How to Open or Purchase a Coffee Shop With an SBA Loan

Starting a coffee shop vs purchasing one vs a franchise

The SBA treats these paths differently, and the biggest difference is how your cash flow is tested.^[1]

• Starting a coffee shop (open one year or less) is a start-up. There is no history to test, so the lender reads your projections. You need 10% of everything it takes to open: build-out, equipment, furniture, opening inventory, soft costs such as permits and deposits, and working capital.
• Purchasing a coffee shop for sale is a change of ownership. A first-time owner's deal is an Initial Acquisition: 10% equity that can't be waived, and the seller's past, reported results must show 1.25 coverage. Your plans to grow the shop after closing don't count.
• A franchise is a start-up or a purchase like any other, with one more check. If the brand meets the Federal Trade Commission (FTC) definition of a franchise, it must be on the SBA Franchise Directory before the loan can be approved. Your lender checks the Directory.
• A second shop can count as an expansion of your first one rather than a new business, under rules your lender or CDC will walk you through. Irene's drive-thru, below, is one.

Roaster deals deserve a careful read. In the book, a roaster offers Naomi a "proudly serving" program: its name on her sign, its standards and a monthly fee. That combination can meet the FTC franchise definition, and whether a given agreement does is your lender's call. Naomi signs a plain wholesale supply contract instead, with no name on her sign and no fee.

One rule applies to every path. Every owner, however small the share, must be a U.S. citizen or U.S. national whose home is in the U.S. In the book, Omar's cousin, a green-card holder, wanted to put in money for 25% of the shop. A green-card holder can't own any share, so Omar owns 100%.

The size limit for snack and nonalcoholic beverage bars, the SBA's industry code for coffee shops, is $22.5 million in average annual receipts, so nearly every independent shop qualifies.^[2]

What the SBA's loan data shows

The SBA has no separate code for coffee shops. They share one with ice cream, smoothie, juice, doughnut and bagel shops, so the figures below cover snack and nonalcoholic beverage bars (which include coffee shops), and the coffee-named subset where noted.^[3]

About half of these loans open a new business, roughly three times the rate across all SBA lending. Start-up rules are the ones most coffee shop owners face, which is why the first worked deal below is a start-up.

Which SBA loan fits a coffee shop

At $350,000 or less, the choice is mostly 7(a) Small or SBA Express. Larger loans use Standard 7(a). The 504 program is for land and buildings. The purchase rules (1.25 coverage, 10% that can't be waived, a 10-year term) apply whichever 7(a) program carries a purchase.

Keep the loan at $350,000 or less

A start-up's loan size decides which rules come next. In the book, Naomi's build-out bids come in $50,000 higher before approval. Her project grows to $400,000, her equity to $40,000 and her loan to $360,000, which is over the 7(a) Small limit, so it becomes Standard 7(a). Her first-year coverage drops to 0.99, which would miss 7(a) Small's 1.10. Standard 7(a) gives her two years to reach 1.15, and her second year at 1.54 passes. But her collateral shortfall grows to $293,750, so the lender must take her available home equity and, because her LLC has one owner, require life insurance for the shortfall. One bid change moved the equity, the program and what she pledges.

Lines of credit and slow months

An SBA Express line can revolve. In the book, 14 months after funding Naomi adds a $50,000 Express line for inventory and payroll swings: a 50% guaranty ($25,000), a $500 fee and no collateral required at that size. If a revolving Express line runs more than 12 months, it must have a term-out at least as long as its draw period, with no advances after month 60.

A Seasonal CAPLine needs at least 12 months of operation, and it pays only for the seasonal build-up of receivables and inventory (and in some cases the extra labor). The SOP says it can't be used to keep a business going through its slow periods. No CAPLine or revolving line can fund a purchase. Finance the purchase itself with a term loan.

Down payment: what counts as your 10%

• Start-up: at least 10% of total project cost on 7(a) Small and Standard 7(a). The 10% is of the project, not the loan. Your own cash and a gift with a gift letter count. Barista courses and business school tuition do not.
• Purchase, first-time owner: at least 10% of total project cost (price plus closing costs plus working capital), and it can't be reduced or waived.
• Seller notes: count only on full standby, meaning no principal or interest payments for the whole life of the SBA loan, and limited sources like that can cover no more than half of the required 10%.
• Price above value: total debt can't exceed the business valuation. Anything you pay above it comes from your equity.
• 504: at least 10% for an existing business, 15% for a new business, 15% when the CDC calls the building a Special Purpose property, and 20% when both apply.

