How to Use Small Business Loans When Buying a Business

So, you’re thinking about buying a small business… but you’re not sure how to finance the business purchase. In this article, you’ll learn:

• how a business acquisition loan can be used to purchase the business
• two types of loans used to buy a small business
• how to secure a business acquisition loan
• whether it’s easier to get financing for a new business or an existing business
• how to access funds right away

Introduction

According to the U.S. Bureau of Labor Statistics (BLS), 45% of new businesses fail during the first five years of being in existence. By acquiring an established business, you can bypass the risky startup phase, increasing the chances that your company will prosper for many years.

But it’s often expensive to buy an existing business – what if you don’t have the cash on hand to make the acquisition?

In that case, a business acquisition loan can be used to purchase the business.

What is a Business Acquisition Loan?

Obviously, a business acquisition loan can be used to acquire a business. But it can also be used for other purposes, such as opening a new franchise location or buying out a business partner. Since a business acquisition is a complex transaction and the loan value is typically on the higher side, lenders often err on the side of caution with loan approvals.

What Types of Loans are Commonly Used for Buying a Small Business?

Term loans and U.S. Small Business Administration (SBA) 7(a) loans are two of the go-to loan options for individuals who are looking to make a business acquisition.

Let’s look at the characteristics of these types of loans, and the pros and cons of each option.

Term Loan

A term loan is a business financing option that provides the borrower with upfront cash to be repaid on a predetermined schedule at a fixed or variable interest rate. Here are the other aspects of a term loan:

• The length of a term loan can be as short as one year or as long as 25 years, so it can be used to finance short-term needs (e.g., inventory) or long-term investments (e.g., acquiring a business).
• If you get a term loan with Biz2Credit, the loan amount can be anywhere between $25,000 and $500,000.
• The interest rate on a term loan is typically low compared to other small business financing options. With Biz2Credit, for example, rates start at 7.99%.

There are pros and cons to using a term loan to finance a business acquisition.

Pros

Here are a few pros:

• The relatively low-interest rate makes it easier for you to cover monthly debt payments from the cash flow of your business acquisition. Since business acquisition loans are often made for six-figure amounts, every basis point makes a big difference.
• There are tax benefits, as the interest on term loans is tax-deductible. That can add up to a lot of money in savings if your term loan is for 10+ years.
• You can get fast approval and fast funding… in some cases. With Biz2Credit, your “time to cash” on a term loan can be as short as a few days.

Cons

Here are a few cons:

• The loan amount limits could be an issue. There aren’t many business acquisitions that are lower than $25,000, but there are a large number of business purchases that are higher than $250,000. If you need a high six-figure or low seven-figure amount, you may want to turn to another small business financing option.
• You need a good credit score and the lender is going to scrutinize the business’s history. Term loans are great – if you can qualify for them – but not everyone meets the stringent eligibility requirements.
• You might not be able to get fast approval and fast funding. The approval process with some traditional bank loans can take several weeks – or even months.

SBA Loan

The SBA is a federal agency that provides loan guarantee programs through multiple financial institutions. The 7(a) Loan Program, one of the SBA’s most common loan programs, can be used for a number of business purposes including short and long-term working capital, refinancing current business debt, and assisting in the acquisition of a business.

The interest rate is usually reasonable on these loans, as the SBA guarantee lowers the risk for lenders. There is a maximum loan amount of $5 million, so the SBA loan is an option for seven-figure business acquisitions.

An SBA loan isn’t an option for all entrepreneurs, however. You’re only eligible for an SBA loan if you’ve exhausted your financing options and you have a high FICO score.

Let’s turn our attention to the pros and cons of an SBA loan.

Pros

Here are a few pros:

• The SBA loan is a way for borrowers to get a seven-figure small business loan – which isn’t easy with other types of financing.
• With other financing options, the interest rate reflects the lender’s risk. The interest rate on an SBA loan, on the other hand, is artificially lower due to the SBA guarantee.
• The SBA makes the loan application process straightforward for applicants, removing a lot of the stress that is common in these types of situations.

