rollover equity: $1,000,000
Investor and buyer cash equity: $3,370,000 ($250,000 from the buyer, $3,120,000 from his investors)
Total sources: $14,520,000 ✓
Senior leverage, term loan plus revolver draw: 3.23x ✓
Total leverage, including the seller note: 3.90x ✓
Total equity, cash plus rollover: $4,370,000 ✓, or 30.1% of the project. If all equity buys in at the same price, the seller ends up owning 22.9% of the new company.
Test 4: Fixed Charge Coverage
Outside the SBA, the headline test is the fixed charge coverage ratio: cash flow after capex and taxes, divided by all interest and scheduled principal. Covenants typically sit around 1.20x to 1.25x. This lender set 1.20x, tested quarterly.
Assumptions, all illustrative with Prime at 7.00%:
Term loan: 8.75% (Prime plus 1.75%), 8-year amortization, monthly payments. Annual figures are the exact monthly payment x 12, rounded to the dollar.
Revolver: 8.25% (Prime plus 1.25%), interest only on the $600,000 drawn
Seller note: 7%, interest only, principal due after the senior loan is repaid or refinanced
Term loan payments: $1,359,151
Revolver interest: $49,500
Seller note interest: $122,500
Total fixed charges: $1,531,151 ✓
FCCR: $2,150,000 ÷ $1,531,151 = 1.40x ✓
Under the buyer's original ask ($8,850,000 term loan, $700,000 seller note), coverage was 1.31x. That passes on paper. Then the lender ran its stress test.
What the Credit Committee Focused On
Customer concentration. 1,400 accounts, but the top 10 are 48.0% of revenue and the largest is 16.0%, about $3,840,000. The lender read that customer's supply agreement and confirmed the bins inside the plant are the distributor's own inventory and the contract survives a change of ownership. Inventory in those bins sits at a customer site, so it counts in the borrowing base only with a signed access agreement.
Gross margin stability. 31.6%, 32.3%, and 32.0% over the last three periods, a range of 0.7 points. The committee stressed it anyway. A one-point margin drop costs $240,000 a year. At the final structure, coverage falls to 1.25x ✓ and holds. At the buyer's original ask, it falls to 1.16x and breaks the covenant. That is why the lender would not stretch past 3.0x of verified earnings.
Inventory quality. 15.2% of inventory had not sold in a year. The QoE booked a reserve, and the borrowing base excludes it. Inventory turns 3.55x a year.
Working capital. Receivables plus inventory, less $1,900,000 of payables, is $6,100,000, or 25.4% of revenue. The purchase agreement sets a working capital target the seller must deliver at closing, so the buyer does not fund a shortfall with his revolver on day one.
The Verdict
Approved, with these terms:
Senior term loan: $8,850,000 requested → $7,800,000 approved
Seller note: $700,000 → $1,750,000, fully subordinated to the bank
Covenants: FCCR of at least 1.20x and senior leverage of no more than 3.50x, tested quarterly
Revolver: $4,000,000, monthly borrowing base reports
The seller took $11,250,000 ✓ in cash at closing, plus a $1,750,000 note and a 22.9% stake in the company he built. He gave up $1,050,000 of cash at closing to make the bank comfortable, and in return the deal actually closed.
The buyer kept a cushion. Cash flow can fall by $312,619, or 12.0% of QoE EBITDA, before coverage hits 1.20x.
One more difference from SBA deals: an earnout was available here. Earnouts are allowed outside the SBA. This deal did not need one.
Finding the Deal Was the Easy Part
This distributor was easy to find. Steady margins, 34 years of history, and a founder ready to retire.
Getting it financed meant knowing the SBA could not carry it, knowing which number the senior lender would size off, and building a stack that passed the stress test before the term sheet arrived.
Deal sourcing is the easiest part of buying a business. Underwriting and structure are where deals are won or lost. That is the work we do every day.
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