Cash flow: the coverage tests

Debt service coverage (DSC) is the business's cash flow divided by its loan payments for the year. Which floor applies depends on the deal.

On a start-up, the projections are yours, and they have to hold up. Naomi's projection is built from her own market study: 350 open days, 200 transactions a day in year one at a $6 average ticket. Those are her numbers, not industry averages, and no government source publishes an average ticket or a daily count for coffee shops. When the "within one year of loan funding" clock starts is your lender's reading. Naomi's lender counts from the final disbursement on opening day.

On a purchase, three rules trip up first-time owners. First, projections can't carry a purchase over the 1.25 floor. Second, only income on the seller's tax returns counts; the lender checks those returns against IRS transcripts, so cash the seller says never made the return counts as zero. Third, when a lender adjusts owner pay, the owner's pay must still be enough to cover current obligations and living expenses, and a global analysis on that pay must reach 1:1. You can't shrink your salary on paper to make the shop look more profitable.

Collateral: espresso machines, the build-out and your home

Coffee shops are light on hard assets, and the SBA discounts what there is. New equipment counts at no more than 75% of its price. Furniture and fixtures count at 10%. In a purchase, used equipment counts at no more than 50% of net book value (or 80% with an orderly liquidation appraisal), and inventory at 10%. The shop's name, recipes and following can be financed but count for nothing.

Your lender decides two things that move the number. Whether a counter, display case or built-in refrigeration is equipment (75% new) or a fixture (10%) is its call. A build-out in leased space generally earns no credit, and any value a lender gives it is its own call. In the book's deals, the build-out counts for $0.

Two equipment traps come up often. A loaner espresso machine from a roaster, tied to a promise to purchase a set volume of beans, isn't yours, so it earns no collateral credit. And a dealer loan on the machine alongside the SBA loan, at about the same time and with the SBA loan behind it on the same machine, is piggyback financing, which the SBA bars. Put the equipment in the SBA loan.

Your home

• Purchase or Standard 7(a), short on collateral: the lender must take available equity in a home you own alone, unless that equity is under 25% of its value, and must consider a lien on a home you own jointly with your spouse.
• 7(a) Small start-up over $50,000: a first lien on what the loan pays for. A lien on your home is the lender's option under its own policy.
• $50,000 or less on 7(a) Small or Express: no collateral required.

A loan can't be declined just because collateral is short. On a Standard 7(a) loan for a one-owner business that isn't fully secured, expect life insurance in the amount of the shortfall. On a purchase, the lender's credit memo has to say on whom life insurance is required and how much, or why none, so expect the question on any one-owner purchase.

Your lease term vs your loan term

Almost every coffee shop leases, and the lease can make or break the loan. When leasehold improvements take $500,000 or 30% of the loan, whichever is less (or build-out and attached equipment make up that share of the collateral), the lender must get your written lease. For a 7(a) loan, the lease term should equal or exceed the loan term. It must if the lender can't get an assignment of the lease and a landlord's waiver. For a 504 loan it must. Only renewal options that you alone can exercise count toward the term.

• Equipment and a build-out can run 10 years, plus up to 12 more months while the work is finished. Naomi's blended term is 123 months.
• A purchase loan can run no more than 10 years when no real estate is in the deal.
• Naomi's $160,000 build-out is far over her $94,500 trigger (30% of her loan). She signs a 10-year lease with two 5-year options only she can exercise, 20 years in all.
• Omar's shop has 6 years left plus one 5-year option only he can exercise, 11 years, at least as long as his 10-year loan.
• A landlord allowance paid back for your build-out goes to pay down the loan, unless your lender counts it as working capital. Naomi's $30,000 allowance brings her balance to $285,000.

Renting your kitchen to a caterer overnight can cause a bigger problem than a short lease. The SBA bars businesses that make money renting space to other businesses, and a business is either fully eligible or fully ineligible. Whether a given arrangement counts is your lender's call. Naomi drops the idea.

Worked example: opening a coffee shop for $350,000

Naomi has managed other people's coffee shops for ten years. Her new LLC opens an independent shop in an endcap unit of a neighborhood strip center, with no drive-thru. Every number comes from the FUNDED Coffee Shop Guide. The 9.25% rate is illustrative (Prime of 6.75% plus 2.50%).

Her collateral is new equipment at 75% ($63,750) plus furniture and fixtures at 10% ($2,500), with the build-out at $0: $66,250, a shortfall of $248,750. Her lender takes a first lien on what the loan pays for. Her condo has $100,000 of equity, above the 25% line of $75,000, but on 7(a) Small a home lien is the lender's option, and hers doesn't take one. Working capital and inventory are 19% of the loan, under half, so no extra lien on all fixed assets is needed.