Cons

Here are a few cons:

• It takes a long time – sometimes months – to get approval for an SBA loan. If you want to buy a business, the owner might be willing to wait on the approval… but there could be an issue if it takes too long.
• It’s hard to get an SBA loan. There aren’t many individuals who have exhausted all of their financing options and have a high FICO score.
• You may not be able to finance the entire value of the acquisition, as SBA loan programs require the borrower to make a 10-20% down payment in some cases. If you are low on cash, this could be a deal-breaker.

How Do You Secure a Business Acquisition Loan?

To secure a business acquisition loan, you need to convince a lender that your financial health and the financial health of the targeted business are good.

Here’s how to prepare:

• Check your personal credit score. Your credit history will determine which types of financing you can qualify for. You might be able to get financing with a credit score of 650, but a 720+ credit score will increase the likelihood of getting attractive repayment terms.
• Gather tax returns. Lenders are going to want to see your personal tax returns, the tax returns of your current business (if you have one), and the tax returns of the acquisition.
• You need the balance sheet of the target. The assets and liabilities of the business you’re buying heavily impact your ability to repay the loan. If the company has a lot of debt, for example, lenders could worry that there won’t be enough cash flow to cover all of the monthly repayments. There could also be assets and liabilities that wouldn’t be immediately apparent without looking at the balance sheet – lenders want to uncover those things.
• You need the income statement of the target. What are the profit margins? What would happen if they went a little lower? A lender is going to determine your ability to make the monthly payments in the first year… and beyond.

If you are prepared and the lender is satisfied with your financial statements, you are much more likely to be able to secure a business acquisition loan.

Is it Harder to Get a Loan to Start a New Business or Buy an Existing Business?

It is sometimes harder to get a loan for a startup, and sometimes more of a challenge to get a loan for an existing business – it depends on the details.

Let’s look at a few factors:

Cash Flow

An existing business usually has stronger projected cash flows than a new business since it has a longer track record, but this isn’t always the case. Let’s say someone wants to acquire a business to eliminate a rival… but the rival has been bleeding cash. Lenders aren’t going to be rushing to provide that borrower with funding.

As stated earlier, many startups fail in the first few years, but it’s possible to identify the companies that are more likely to succeed. A small business owner who has done their homework, for example, has better odds than someone who hasn’t.

This is very company-specific, but established businesses do have an edge over new businesses, on average.

Valuation

It’s nearly impossible to come up with an accurate valuation for a new business. With an existing business, on the other hand, there’s almost always a way to settle on a number (e.g., discounted cash flow analysis, price-to-earnings ratio, comps, book value, etc.).

From a valuation standpoint, it’s easier to get a business acquisition loan than a loan to start a new business.

Industry

Do you want to buy a business in an emerging industry with low competition and massive margins? Or do you want to buy a business in a crowded industry with declining profitability?

If it’s the latter, you may struggle to get financing.

There are certain types of businesses that are viewed by traditional financial institutions as risky, including restaurants, grocery stores, businesses that only have one or a few customers, businesses in vice-related industries (liquor stores, adult entertainment, etc.), and businesses that sell obscure products or services that don’t have popular appeal.

While a traditional bank may not extend financing to you if you want to purchase one of those types of businesses, an online small business lending platform, like Biz2Credit, can help you secure funding from alternative lenders.

There are both startups and established businesses in “risky” industries, so this one is a tie.

The bottom line is that, overall, it’s harder to get a loan to start a new business than to buy an existing business – on average.

You Don’t Have to Wait Long for a Small Business Loan

When an amazing acquisition opportunity is presented to you, the last thing you want to do is spend months waiting for the approval and funding… wondering whether or not someone else is going to snap up the business. With Biz2Credit, you don’t have to worry about that problem.

Consider the case of Deepak Verma, who took over Philly Express Wash. He decided to make the move, got a loan in 24 hours, and the business belonged to him the next day. Verma’s case manager, Shawn, saw the urgency of the opportunity and worked hard to get the deal done as soon as possible.

Learn more about how Biz2Credit can help you get a business acquisition loan.