The Best Financing for Buying an Accounting Practice
March 11, 2022 | Last Updated on: February 7, 2023
March 11, 2022 | Last Updated on: February 7, 2023
This article discusses the following:
Securing financing for the purchase or acquisition of an accounting practice is not without its challenges, but it is feasible. Small business lenders typically have rigid requirements for qualifying and approving business financing. Here, we’ll discuss what the best financing options for buying an accounting practice might be for you.
But, first, let’s look at the benefits of buying an accounting practice rather than building a practice from the ground up.
You’ve likely looked forward to owning your own CPA firm for some time. To achieve that goal, you can build your practice from square one or purchase an existing accounting practice with a well-established presence. The latter has many advantages, including:
It’s easy to see the benefits of purchasing an accounting business. The downside is it may cost more to buy an existing accounting practice. But the reward is that the practice is already up and running, and you’re already on your way to having financial success.
When an accounting practice changes hands, a successful transition is crucial for maximum client retention. Everything that occurs within the first few months after the closing will influence whether a client leaves the practice or stays.
The seller can help the transition by communicating to clients that they’ve found the best buyer for their business, one that will be just as invested in providing valuable services. You can also encourage the seller to introduce you to clients to begin building rapport with them.
As the buyer of an accounting practice, you can also help the transition by minimizing significant changes for clients for a few months. This might mean avoiding major policy changes or ensuring that the location of the business is within a reasonable distance (5 to 10 miles or so) of the original practice if you decide to move.
The point is that you don’t want to lose the best advantage of buying an existing practice – its clientele. A transition plan should be part of your strategy to help retain an existing client base.
An accounting practice startup may be more financially attainable for some business owners. If you start your business from home or get a shared office space to run your practice, starting an accounting practice could cost as little as $2,500 to $25,000.
But, if you purchase real estate or build a brick-and-mortar site from which to run your CPA practice, the cost can run into the hundreds of thousands.
On the other hand, buying an existing practice could also cost you hundreds of thousands of dollars.
While starting your own accounting practice is an exciting prospect, consider this. It will take more time for your business to generate revenue, mainly because you’ll have to solicit clients for your practice.
You’ll also be responsible for all of the tasks that come with starting a new practice. In the end, you could spend quite a bit of time building a new business that won’t see a profit for a while. But, as you become more established, your hard work will be rewarded.
According to smallbiztrends.com, accounting practices such as bookkeeping and tax preparation services are considered one of the most profitable small businesses in the U.S.
Still, if you decide to go the route of buying an existing accounting practice, there are a few things you should know.
Many small business owners initially don’t realize the in-depth process of buying a business.
Realistically, it goes something like this: an entrepreneur is interested in a business, makes an offer, then negotiations begin.
At this point, buyers may discover that they have competition, i.e., someone else is also interested in purchasing the business. It becomes a game of who has more cash at closing or enough money for a down payment, and who has the best credit and can obtain faster funding. Naturally, the seller wants to close a deal as swiftly as possible.
The buyer then begins meeting with banks and financial institutions to fund their business loan. This is when unprepared buyers may realize there’s a lot more to small business financing than they thought!
Even more than that, they realize, financing won’t happen overnight with many lenders. Worst still, many entrepreneurs are initially turned down for a business loan.
At the same time, countless business owners every day fulfill their ambitions and are successful at obtaining business financing.
So how do they do it? Some have enough cash to purchase a business outright, or at least make a large downpayment. Others get prequalified before making an offer. But the rest simply do a great job of preparing for the loan application process and ensure they have everything they need in order to make the process go smoothly.
Lending criteria vary from lender to lender. However, some lending fundamentals are a given. These include a look into your personal and business credit scores, financial and legal documentation including tax returns, your business plan, time in business, and sometimes, collateral.
When it comes to purchasing an existing accounting practice, some lenders will look at the debt service ratio. In other words, they’ll want to be sure that there is enough cash flow to pay for the loan debt and an adequate salary for the new owner to meet their private financial obligations.
The lender will examine the Seller’s Discretionary Earnings, i.e., the revenue generated by the current practice, then subtract the borrower’s proposed salary. There must be enough left to pay for the annual loan payments and a cushion for other liabilities or business debt.
There are several avenues for financing an accounting business. Your options include term loans through the Small Business Administration (SBA), banks, credit unions, and online lenders.
Business lines of credit, working capital loans, and even seller financing can also help you get funded for your business.
The credit score requirements, interest rates, and loan terms associated with each type of financing will vary. Here’s a closer look at each type of financing.