As SBA Express, the same loan would carry a 50% guaranty ($157,500) and a $4,725 fee, and her lender would still be likely to ask for the 10%.

Worked example: purchasing a coffee shop for $270,000

Omar has spent 16 years as an operations manager. The downtown coffee shop he has visited for years is for sale, 12 years old, on the leased ground floor of an older building. The founder asks $340,000, built on a story about cash that never reached the tax returns. His new LLC purchases the assets for $270,000. Every number comes from the FUNDED Coffee Shop Guide. The 9.25% rate is illustrative.

The broker says the shop really makes $85,000 because of $30,000 of cash sales the books don't show. That would be coverage of 2.05, and it counts for nothing. Had Omar paid the $340,000 asking price, the $55,000 above the valuation would have come out of his equity. If it is not on the tax return, it does not count toward your loan. Omar and his lender also confirm that sales are counted without the card tips the register reports, since tips belong to the staff.

Collateral is thin. Used equipment at 50% ($30,000), furniture and fixtures at 10% ($2,000) and inventory at 10% ($500) come to $32,500, a shortfall of $237,500. Even on 7(a) Small, a purchase must meet the fully secured rules, so his lender takes his home equity: $120,000 on a $400,000 home, above the 25% line of $100,000. As SBA Express the fee would be $4,050, and every purchase rule would still apply.

The founder is the face of the shop. After closing she can't work shifts or stay as an employee; she is a paid consultant for 6 months (the limit is 24). She asked for an earnout if sales hold up, and the SBA bans earnouts. Omar's $5,000 of unredeemed gift card balances is settled by the purchase agreement, which credits him at closing.

Worked example: a drive-thru second location through 504

Irene's coffee shop has been open six full fiscal years, with $1,100,000 of sales last year and $190,000 of cash flow after her $70,000 market salary. A new LLC she owns 100% purchases a pad that was a gas station decades ago and builds a drive-thru coffee building. The new LLC and her first shop sign together as Co-Borrowers, which makes it an expansion, not a new business, for 504.

Three details shape this deal. Her CDC concludes the building is not a Limited or Special Purpose property; a drive-thru building isn't on the SBA's list, but the list isn't complete and the CDC decides. Her merchant cash advance can't be folded into the new loan, because an active advance can't be refinanced with SBA money, so its $35,000 a year stays in her debt. And because the pad was once a gas station, the environmental review must start with a Phase I whatever the loan size; what follows depends on the Phase I and her lender. Her $400,000 debenture needs 5 jobs, and she plans 8. Whether the second location counts as a start-up for the 7(a) loan is a question the SOP leaves open, and her lender asks for 10%.

Run your own coffee shop numbers, free

No sign-up. Each one uses the SOP 50 10 8.1 rules above. Your lender makes the final call.

• Equity injection calculator: your 10% and what counts toward it
• Global DSCR calculator: business and household coverage
• Collateral adequacy calculator: equipment, fixtures and your home
• Max purchase price calculator: the most a shop's reported cash flow supports
• SBA loan calculator and guaranty fee calculator

Common mistakes on coffee shop loans

• Pricing on unreported cash. It counts as zero, and any price above the valuation comes out of your equity.
• Letting the build-out push the loan over $350,000. The loan becomes Standard 7(a), with a home lien and life insurance on the table.
• Signing a roaster or brand program without asking. If it meets the FTC franchise definition, the brand must be on the SBA Franchise Directory.
• Taking a dealer loan on the espresso machine. A second loan on the same equipment, with the SBA loan behind it, is piggyback financing.
• Signing a short lease. A lease shorter than the loan, counting only options you control, can stall the loan.
• Agreeing to an earnout. The SBA prohibits a price that grows with future results. A buyer rebate, paid back to loan principal, is allowed.
• Counting on the founder to stay behind the counter. In an Initial Acquisition the seller can consult for up to 24 months but can't stay as an employee.
• Adding an owner who isn't a U.S. citizen or national. Fix ownership before you apply.
• Expecting to refinance a merchant cash advance. An active one can't be paid off with SBA money.
• Leaning on a Seasonal CAPLine for slow months. It can't pay to keep the shop going through a slow stretch.

What to bring your lender

Related guides

• SBA Loans for Start-Ups
• SBA Restaurant Financing
• SBA Loan Down Payment
• SBA 7(a) vs 504
• SBA Collateral Requirements
• Verifying Seller Financials
• SBA Franchise Financing