How to Use Small Business Loans When Buying a Business
January 25, 2022 | Last Updated on: July 27, 2022
January 25, 2022 | Last Updated on: July 27, 2022
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:
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.
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.
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.
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:
There are pros and cons to using a term loan to finance a business acquisition.
Pros
Here are a few pros:
Cons
Here are a few cons:
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:
Cons
Here are a few cons:
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:
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.
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:
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.
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.
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.
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.