An SBA loan is considered by many to be the best small business financing there is. The Small Business Administration doesn’t actually provide the loan funds but instead guarantees up to 85% of the loan through one of its approved lenders, usually a bank or credit union.
While many CPAs would prefer the route of an SBA loan, it’s not always that easy to obtain SBA financing. The red tape involved in getting approved for an SBA loan is extensive and may be overwhelming for some borrowers. Plus, the SBA has so many requirements to approve a loan that many borrowers don’t meet the SBA’s lending standards.
An SBA loan for an accounting practice acquisition will usually require less of a downpayment because they put more emphasis on the cash flow of the business. The SBA will usually require that a practice’s cash flow equal 125% of the total of a new practice owner’s debt payments and salary.
In addition, the SBA determines how qualified a borrower is to run the business and scrutinizes their credit history.
But if you manage to get SBA approval, their loan terms are more reasonable than other lenders. Interest rates on SBA loans are variable and average from 5.50% to 8%.
Most SBA loans allow a generous 10-year term (longer for real estate loans) for repayment. But SBA loans have slightly lower interest rates for business loans repaid in less than seven years.
Traditional bank financing for business loans is hard to get. This is because of the rigid credit underwriting requirements imposed by banks.
Moreover, there may not be enough assets that a bank can use as collateral for accounting practice financing. There typically aren’t many hard assets in a CPA practice like there are for other types of businesses.
A banking institution is also likely to require a higher down payment and excellent credit, plus a host of other requirements.
To top it all off, a bank’s application process is lengthy and complex. In the meantime, borrowers are potentially left waiting for months just to find out if they even qualify for a bank loan.
But if you manage to finance a business purchase with a bank, the interest rates can span between 2% and 13%, and the repayment period for the loan usually runs between five and seven years.
A business line of credit is a type of unsecured credit with a revolving credit line as opposed to upfront financing.
Lines of credit work in a similar way to credit cards. They are often issued by a lender with whom a borrower already has a working relationship. This includes a bank that might not approve a traditional business loan or higher loan amount but will approve a business line of credit.
With lines of credit, there is no collateral or down payment. The lender will approve you similar to the way they would for a personal loan, up to a set limit, and based on the strength of your credit profile.
The interest rate on a business line of credit will vary anywhere from 5% to 35%, depending on a borrower’s creditworthiness and the lender’s rates.
Working capital loans are helpful to business owners who need help with cash flow management, operational expenses such as payroll or supplies, or who have seasonal businesses.
A working capital loan might benefit an accounting business that thrives during tax season but has more of a downturn in the off-season.
The interest rate on a working capital loan varies by lender but is usually higher than traditional financing.
However, they are a type of fast funding that can get much-needed capital in a borrower’s hands, sometimes within a couple of days.
Seller financing has become a more common financing option for accounting practice acquisitions. Seller financing is sometimes called a seller carry.
In seller financing, a buyer makes a down payment, and all or a portion of the balance of the purchase amount is held as a note by the seller. The seller essentially acts as a lender for the acquisition loan.
The borrower makes the typical monthly payments that include principal and interest over a set period of years.
Interest rates in a seller-financed business transaction are usually competitive and no higher than what banks charge. Sellers will usually only finance a portion of the loan amount, typically up to 60% or less.
Online lenders like Biz2Credit have become a popular business-financing option as more small business owners seek seamless and faster ways to fund their businesses.
For instance, Biz2Credit offers term loans and commercial real estate loans to small business owners, and many loan applications are funded within a day or two, as opposed to the months it takes just for the loan application process you’ll see with other lenders. This means you’ll receive the capital you need to fund your business sooner.
An online lending marketplace forms partnerships with financial institutions and processes loan requests more efficiently, while matching borrowers with the best loan program available for their needs.
Essentially, they act as a business broker to help facilitate the accounting practice sale by getting you the financing needed to fund your practice. Ultimately, the lending criteria are easier to meet with an online lender than with a traditional lender.
Buying an existing accounting practice has its advantages. But what works best for you will ultimately depend on the amount of cash you can inject into your practice, whether through your own funds or through small business financing.
If you have time to wait, an SBA loan is considered the best type of financing for buying a business. However, added time sometimes means missed opportunities for you to expand your business or seal the deal, particularly if you find an accounting practice that is right for you.
In that case, working with an online lender becomes your best bet. Just ask Frank Prestia, a public accounting practice owner. Prestia noticed how long and arduous it was to try and obtain traditional business financing.
So he turned to Biz2Credit when he decided he needed to expand his client base and hire additional personnel. Biz2Credit got him fast funding, and the rest, as they say, is history. We’re also one of the best online resources and information hubs for small businesses, including accounting firms.