The process of buying a business has a couple of major milestones: identifying the business, signing the LOI, getting a term sheet from a lender, the commitment letter, and ultimately closing.
The tipping point in the deal from might happen to likely to happen is the issuance of a commitment letter from an SBA lender. This is one of the most important steps in the SBA lending process.
The signed bank commitment letter means the bank has reviewed the business in-depth and will provide the financing assuming you meet the criteria specified in the letter.
At MidStreet, we have sold businesses to hundreds of individual buyers who utilized SBA financing. Each secured a commitment letter that outlined the requirements to receive the loan.
In this blog, we’ll cover when you receive the commitment letter and what you should expect to be included.
Let’s jump in.
When Does a Commitment Letter Come Up In a Business Sale?
After you submit a letter of intent (LOI), you will go through nine more steps before you close on your new business.
- You submit an LOI and the seller accepts
- The bank reviews the information and asks questions
- The bank issues a term sheet
- The buyer and seller provide more information to the lender
- The bank requests more detailed reports and starts underwriting
- The bank approves and issues the commitment letter
- You and the seller work to complete the purchase agreement and other documents
- You and the seller work through the closing checklist
- The loan/deal closes
The first official document you will receive from the lender will be the term sheet. After you have received the term sheet, signed it, and given your non-refundable deposit, your loan will be given to the underwriter at the bank for credit approval.
Once the loan has received credit approval, the lender will send you the commitment letter and more non-refundable money will be requested.
For the most part, the terms of the deal should remain the same between the term sheet and the commitment letter.
The Importance of a Commitment Letter in Receiving SBA Financing
The commitment letter is a large step in your SBA 7(a) loan journey. At this stage, the bank has done most of its investigation into your deal and they are giving you a firm commitment to lend if the closing checklist requirements are met.
Some examples of items that may be included in the checklist are:
- A business appraisal
- An appraisal of collateral
- Evidence of business licenses
- Evidence you have relocated close to the business
- A list of legal due diligence items about the seller’s company
- A list of equipment the business has
- Business financial statements including tax returns
In order to move forward with receiving financing, you and the seller will need to complete each item on the checklist.
What Information is Included in a Commitment Letter?
There are usually about 20-30 terms contained within a commitment letter, but they generally fall into the three following categories:
Loan terms - This will usually include the interest rate, max loan amount, loan term, guarantors, down payment, fees, repayment terms, and prepayment penalty.
Loan requirements - This will typically include the closing checklist, latest closing date, collateral, guarantors, credit qualifications, and life insurance.
Commitment deposit - This is a deposit required after you sign the commitment letter.
To ensure you understand each of these terms, you should review your commitment letter with your attorney.
What to Look For in a Commitment Letter
There are a few items in your commitment letter that you should pay special attention to:
Amount - This will specify the maximum amount of the loan.
Equity - The down payment you will be responsible for. If the seller is providing a seller note (seller financing), it will also specify how much the seller note will be.
Collateral - This will cover what business and personal assets will be put up as collateral on the loan.
Advances/Working Capital - This will state how much you receive from the lender at closing to use within the business (working capital).
Fees - This will specify how much you will owe in SBA fees for the loan.
Expenses - These can be anything ranging from attorney fees, third-party appraisals, environmental assessment reports, flood certification fees, credit report fees, or recording fees that you will be responsible for.
Closing requirements - These will be specified in the closing checklist.
Commitment deposit - The deposit due at the time of accepting the commitment letter.
Understand The Importance of a Commitment Letter
Now that you know how a commitment letter falls into the loan approval process, you will be able to better understand what it means for your business acquisition.
If you plan on applying for an SBA 7(a) loan, you will also want to understand personal guarantees. Learn more about what a personal guarantee is by reading “What is a Personal Guarantee in a Business Sale?”
Buying a business is complex and has large financial implications. If you are thinking about purchasing a company and have questions, give us a call today.